Customer Acquisition · Venture capital

Customer acquisition costs vs. lifetime value?

Charlotte Price Fintech Startup

August 25th, 2015

I've been thinking about how to present to VCs my data for customer acquisition costs vs. lifetime value. would be interested to hear what words are working well with VCs these days and what charts could help me really nail that part of my presentation?

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August 25th, 2015

i'm only sort of joking when i say that your cac charts should go down and to the right whileyour ltv charts should go up and to the right.

some of the a16z team recently posted about 16 metrics -- #5 and #8 (pasted below) will be of particular interest to you.

#5 LTV (Life Time Value)

Lifetime value is the present value of the future net profit from the customer over the duration of the relationship. It helps determine the long-term value of the customer and how much net value you generate per customer after accounting for customer acquisition costs (CAC).

A common mistake is to estimate the LTV as a present value of revenue or even gross margin of the customer instead of calculating it as net profit of the customer over the life of the relationship.

Reminder, here’s a way to calculate LTV:

Revenue per customer (per month) = average order value multiplied by the number of orders.

Contribution margin per customer (per month) = revenue from customer minus variable costs associated with a customer. Variable costs include selling, administrative and any operational costs associated with serving the customer.

Avg. life span of customer (in months) = 1 / by your monthly churn.

LTV = Contribution margin from customer multiplied by the average lifespan of customer.

Note, if you have only few months of data, the conservative way to measure LTV is to look at historical value to date. Rather than predicting average life span and estimating how the retention curves might look, we prefer to measure 12 month and 24 month LTV.

Another important calculation here is LTV as it contributes to margin. This is important because a revenue or gross margin LTV suggests a higher upper limit on what you can spend on customer acquisition. Contribution Margin LTV to CAC ratio is also a good measure to determine CAC payback and manage your advertising and marketing spend accordingly.

See also Bill Gurley on the “dangerous seductions” of the lifetime value formula.

#8 CAC (Customer Acquisition Cost) ... Blended vs. Paid, Organic vs. Inorganic

Customer acquisition cost or CACshould be thefullcost of acquiring users, stated on a per user basis.Unfortunately, CAC metrics come in all shapes and sizes.

One common problem with CAC metrics is failing to include all the costs incurred in user acquisition such as referral fees, credits, or discounts. Another common problem is to calculate CAC as a "blended" cost (including users acquired organically) rather than isolating users acquired through "paid" marketing. Whileblended CAC[total acquisition cost / total new customers acquired across all channels] isn't wrong, it doesn't inform how well your paid campaigns are working and whether they're profitable.

This is why investors considerpaid CAC[total acquisition cost/ new customers acquired through paid marketing] to be more important than blended CAC in evaluating the viability of a business -- it informs whether a company can scale up itsuser acquisition budget profitably. While an argument can be made in some casesthat paid acquisition contributes to organic acquisition, one would need to demonstrate proof of that effect to put weight on blended CAC.

Many investors do like seeing both, however: the blended number as well as the CAC, broken out by paid/unpaid. We also like seeing the breakdown by dollars of paid customer acquisition channels: for example, how much does a paying customer cost if they were acquired via Facebook?

Counterintuitively, it turns out that costs typically goupas you try and reach a larger audience. So it might cost you $1 to acquire your first 1,000 users, $2 to acquire your next 10,000, and $5 to $10 to acquire your next 100,000. That's why you can't afford to ignore the metrics about volume of users acquired via each channel.

John Seiffer Business Advisor to growing companies

August 25th, 2015

Forget about "words that are working well." Just tell the truth about what you believe is the LTV and the CAC then share the data and assumptions that lead you to that belief. Use whatever words and charts are best at communicating your ideas.

Raising money from VCs is not a transaction (I say this, you give me money). It's a relationship. Many investor relationships last longer than many marriages. I won't comment on who's getting screwed [grin]. 

But seriously, would you want to be married to someone who was so impressed by the words you spoke that they ignored a critical part of who you are and how you think? You wouldn't want that in a VC either and smart ones will look behind whatever you say to learn how you think and what data you have to inform your beliefs. 

Nicholas Stocks Principal at Global Founders Capital

August 25th, 2015

This is an absolutely key metric that any investor would look at. For an initial discussion, I think take what Antonia said and on one slide show current vs future. 

