Maximize CLTV over CAC
Have you ever wondered why big billion-dollar tech organizations like Facebook would acquire other big techs like Instagram and Whatsapp? The Big Tech Landscape is laced with deals like these. One could argue that big wigs like FAANG could build their own products easily, at least for the acquisitions in the mobile app product space. They have the talent, the attention, and the scalable platform to reach the customers.
What are they paying for? The answer is you (the users). They are acquiring your time and your social network on these platforms. And the promise that you would continue to spend time here within your network (future cash flows). When VCs and investors make investments in another tech company, it’s based on potential growth (Market Valuation).
This is especially true for mobile app spaces that operate on social networks. This social network becomes exponentially (being the operating word) more valuable as it continues to grow, and it becomes extremely difficult to create a new one. That’s why it made sense when Microsoft bought LinkedIn for $26 Billion. On the other hand, the history of the mobile app space is laced with various expensive adventures that the Big Tech organizations undertook and failed. Facebook tried building Watch, a competitor to Netflix. Google built and launched Google+ and it failed. The phenomenon to go mobile permeated the digital/physical product space as well when Microsoft Zune was launched as a digital music player. Hence, it is more effective to acquire an established social network than to try to replace it.
Understanding CLTV and CAC
Let’s talk about future cash flows. In the world of mobile app development, there are various metrics that are tracked or benchmarked against e.g. Monthly Active Users, Valuation, Scalability, Acquisition, and Retention costs. Here is a comprehensive list of mobile app metrics. However, they all whittle down to the two metrics: CLTV and CAC. These two key indicators either include or influence most other metrics that we mentioned above. Such is the significance of these two indicators.
Customer Lifetime Value (CLTV)
It is the sum of marginal profits earned from each item sold to an average customer until they quit using your product. Note: it is marginal profit, not revenue. CLTV could be calculated as the sum of marginal profits per customer x average customer lifetime
But how do you leverage this indicator to predict average revenue from a new customer?
You can obtain a sum of marginal profits per customer in a unit of time (month, quarter, or year) But, it is difficult to predict a customer’s lifetime.
We can leverage metrics like ‘Churn Rate’ to predict the percent of users who quit using your product in a month, quarter, or year. Thus, giving us the Average Customer Lifetime (=1/churn rate). Say your average churn rate is 40% in a year, and the Average Customer Lifetime = 1/0.4, which is 2.5 years.
To give you a perspective, the average revenue per user varies from $752 per user on Amazon to $112 per user on Facebook. And, if you have been Googling for the last 20 years, you have made Google on average $349 and some change each year for the last 20 years.
Therefore, it makes sense as a company to be focused on maximizing customer lifetime value. Hence, this shifts the conversation to the costs — acquiring the customers and retaining them, that is, the subtle art of Product Management.
Customer Acquisition Cost (CAC)
It is the average amount of dollars spent bringing a unique customer to your product.
Note: The acquisition costs could be sneaky and difficult to quantify.
To account for acquisition costs, we can consider: sales & marketing costs i.e., salaries of customer success managers and cost of running campaigns, salaries of product managers and developers, QA and others working on launch and integration, cost of servers hosting your data. If you are running your product on a freemium model (ala Spotify), it is also the opportunity cost of running a free tier of your product. Therefore, it becomes increasingly difficult to know where to draw the line. Hence, the rule of thumb is CAC should not be captured at a point in time but over time that counts for the average number of users.
The ‘Network Effects’ mentioned above, mean that you are invested in the business for the long-term continued flow of profits (CLTV) with continued expenses (CAC). It’s a delicate balance.
The other part of the equation is retention costs to keep the customers with you. It is the cost of product management where you are continuously tailoring the product to appeal to your users and keep it relevant for the future. It could also include running the new campaigns to keep your customer aware of the new features, the cost of customer support, and the cost to run servers. If we add retention costs, the conversation becomes more balanced with the true and total cost of holding the customer’s attention.
Hence, for all these reasons, the CAC is marginally over-hyped considering the overall costs (acquisition, long-term product management, and of course, the customer lifetime value). It is difficult to quantify the long-term cost of product management. It could mean the salaries of product managers and developers, and the cost of making product mistakes and learning from them. One could argue that CLTV should be more than CAC to break even. Yes, of course. But it should be significantly more considering the sneaky nature of acquisition costs. However, the word on (Wall) street and (Silicon) Valley is that the CLTV should be at least three times greater than the CAC. I guess it ensures that the tail does not wag the dog.
CLTV v/s CAC in the current times: What should you focus on?
It becomes pertinent to view the above through the lens of the times we live in. During the pandemic stage, the government provided stimulus to citizens and circulated a lot of money in the market, and reduced interest rates. Thus, user consumption went through the roof. During the pandemic, big tech firms benefited hugely from consumers staying home and spending hours online instead of going out. Thus, the customer lifetime value broke the charts with a below-normal cost of acquisition as you didn’t need to convince somebody to watch more Netflix or scroll more on Instagram.
Now, during the post-pandemic stage, we are going through unprecedented times, considering global supply shortages and geo-political conflicts. Now, the governments are curbing consumer spending by raising interest rates which curb the spending but also halt economic growth. The economy has been led to the point of hyperinflation and a high shortage of goods. Thus, leading us to Stagflation (a period of stagnant growth with high inflation). In the context of product management, the churn rates for non-essential digital products would dramatically increase (see Netflix). In terms of product development, it would require ruthless prioritization of the product roadmap. It becomes more and more pertinent to maximize customer lifetime value. Thereby customizing your roadmap to attune to the needs of your customers and launching relevant features.
During these times, it calls for a re-evaluation of the GTM approach. We need to re-assess the market and the segmentation we are targeting. The problem we are solving for customers — Is it essential, and for which customer or user segment? It also requires prudence in CAC. If your product does the job, the word of mouth would sway a potential customer, but over-splurging on social media spending may not.
End Notes: It becomes pertinent to understand the above argument in the context of today’s economic headwinds. How you pursue your customers depend on the long term Product Strategy. If you want to be engaged with your customers in the long term, it makes sense to work on your product first. Then, focus on acquiring customers promoting which customers’ problems you have solved with your latest release.
About me: Seasoned Product Manager working at the intersection of business growth, technical knowledge, and design principles with 12+ years of experience working in the Tech Industry enabling ‘Digital Transformation and Organization Change.’ Feel free to connect with me on LinkedIn
