Why is Troy Obsessed with CAC?
Transcript
If you've ever been in a meeting with me, you've probably heard me dig in on customer acquisition cost or CAC. Why am I so obsessed with CAC? One of our interns asked me that question just yesterday. It turns out that it's because I believe that if you know how much it costs you to acquire a customer and what the lifetime value, how much value derived from that customer, you know the unit economics of the customer. And if that's profitable and you can repeat that many times, you know you have a profitable business. Seems pretty simple.
Let's talk about lifetime value first.
Lifetime value seems pretty easy to figure out, right?
It's how much value you get from the customer over their lifetime.
The biggest mistake I see entrepreneurs make, and they make it all the time, is that they'll
report lifetime sales.
They'll take the gross sales they get from the customer over their lifetime.
That's not the lifetime value.
What we have to do is subtract out of that number all of the things that cost us money
to deliver the service.
If you're a SaaS business, it's very little.
But if you're an e-commerce business, it's the cost of the stuff that goes into the box
that you ship, the box itself, the shipping cost.
All of those come out of your lifetime value.
And then what lifetime value is, is your contribution margin, what you're left with.
Sales minus cost, contribution margin.
Hopefully that's really clear.
The second thing is you have to understand your customer acquisition cost.
You see, one of the most common things I hear when entrepreneurs come to pitch me is they'll
talk about their blended customer acquisition cost.
And this is a big red flag.
They'll tell me, oh, my blended customer acquisition cost is 20 bucks.
Well, that may be very true, but they may have gotten 99% of their customers for free.
They may have gotten them all from SEO and organic and word of mouth and gotten very
few that they actually paid for.
So how much would their next incremental customer cost?
That's what I really care about.
Because if I'm investing money in the company, it's to grow that rate of sales, it's to
invest in those customers, and I need to know how much the next customer costs.
So let me give you an example, a real life example.
We invested in a company called Eat Street.
And their model was that their blended CAC was about 20 bucks, and they got about $50
actual customer an actual lifetime value from those customers great spend 20 get 50. it's a good
business now it turns out that in the first board meeting i attended they were all excited because
they had a new way to get customers even cheaper you see they had a way to get customers for 18
and the way they did it was they offered the customers a sweet offer that sweet offer was
$10 off their first pizza or sandwich when they ordered food on Eat Street.
Well, it seems awesome.
They assumed that it was also going to result in customers who were worth 50 bucks.
And so they leaned in and leaned in hard, spent about 50% of their marketing on this
campaign.
It wasn't until about three quarters later that they got a product called Tableau.
Tableau is sort of like Excel on steroids.
Tableau allows you to slice and dice and be able to look at data.
So they were able to look at what is just the CAC and the lifetime value of these customers
who come in through this offer.
And it turns out that if you're on a college campus and you're a college student and you
figure out that you create a Gmail address, sign up for Eat Street, get 10 bucks off your
pizza, the next time you're going to do the same thing.
You're going to create another Gmail address, another account, and sign up and get another
pizza with 10 bucks off, et cetera, et cetera.
The lifetime value wasn't 50 bucks.
lifetime value was basically zero because they never came back they lost
$18 on every customer that they got in through that channel round numbers that
means that this was a losing proposition but they were getting a lot of them so
they made the hard decision they canceled this entire program it slowed
down their growth but it increased their profitability today eat Street is
is growing profitably, they have an amazing business,
and they're poised for a great exit because of it.
Had they not understood Life to CAC
and Lifetime Value by channel,
they could still be burning cash like this.
Hopefully, you'll take this lesson,
apply it to your business,
look at each of your channels
and understand what it costs you to acquire a customer,
what the value is, Lifetime Value is,
so you understand which channels are valuable
and which channels aren't.
I hope that's helpful.
If you’ve ever met with Troy, he has probably asked you countless questions about your CAC (Customer Acquisition Cost). The reason is, if you know your CAC and your LTV, then you know the unit economics of your customer. If your unit economics are profitable, you can repeat that many times to become a profitable business. Watch today’s video to hear a real example about one of our portfolio companies.
Originally published on the MATH Venture Partners blog.
1 Comment
Comments are closed. These were carried over from the original post.