Remember to use net, not gross, and show the calculations as they will inevitably ask for this. For example, in a marketplace model, show the AOV, commission %, and repeat rate currently shown by your cohorts. Then put your CAC and show the CAC coverage and months to breakeven. On the other side you can highlight how you expect it to develop in the future with CAC optimised and repeat rates increasing as you get more liquidity, potentially also with AOV increases if that is the case. You'd speak to this and explain the logic behind all assumptions.

Another slide could refer to your cohorts and how they are getting stronger, which could support an argument for increasing the repeat rate in the future scenario. Here a graph with cumulative spend by cohort or even just a table works.

In subsequent meetings investors will definitely dig into the unit economics and look at how it has been developing, they'll also ask for full details around the cohorts, CAC over time and by source etc.

Note: of course, it really depends on a case by case basis what is the best way to present depending on the stage you are at. If you have been consistently improving your unit economics every month it may be worth showing this on a monthly basis so that an investor can see the improvement


August 26th, 2015

It's not LTV vs. CPA (cost-per-acquisition); not one against the other. Use LTV (and PRR, Project Rate of Return) to calculate the CPA. 

A startup won't know the variables (the actual numbers), but they should have the formula and make a best-effort guess at the variables. Plug those in and then carry out marketing campaigns in Google Adwords (cheapest, fastest, most data) for a few weeks. Update the variables. Do this over and over until you get good numbers. 

At some point, you'll know your CPA. Say, $7.54 to acquire a customer. You then go to the board and say "you want 10,000 customers in October. CPA is $7.54, so it'll cost $75,400 to get 10,000 customers". Basically, you're buying customers. That tells them how much funding has to be raised, allocated, etc.

Investors, CFOs, etc. really want these KPIs. It shows if the project is financially viable.

It also gives marketing the tool to manage the marketing. Try every channel (PPC, social, influencers, email, etc.) (and the various sites within each channel: FB, Twitter, etc.) and compare the CPAs. That tells you which channel/site is profitable and which loses money.

ritee rouf

August 25th, 2015

I think the key is to prove a model (let's say with your first 1000 customers) that your CPA has been lower than your LTV and that you have a healthy retention model (via cohort analysis). 

I haven't reached that stage yet. So, not sure if this helps. But there is an article that talks about what metrics matter to VCs and a presentation that outlines growth. Hope this helps.

Michael Brink Founder at StayHub

August 27th, 2015

Everyone has good points in here and the a16z repost covers lots of content.  The only thing I'd add that seems rather obvious but often overlooked is to start at the very top of the customer funnel and tailor the kpis so they are communicating a logical story behind how the dollars flow in and out over time (I.e. SAAS businesses care about the same general concepts as an ecommerce retailer but certain kpis are far more relevant in communicating cash inflows and outflows for one vs the other.  So if I'm a saas biz I'm talking about pipeline, new ARR momentum, retention and whether payment terms enable positive or negative working capital during periods of growth.  If I'm ecomm, I'm talking visits, conversion, aov, repeat purchase, LTV set against CAC, gm, and contribution margin.  All of which are shortcuts to figuring out  whether the unit enconomics are profitable /are likely to stay that way.

John Seiffer Business Advisor to growing companies

August 26th, 2015

I would add one thing to what Andreas Ramos said. You need to know the length of the sales cycle. Especially for a startup without revenue that needs money just to stay alive.

If you can get 10,000 customers in a month then (using Adreas' numbers) $75,400 might get you there. But if it takes 6 months then you also need to tell the board you need 6 months of overhead to get to that number. 

Rob G

August 26th, 2015

Start with the data you used to sell yourself and your team and your advisors on your startup/idea.  Use that data or some subset and put it in a format that is easy for you to explain and others to grasp.  List the assumptions you used to support your numbers.  If you don't buy your numbers then no VC will.  If you have not already analyzed every reasonably important metric 6 ways to sunday yourself prior to bringing on your first co-founder or advisor then you are fooling yourself and no words or fancy charts will get you there. 

Blair Austin

August 27th, 2015

This is an easy-to-follow infographic that includes a logical LTV formula. I hope it helps:

It's a great question and a key metric. 
I think the key issue that you have to present is current vs. future. i.e.  you may be experimenting and over-spending today to acquire customers that today only bring you X in revenue. But in the future you should be able to acquire customers for far less and bring in some multiple of X in revenue.