How to Answer the Question – What is your CAC?

0:00 So last week we talked about lifetime value customer acquisition cost and the ratio of LTV to CAC and specifically how important it is to track it by channel because it varies by channel and you have to make sure that each channel you sell into you have a profitable proposition. And I even gave you an example of a company we invested in where it almost burned the company. But that's not the whole story. You see CAC doesn't vary just by channel. It also varies by volume.

0:30 I can tell a lot about an entrepreneur and how sophisticated or how far along they are in their business just by asking the simple question, what is your CAC?

0:38 If they answer with a number like $20, I know they've thought about it, but they haven't measured it.

0:45 If they come back with an answer like $19.72, I know they've actually measured it.

0:51 If they come back with an answer of, well, it depends on which channel, I know they've watched last week's video, or actually measuring it by channel.

1:00 But the most sophisticated will actually answer the question with a question.

1:05 At what volume and in what channel do you want to know the CAC?

1:09 You see, CAC isn't constant even within a channel.

1:13 Let's take a look.

1:14 We're going to go to the whiteboard.

1:16 On the vertical axis is going to be what it costs us to acquire a customer.

1:20 And on the horizontal axis is going to be how many customers we acquire per period, volume per month.

1:27 You see, there's some number of customers that we get for free every month.

1:30 Those are basically people who come in through SEO, could be friends and family, word of mouth.

1:35 They're awesome.

1:36 The problem is that there's a finite number of them.

1:39 That's it.

1:40 If you want to get more, you're going to have to pay.

1:42 Let's say this channel is Google AdWords.

1:45 There probably are some long-tail keywords that you can pay a relatively little amount,

1:49 and you can get a bunch more customers.

1:52 When those long-tail keywords run out,

1:53 you're probably going to have to buy more expensive keywords and those will go for a while

1:58 and they'll run out, et cetera, et cetera. At some point you could even do something crazy,

2:02 like, you know, putting ads on the Superbowl would cost you a lot, but you could probably

2:08 get a lot of customers. The challenge with that of course is that you only make so much

2:13 money per customer. So if you have a lifetime value somewhere in here, you obviously wouldn't

2:21 want to spend more than the lifetime value and you probably want to keep your ratios in line with

2:25 what we talked about last week. So how do you know? It's really important for you to know where you are

2:29 on a stair step. So if this step is, let's say it's around $10, I'll call it 1050 per customer.

2:38 How do you know if you're at the beginning of the step or the end of the step? Because if you're at

2:42 the end of the step, you know that the next incremental customer is going to cost you a lot

2:46 more money. And this is where I'm going to let you in on a secret, a secret that I call pulse

2:51 testing. You see, if you were spending $500 a month on Google AdWords and you were getting

2:57 roughly 50 customers a month, hence the $10, that's great information. But I'm about to invest

3:05 money in you and I want to know, can we do this at 10 times the volume? Can we do it at 100 times

3:11 the volume. And if you look at this graph, you may find out that at a hundred times the volume,

3:17 it's way, way, way too expensive, but there's a way you can get the answer. So you're spending

3:22 $500 in a month. What if you went to Google and spent that whole $500 in a day and then spent zero

3:29 for the next 29 days, you'd still spend $500 a month, but you'd see what it would cost you to

3:36 customers at the rate of $500 a month, but doing it all in one day. So it's the equivalent of doing

3:44 it 30 times the volume you're doing today. If you still got 50 customers for your 500 bucks,

3:50 it's looking good. You're still somewhere on this horizontal line. You want to make it be

3:57 100 times the volume, spend your $500 in eight hours, right? Because if you can still get 50

4:04 customers by spending $500 on Google in eight hours, you know that you could likely repeat

4:09 that a hundred times through the month. And instead of 50, get 5,000. So that's pulse

4:16 testing. That gives you a way to test if this customer acquisition price is something that

4:21 you can continue on for a while or know that you're about to run into a roadblock and have

4:25 to pay more for the next customer. Because as we said last week, the thing that I care

4:30 about as an investor when it comes to customer acquisition cost is not what the average of your

4:35 previous customers was, but how much it's going to cost you to get your next one and how much

4:40 you're going to make from them. I hope that was helpful.