Business Model: Customer Acquisition Costs

Business Model: Customer Acquisition Costs

You cannot count on viral growth when building a sustainable business.

Existing companies execute known and tested business models. In contrast, startup companies search for repeatable and scalable business models. Executing and searching are the primary differences between the two. Viable business models require the ability to balance customer acquisition costs (CAC) and the ability to monetize those customers over the long-term – referred to as long-term value (LTV) of customers. Startup companies fail when their CAC exceeds LTV for an extensive period of time (i.e., unable to self-fund or venture capital runs out).

To compute CAC, you divide the total cost of sales and marketing for a specific period by the total number of customers acquired during that time. For example, if total sales and marketing costs were $100K for Q4/2013 and ten customers were acquired during that period, the CAC is $10K. To compute LTV, you determine the gross profit expected from the customer over the lifetime of the relationship. A viable SaaS or other recurring revenue model requires LTV to be three to five times higher than CAC. For example, CAC of $10K requires LTV of $30K-$50K.

The price of the company’s products or services should be in-line with its average deal size and sales and marketing structure. Accordingly, the business plan should include cost per lead and conversation rate at each stage of the sales process, as well as level of touch required. The greater the human touch required (no touch self-service to high-touch direct sales), the greater the CAC. Figures are then compared to expected monetization. The best business models recover CAC in 12-months or less (faster the better); otherwise, the company will require too much capital to grow.

All contents copyright © 2013, Josh Lowry. All rights reserved.

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4 Responses to Business Model: Customer Acquisition Costs

  1. Delphia Peek says:

    I could not resist commenting. Exceptionally well written!

    Like

  2. Alice Kandall says:

    Awesome post! Covered what I was looking to learn.

    Like

  3. Adi Wigington says:

    I liked this blog. A very basic, easy to understand post on CAC.

    Like

  4. Janelle says:

    Really enjoyed the article – thanks Josh!

    Like

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