If you want to know whether your startup can scale up sustainably, you need to know 2 key metrics: Your CPA — Cost per Acquisition (aka CAC — Customer Acquisition Cost, or even COCA — Cost of Customer Acquisition), and the LTV — Customer LifeTime Value. In a nutshell, if your LTV is several x bigger than your CPA, and your CPA decreases as a % of your revenue over time, then you’ve got a scaleable business model — congratulations!
We dealt with LTV in a previous article — this one is concerned with the CPA and also builds on Bill Aulet’s MIT Disciplined Entrepreneurship.
Please note the final results should be a range as you’ll be working from assumptions, until you can test cohort by cohort and validate your results.
Please also note that your CPA should decrease as you scale up and become more efficient — in the end, the ideal CPA is 0! One of the key questions is how long will it take for the CPA to drop below the LTV, so that you start generating (rather than burning) cash. You can make different assumptions for different time periods, taking into account any change in your go-to-market process as well as increased efficiency.
Lastly, please note that although a total CPA is useful, if you are targeting different segments then you should a compute a CPA for each of them (alongside their LTV), so you can compare and prioritise with a view to getting the best ROI.
In determining the CPA, you must quantify all the sales and marketing costs involved in acquiring a single “average” customer (but exclude the cost of retention activities, which should be budgeted for separately and are likely to be much cheaper). Note you need to include ALL you sales and marketing costs (even salaries of your commercial team), but nothing else (no cost of goods or R&D for instance). You should go through your P&L to list all the relevant costs, as some might not be under Sales & Marketing (eg travel expenses to attend a trade conference?). Note if the prospective customer doesn’t buy, you still need to include the cost!
If you are already in business, best is to take a top-down approach: take your current yearly spend on sales and marketing, subtract any retention activity spend (as on existing rather than new customers), and then divide that total by the number of new customers gained over that time period — easy!
It gets tricky if you’re not in business yet and therefore don’t have a starting point, which then requires a bottom-up approach:
-First of all, you need to map the list of stakeholders and decision makers from the target customer (from 1 for individual consumers to potentially hundreds for entreprise sales) and their decision / purchase journey (how do they research and decide?), so you can have an idea of the touch-points to generate, qualify and nurture leads.
-Then you’ll need to get some data (eg the cost per click for a LinkedIn campaign or the cost of speaking at a trade conference) and make a few assumptions (how many of your ads do they need to see before they become a lead). If your go-to-market is 100% online, once again you’ve got it relatively easy as you can do a whole bunch of tests and validate your assumptions. If your go-to-market includes offline touchpoint however, it will take more time and time to validate these and the overall “proof of concept”.
-In the end, you should be able to draft a matrix with the key target segments on one axis and the touchpoints / activities on the other, with a cost in each relevant intersection, thereby understanding both your average cost per touchpoint / channel / activity and your average CPA per segment.
-Having the details means you can optimise the conversion rates in your sales and marketing funnel, and thereby decrease your CPA. As a rule of thumb, try and improve your conversion rate (ie close more leads) rather than create more leads, as it is more effective, especially through better lead qualification and nurture. Analytics is key to attribute back success where success is due: which segment (type of customer) converts best, which channel / activity, etc. In addition to conversion rate, think also about what can be done to increase sales velocity, ie speed up the sales cycle. Speeding up the sales cycle often comes through removing barriers to purchase, such as uncertainties about the product, service or pricing, so talk to your prospect customers to remove friction in the decision / purchase process.
In conclusion, here is a key learning from working out a CAC: it is typically cheaper to keep an existing customer than to find a new one, so make sure you listen to your existing customers and iterate on improving your product and the customer experience until you have a product-market fit!