#85 - The Bill Gurley Starter Kit - Part 2

Why Conversion is the Most Important Metric

Jul 25, 2021

Hi 👋 - For online businesses, improving conversion is a superpower. This week, a look at conversion rates, what Bill Gurley, a general partner at Benchmark, calls the most important metric of all. Thanks for reading.

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Conversion 101

Conversion is the holy grail of online business. Improving conversion is a force multiplier producing outsized financial results and driving competitive advantage. No wonder Gurley sees conversion as the most important metric1:

This is the art of conversion: improve your site’s conversion and you simultaneously increase operating leverage AND increase competitive differentiation – a truly powerful combination.

A conversion rate is the ratio of visitors that take a desired action divided by the total number of visitors. It’s getting a visitor to buy something or to share a free weekly newsletter on business and technology with friends2.

If twenty people visit a website, and three make a purchase, the conversion rate is 15%. Most businesses would kill for a conversion rate that high. In e-commerce, mid-single digits is considered a good outcome.

average-conversion-rate-by-industry-survey-2012 — Source: Bill Gurley, Above the Crowd, Conversion: The Most Important Internet Metric of All (Revisited), October 2, 2013

Conversion measures how effectively and efficiently a business drives positive outcomes. It encapsulates performance across a host of functions: product quality, site design, ease of checkout, payment options, copywriting, marketing efficiency, and about 2,787 other things. Gurley likens it to a proxy for usability and convenience that reflects many qualitative aspects of a website and the user experience3. Think of it like a quality score for online businesses. Absolute levels matter between companies, while for an individual company trajectory over time is what matters.

Fifty Shades of Conversion

Conversion rate is a bit of a misnomer. While companies talk about conversion as one number, in reality there are many conversion rates. There’s one for each step between visiting a site and completing checkout. For example, let’s say Sweetgreen emails you about their new summer menu4, including a call-to-action for ordering. At a high level, the conversion flow looks like this:

Open Rate: How many people who received the email opened it?

Click-Through Rate: How many people who opened the email clicked on the menu?

Add to Cart Rate: How many people who clicked on the menu added a salad to their shopping cart?

Checkout Completion: How many people who added a salad to their shopping cart completed a purchase?

At each stage, the number of users who advance is whittled down. Emailing 100,000 people might generate 1,500 orders, a 1.5% conversion rate. That’s why conversion is referred to as a funnel: there’s a lot of traffic at the top, but only a fraction makes a purchase.

Conversion rates also differ by device (desktop, mobile web, mobile app), operating system (Android vs. iOS), market (domestic vs. international, developed vs. developing), channel (free vs. paid), price-point (low vs. high), industry, season (conversion spikes during the holidays), and customer type (new vs. returning). For example, in e-commerce, iOS devices have higher conversion than Android devices. Because of their high cost, iOS devices are a proxy for “has disposable income” and people who have disposable income buy things.

Source: Criteo, United States Global Commerce Review, Q1 2018.

Source: Unbounce via Lenny Rachitsky on Twitter. Data on landing page conversion rates.

How to Improve Conversion Rates

Online businesses boil down to customer acquisition and customer optimization. Gurley argues that customer acquisition is a poor place for a business to seek competitive advantage. First, due to high competition, ROI on performance marketing declines over time. Second, ad spending does not provide leverage. To grow, companies need to buy more traffic every year, which entails spending more. The risk is that the marketing tap can never be shut off. As such, he argues internet companies should obsess over customer optimization. That means focusing on conversion rates because5:

Small gains on low conversion rates can have unbelievably powerful effect on a company's performance. What’s more, focusing on conversion rate will help improve all elements of a company’s business, including performance, convenience, customer service, advertising effectiveness and word of mouth advertising as a percentage of sales.

Product and marketing teams focus on bringing more traffic to the site - expanding the top of the funnel - and optimizing each step in the process. Optimization is fixing leaks in the funnel so that more traffic completes checkout. It’s figuring out where people are falling off and then testing tactics to reduce the leakage.

Improving conversion is a high ROI investment. As Lenny Rachitsky, a former product manager at Airbnb notes, that’s because6:

Not only do conversion improvements make your existing growth channels more efficient, the wins last forever.

Since conversion is a proxy for convenience and usability, many variables influence it, including:

Site Performance: Slow sites have low conversion and speeding up a site (decreasing page load times) increases conversion. For example, Amazon found that 100 milliseconds in latency reduced sales by 1%7. This is why e-commerce companies obsess over page load speeds.
Design: Sites that are cumbersome or hard to use have lower conversion rates. Since people drop off at each step in the funnel, removing unnecessary steps and providing good defaults where you can’t improves conversion8. This is what companies mean when they talk about reducing fiction. Uber does this well: enter where you’re going, tap confirm, and presto, you’re done.
Payment Information: Entering credit card and shipping information is a pain, especially on a small screen. Lots of shopping carts are abandoned here. That’s why companies prompt users to save payment and shipping information during checkout. Having this information saved is a boon for conversion. Enabling features like Apple Pay is another way tackle this problem.
Effective Advertising: All traffic is not created equal. Is your advertising targeted and attracting high-intent potential buyers?
Product: Site optimization will only get you so far. Are you selling a product customers want at a fair price? Growth tactics can’t overcome a rubbish product.

Because there are many conversion rates, there are many ways to improve conversion. The key point to remember here is that there’s no silver bullet. Improving conversion is a ground war that requires lots and lots and lots of lead. It’s pushing a boulder uphill in two feet of mud. A single enhancement might lead to an improvement of a basis point or a fraction of a basis point. It’s all about aggregating marginal gains.

When really small numbers are multiplied by large traffic volumes, uplift ban be meaningful. This is why tech companies A/B test everything. Companies like Airbnb or Booking.com run hundreds or thousands of experiments simultaneously.

A/B tests are randomized online experiments measuring two approaches - a test and a control - to see which produces better results. For example, since new buyers have lower conversion rates than returning buyers, and lower priced goods have higher conversion than expensive goods, a test might boost the percentage of lower priced goods in search results for potential new buyers. If the test produces a statistically significant uplift, it’s put into production.

Conversion Compounds

Gurley calls conversion improvements magical because they drive economic leverage. Here’s what he means, assuming a $25 purchase price:

Note: Analysis assumes a $25 average order value

For a given amount of traffic, higher conversion means higher revenue. Improving conversion without changing expenses causes profitability to spike, creating the potential for non-linear outcomes. Further, this creates more capacity to invest in hiring engineers, designers, growth marketers, and product managers, potentially further improving conversion. There are downstream benefits as well. For example, if a company’s conversion is higher than its competitor, it can profitably pay more to acquire the same customer. In business, that’s as close to magic as you’ll get.

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