Pilot Test (Part I)
What’s new, reader?! How are you doing? In this column, we’ll tell you about Resuelve’s pilot test. If you remember, our shareholders decided it’d be a better idea to do a market test, before investing the total amount we had requested. The famous Fail Fast and Fail Cheap.
There we were, Zorro and I, pretty demoralized by how the closing meeting had gone. Besides, the following days were incredibly lame since we had to chase some investors so that they would deposit their share, and we could launch the pilot test. We got to the point of standing outside people’s offices because they wouldn’t even take our calls. Unlike the USA, where you quickly get a “Yes” or a “No,” in Mexico is harder for people to reply. We’re reluctant to conflict, and normally, we ignore the problem instead of giving bad news to others.
After a couple of nerve-wracking, and stressful weeks, we had 9 investors depositing the 2 million pesos we needed in order to start. Let me remind you that Lorenzo Gonzales, and Fernando Nieto, didn’t enter the project even though they’d made a mess during our previous meeting (just in case you didn’t read the last column, haha).
Before starting with the pilot test, we had to create a mini business plan (by then, we were experts) to define what would be successful results, and above all, trying to understand how far we could go with those 2 million pesos.
We were in September and, according to the pilot model, the money would get us through January. So, basically, we had 4 months to do or die.
The goal of our pilot test was to validate certain aspects of the business that our shareholders still questioned, and, to be honest, us too. As we’ve mentioned before, business models always have unknown variables, and the only way to know how they’ll behave is by testing them. You need to get to it!
One of the main things to identify in a pilot test is how your Unit Economics would be. Sometimes, when we see new entrepreneurs as they pitch, they tend to focus on general financial statements of their company, but those irrelevant for us at that stage of the company.
Unit Economics reflect how profitable, or not, is a customer. In other words, how much income does a client bring, and how much money does a client cost? This criterium is vital to understand if your business will be sustainable through time. As we’ve previously mentioned, your financial statements should be built from the particular to the general.
Generally, Unit Economics’ analyses encompass the following:
1-. Client’s Life Time Value (“LTV”). This measurement tells you how much income will a client bring to you in his lifetime. Depending on your business model, this can vary so much.
Let’s do a hypothetical exercise to know the LTV of an UBER client.
To do this, we must know, how many trips does a client take, on average, by month, and then yearly.
In my case (I don’t have a car), I take a ride around 35 times a month, paying an average of 100 Mexican pesos per each trip. This means I’m spending more than $3,500 each month, and $42,000 a year (Jesus!).
We need to consider that many clients use UBER for more than just one year. Hence, it’s vital to know how many clients drop the service after 12 months, or before; this is known as the desertion rate.
Assuming that 25% of people who use this service for a year, stop using it in the following year, out of 100 people who downloaded the app, by the second year, only 75 would be using the service; by the third year, around 56 people; by the fourth, only 42, and so on.
For this exercise, we’ll assume that no one uses UBER by the 5th year. If every UBER client behaved as I did (which they clearly don’t), it’ll mean that UBER’s LTV is:
This means that the LTV of an UBER average client, leaves this income amount in 5 years.
Another time of estimating a client’s “Life Time”, is dividing $127,680 by $3,500. In this case, the outcome is that, an average client, lasts 36 months using UBER.
This means that the LTV of an UBER average client leaves this amount of income in 5 years.
Another time of estimating a client’s “Life Time,” is dividing $127,680 by $3,500. In this case, the outcome is that an average client lasts 36 months using UBER.
2.- Customer Acquisition Cost (CAC). This measurement tells you how much it costs you to get a client. Typically, it involves marketing and sales costs.
The sales cost can encompass the expenses to get raw materials, salaries, or both. If your business model doesn’t take a sales force into account, for instance, e-commerce, then your marketing cost equals your CAC.
Some companies, especially those leading in their field, cheat when calculating the CAC. What they typically do is not to include marketing expenses in their calculation. For instance, if a bank makes a significant marketing effort (sponsoring a football team), the guy managing credit cards doesn’t include that expense in the product’s CAC. We believe that EVERY marketing expenses, be it branding or performance, must be included in the CAC.
A common question is: what percentage must the CAC represent in your LTV?
(If you’re thinking that I feel superior for using English in acronyms,
I want you to know that I hate it, but sadly, it’s the lingua franca in the
entrepreneurial environment).
The answer to this question depends on your business model. If it has an
intensive operation, you would normally spend less on acquiring a client. If it’s a light operation, you can spend more on the acquisition. For a service business model, a CAC can be around the 30% and 50% of the client’s LTV.
3.- Operational Cost. This is self-explanatory, Meaning, how expensive is it to provide your service to a client?
To finish this hypothetical example, let’s suppose that UBER pays 20% of sales to the drivers. This will return a driver’s expense, per client, of $127,680 x 20%= $25,536. Additionally, the company spends $50,000,000 a month, among executive salaries, driver’s training, and other expenses.
Therefore, if UBER has 100,000 active users in a month, each user costs UBER $500 (50 million/100 thousand users), and, multiplied by the 36 month Life Time, it means that providing services for each user has a cost of $18,000, and the total Operational Cost amounts to $25,536 + $18,000 = $43,536.
After all the math, UBER’s Units Economics would be as follows:
Not bad, right?
Back to our story (I’m getting a headache from all these numbers), we had to figure out three points related to our Unit Economics:
First: knowing if people in Mexico would want a product like Resuelve, and how would we capture such market. This would give us some clarity to foresee our CAC. I must remind you that the bankers had labeled us as “losers,” and said that no one in Mexico would save to pay off debt.
Second: the average debt amount of our clients. This was important because our charge was related to this amount, and we would calculate the LTV much better.
Third: if banks would accept negotiating with Resuelve, and how would that interaction go. By making the first tests, we would be able to understand the structure better and determine our Operational Cost by serving our clients.
I’m running out of lines, so I’ll continue in the following publication. I promise more enticing stories and less theory on the inner workings of the pilot test.
See you! If you have any comments, questions, complains, or suggestions, nag me on Twitter. Find me as @Javivelop.
P.S. Never in your freaking difficult and bitchy life surrender!
