360 views on tech #37

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🍕 Food for thought

Revisiting Lifetime Value and Customer Acquisition

Rex Woodbury

At its simplest, business comes down to straightforward math:

1. A business (typically) has to spend money to get a new customer — Customer Acquisition Cost (CAC).
2. Then, that business will generate a certain amount of money from that customer over time — Customer Lifetime Value (LTV).

To run a profitable and scalable business, you want LTV > CAC.

In recent times businesses have had to face many pressures on their CAC. Google, Facebook, and now Amazon are monopolizing digital ad spend rising the costs. At the same time, Apple’s App Tracking Transparency (ATT) changes have made advertising more difficult to measure. We have rising CACs and less scalable, measurable acquisition — and it’s all happening in a recessionary market environment.

Given what’s happening with CAC, it’s worth examining LTV.

Let’s say a new business starts with an early market capitalization of A. Through aggressive marketing techniques, and aggressive fund raising, the company is able to achieve amazing revenue growth (and corresponding losses), but nonetheless creates a rather sizable organization. At this point, the company is valued at point B. Eventually, gravity ensues and the constraints outlined herein raise their head, resulting in a collapse to point C. For early founders and investors at point A, they may do OK (as long as C>A), but it will be accomplished on the backs of later stage investors that helped fund the unsustainable push to point B.

This is the story of many a startup over the past few years. Companies with poor unit economics found themselves propelled by aggressive venture dollars that were turned into aggressive customer acquisition. Until recently, the market rewarded growth at all costs. The last decade showed that questionable business models can subsist for a long time when capital is abundant. However, a flawed business model always catches up to you.

Common mistakes when computing LTV

The first mistake that many companies make is to use revenue as a proxy for LTV (*gasp*), which is a cardinal sin. Rather, LTV should take into account costs; after all, the company isn’t keeping all the money customers give it.

Another mistake early-stage startups make is overestimating LTV. This is easy to do in the early days of a company, when you don’t know how long customers will stick around. Often a better gauge in the early days is CAC payback — how quickly you’re paying back the money it costs you to get a subscriber. This chart helps visualize payback:

The best consumer internet companies can pay back CAC immediately, often by incentivizing an annual subscription plan rather than a monthly plan. Indeed, annual plans have cash flow benefits, with businesses collecting that cash upfront.

One more point on LTV: it’s important to discount future years of $$ from customers. Money today is worth more than money tomorrow, and businesses are spending on CAC today for an LTV payoff tomorrow. Failing to take into account the time value of money can lead to unsustainable economics.

A rule of thumb that applies to both LTV and CAC: it’s important to segment users by organic vs. paid. Organic users are the users that discover your product naturally (e.g., word of mouth), while paid users are acquired through paid marketing channels. On the LTV side of the equation, organic customers will always have higher LTV: an organic customer willingly chose to use your product, vs. needing to be persuaded to give it a try. An organic customer will spend more money with you, will have lower churn, and will have higher engagement. A paid customer will come in lower on each dimension, and thus have lower LTV.

The same goes for CAC. Often companies will show blended CAC, which includes both paid and organic customers. This can give a murky view of the business. Rather, organic customers should be removed from the denominator and your math should include only paid customers. Using blended CAC is dangerous, as it can lull you into false assumptions about your marketing efficiency or overall unit economics.

Final Thoughts

Growing rapidly with strong unit economics is very, very difficult. Often in startups, it makes sense to “land grab” in the early days (particularly in new markets) and to subsidize growth. But land grabs only work if the underlying business model is sound. There’s no place for “voodoo math” when measuring LTV and CAC. Founders need to be razor sharp on intricacies like the mix of paid and organic, true profit per customer, and payback period. Because again, the music always runs out.

Of course, the holy grail for any business is organic growth. There’s no substitute for savvy, viral acquisition efforts. Organic acquisition is critical, and maximizing organic’s share is key to keeping CAC down. But few businesses can get to meaningful scale on purely organic growth.

Most companies, rather, will need to figure out paid acquisition that’s profitable on a unit economics basis. That means intimately understanding the nuances of LTV and CAC, and how they interrelate in your business.

In this market environment, with an ongoing downturn and with skyrocketing CACs, it’s more important than ever to nail down those economics and build in discipline from the early days.

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💸 Money matters

• 🔴🟠🟡 Prophesee, a startup behind advanced neuromorphic vision systems, raised €50M, from Prosperity Ventures, Sinovation Ventures and Xiaomi, 360 Capital is among the existing investors that backed the round.
• Zenchef, the restaurant tech player, raised €50M, from PSG Equity.
• Immortal Game, the next generation chess platform, raised €15.5M, from TCG crypto, Greenfield One, Caccius, Sparkle Ventures, 35V, Blockwall, Kraken Ventures, and Spice Capital.
• Innomy, a foodtech startup making mushroom-based alt-protein, raised €1.3M, from Corporación Cervino, Zubi Capital, Eatable Adventures, the National Center for Technology and Food Safety (CNTA) and Rockstart.
• Cello, which developed a user-led growth platform tapping into word-of-mouth as a valuable growth channel, raised €2.3M, from Tiny VC, Possible Ventures and Notion Capital.

😂 Meme of the week

https://www.facebook.com/photo/fbid=608872119679965&set=ecnf.100063895701010

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