How to Optimise CAC and Voucher Usage
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You are not for free. When you see adverts at the side of the web page, or in between two posts on your Facebook timeline — those annoying interruptions are someone’s Customer Acquisition Cost (CAC). When you click on the link (all of us do it sometimes) and later become a customer, you enter into a bucket of people whom the company has paid to acquire, with a cost assigned to you. You are not for free. The amount spent on you typically depends on the amount you will probably spend. Good marketplaces have a low CAC compared to their peers. Amazing marketplaces with viral growth (although this is rare for a pure marketplace) may have almost no CAC.
CAC is important because, if measured correctly, it will tell you how efficient your marketing channels are and thus whether your marketing strategy is working or not. It will tell you how you perform compared to your peers (assuming you know the data points). Most importantly, when compared to your customer Life Time Value (LTV), it will tell you whether your business model is sustainable or not. Having a CAC that turns out to be higher than the ability to monetise your customers is probably the second biggest killer of startups. Another use of CAC is as a measure of business efficiency; investors often want to see how a company’s CAC has developed over time and have confidence that it can acquire customers in an efficient and scalable way — often that implies spending money (a lot of money).
CAC can be operationalised in a number of different ways — sometimes it’s paid ads at the top of a Google search, it might be an advert in your Facebook or Instagram feed, or you might see an ad on the side of a bus on your way to work. In this post we talk about a specific tactic for acquiring customers — vouchers. Imagine it’s Wednesday evening and you receive an email from a marketplace startup with a voucher of 25% discount valid only for the next 48 hours. This is voucher-based customer acquisition/retention tactic. We want to take a deeper look at vouchers because, unlike other forms of CAC, there are ways that the benefits can be misinterpreted.
Vouchers are not always CAC. Vouchers can be CAC, but only if you use them to bring you First Time Buyers (FTBs). This is because you use the money to acquire customers; if you give vouchers to existing customers, as many startups now do, this is not true CAC — it is a reduction of your revenue (or at least gross margin). Vouchers can be useful because they bring you customers who may not know about your company, or may not be looking for your service — they generate awareness. They also entice people who otherwise may not make a purchase with the emotional satisfaction of saving money on the service (this can be a double-edged sword). Vouchers can also have a series of negative effects that must be carefully managed. They can attract the wrong type of customer, they can damage the company economically and they can generate the wrong kind of customer behaviour. They can also destroy the value of a brand and, in some cases, jeopardise the business model as a whole.
From a financial perspective, if a customer uses a voucher as an FTB then the cost can be categorised as CAC. If a returning customer uses a voucher, then it is money spent on improving the retention of the company’s customers. When you get an email from a marketplace that you haven’t used for a while, with a ‘summer special’ or promotional voucher attached, luring you to click on the link and use the discount code — that is really operational spend, often in an attempt to improve a company’s cohorts. This kind of voucher usage is risky because not only does it affect the margin of the business, but it also blurs the customer LTV. Much like doping in sport, existing customers who are fed vouchers are the LTV equivalent of cyclists using EPO — you never know how good they actually are. Will they still be there if you cut off the vouchers? What is their real average order value? For many startups, it can be tempting never to find out..
Vouchers can also financially impact a company by attracting the wrong type of customers. Low value customers begin using the service out of economic motivation — they like the discount and that is incentive for them to start using the service. They may subsequently stay on the platform and become recurring customers, perhaps because it removes enough friction from the direct transaction experience for it to be valuable, but often their average order value is lower than that of a regular customer. This phenomenon has in fact been proven out by many startups.
This is not to say that FTBs with a lower average order value should not be welcome — they still contribute to revenues. However, they should be taken into account when allocating a target CAC for them.
From a retention perspective, bargain hunters can also have a higher than average churn. In particular, customers who use couponing companies are known to have particularly low retention — sometimes as low as 2–3%. This type of voucher campaign can be tempting as it will boost platform growth, but it will not reflect well in the cohorts of the company (and may put off potential future investors). It may also be a waste of money — if you do not return more value from customers than you spend on acquiring them, it can be better not to have them. There are some geographies where this kind of behaviour is more common — usually developing nations. Many startups have understood this and built mechanisms to reduce the churn of bargain-hunters, such as minimum subscription periods or a cancellation process that is so painful to execute that most people give up trying. However it is something that still plagues recently founded companies that are pushing for growth.
Finally, from a brand perspective, regular use of vouchers can destroy the company’s brand value. This kind of activity can develop irreversible behaviours in customers. Once customers are hooked on promotions and discounts then their purchasing revolves around waiting for the next deal to arrive. It is easy to get into a cycle where people wait for an email with discount voucher before they order. This is an issue because it means people don’t order, which creates concern and demand for more orders, so more vouchers are given and the problem continues.
Vouchers are not the root of all evil, but it is important to know how to use them properly. In order to build liquidity very quickly in a marketplace, you may sometimes subsidise both sides of the marketplace — demand and supply. You may even subsidise all sides of a three-sided marketplace, in order to gain maximum market share and win a winner takes it all industry (as some well known companies are doing right now), but it is worth bearing in mind the above points and you should be prepared for longer paybacks.
Watch this space for more Samaipata opinions on marketplaces and disruptive e-commerce..