Unit Economics: How to Calculate CAC & LTV – It Depends – Podcast Transcript
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Teaser
As much as possible. I try to stay away from the average. Once you collapse everything into an average, you’re losing information.
Innovation Metrics Intro
Welcome to the innovation metrics podcast, where we bring you the latest on innovation management. We provide insights on how to measure innovation, innovation, accounting, and managing the uncertain process of developing new, sustainable, and profitable business models. You can find links to the main topics covered in this episode and information about the guests and hosts in the show notes, or go to our blog on innovation metrics.co. Your host is Aaliyah island.
Elijah
Hi everybody. Today, Paula is joining us. We’re talking about customer acquisition costs, customer lifetime value and dirty things like that. Well, we hope we can make it a bit of fun along the way. Paul has written a fantastic book called growth units, which will guide us along the podcast today. Welcome to the show Paul
Elijah. I’m so happy to be here to talk unit economics and all things related. Thanks for having me on.
Elijah
Fantastic. Thank you. But would you mind telling listeners a little bit about yourself before we get started? Like your background, what do you currently do in?
So I am a former startup founder and in that experience that I had, I had to start up in New York for a couple of years where I made a ton of mistakes and became really interested in that process of how founders figure things out or often don’t figure things out. And for me, the next step that made sense was that I made that, you know, part of what I did. So since that time I’ve gone on and I focused on building startup accelerator programs and incubator programs around the world, I built Hong Kong’s first funded startup accelerator. I was brought in to build a program in Rome that was themed around environmental tech. I’m now helping a large nonprofit build a community health incubator. And day-to-day, I actually am at the university of Southern California. So I run the, the university startup incubator there and I also teach in the entrepreneurship center.
Elijah
So we’re qualified to talk about the topic. So you wrote this book and as I mentioned earlier, when we spoke before the show, I think it’s fantastic. It’s, it’s like, it’s a really great book to just pick up and, and you’re able to read it. It’s, it’s easy to read and make me smile a little bit, and it gives you also enough, enough to really do something right enough to take a spreadsheet and start calculating things and understanding why you’re doing things. And what questions do you want to ask? Kind of prioritize a little bit of what to learn. So it’s, I think it’s fantastic book, maybe guide us through a little bit about the high level of, of, of this book. And then that can help us then later on, on a podcast to follow through a bit like, so maybe why don’t you write the book and so growth units and what is it about,
I appreciate that. So I wrote the growth units book because I had been working with startups on these unit economics questions for a long time. I had actually been teaching a class at USC that was focused on this topic, you know, largely we would bring startups into the classroom and they would get a team of students to work with them on one element of their growth. But part of that is understanding like where are there levers that you can press on to help that business? And it’s always going to be a little bit of a different answer, you know, you’ll find, so I was teaching that class. I was running these startup accelerators or incubators, and when everything went remote in 2020, you know, a lot of the way that I worked had to change. So I was previously, you know, most comfortable working kind of at the whiteboard in front of a class.
And we would, you know, in a live session, derive formulas and we figured out a conversion funnel. We would figure out basically these elements of unit economics, you know, figuring out lifetime value customer acquisition cost. And, and when that went away or that in-person, you know, you know, environment went away. I didn’t think that I could really transfer that very well, you know, to a zoom session necessarily. So instead I spent some time writing down a lot of these concepts, a lot of the things that I had worked on in built previously, really a series of marathon sessions in writing this out and trying to make it really, you know, just useful, straightforward, but ended up putting this book out there late summer 2020. And to be honest, I, I kind of left it there and I didn’t really do anything else with it. I kind of almost forgot about it for awhile.
And then what happened to me, which, which shows maybe I’m not the best marketer, but what happened in my case was a few months ago, I ended up discovering not because I was really tracking it, but just by accident, I was discovering that people will outside of my network or the students that I had had, or anybody who would have known me personally, people were discovering this book and they were posting that they were also getting value from it or how they were using it. So it kind of made me want to return to this topic, you know, serious way. But, but yeah, the, the approach that I took was let’s first come to an understanding of what we mean by unit economics or specifically lifetime value and customer acquisition cost. These terms are thrown around a lot. I find that people use them in different ways. So I, some, some approaches and why I felt that some were better than others. I go through a number of case studies where we look at the businesses in one of these elements and how they are either doing well or not doing well.
Elijah
You show really well why we’re using the same term. And we come to a different number, what might be the better way and why? And it’s really simple. Like you can actually, yeah, you get it. It’s not too crazy. And I think it’s really due to the way you’re, you know, you presented in a, again, you have done it obviously a couple of times before you wrote, you wrote that book that really shows and makes total sense now why it’s so by flow source. So maybe we start off going into it, unit economics or growth units. Let’s just quickly explain what we’re actually talking about there. Is that a fair way of starting?
Yeah, no, it makes sense. So usually when we’re talking about unit economics, we’re actually trying to look at the, like at the customer level rather than the level of the entire business. So that means we’re not necessarily, or we’re not really looking at like top line, you know, total revenue that a business is, is generating or all the costs that they were generating. Instead, we’re trying to look at that at like for one sale or for one customer over time, what does that business derive? And so there’s a few parts of that on lifetime value.
Elijah
So it’s a one cup of coffee rather than we’re looking at your whole business. We’re looking at, I think we’d use in a coffee shop thing. It sounds you had the book and yeah, like I think restaurants and stuff later as good. And so why are we doing that? Why are we, why is it important to look, maybe you were about to say anyway, but why is it important to, to what is the value of just looking at, at the, at the unit economics rather than, you know, trying to analyze the business?
No, that’s a great question. I like to bring it back down to the unit level, because that’s really where like a lot of the action takes place. So if we don’t do that, we’re kind of looking at the aggregate we’re looking at we’re then at the point of, you know, averages, you know, if we go down to a unit level, I can, I can have a different lifetime value for a specific customer segment. And I might have five different segments that I am trying to serve. They might have different payback periods. They might have different margins. Like that’s where we can get into the, like the granularity of this topic. If you keep it at that like business level, like total revenue, total costs, et cetera, you lose a lot of that helpful detail. And I find like, certainly for startups also, certainly for organizations, you know, it’s, it’s a little bit of a mistake to, you know, leave it at that like top level. So once you go down, we can, maybe I’m diving in a little too soon, but as an example, like lifetime value, the way I like to describe lifetime value is it has three things that help you determine it. It’s price per unit that you’re charging. It’s a cost of serving that unit up. And it’s like the number of times that somebody is going to stay in and buy that unit. So it’s a retention metric.
Elijah
I feel like we should probably pause it there, maybe. So it’d be like customer acquisition costs and customer lifetime value. So these will be the two essential, I guess the most essential terms we’re talking about today. Why are we looking at the unit? I think it will be really if you’re okay with sticking to this. And we spoke about this before the podcast and you know, when we’re, when we’re catching up beforehand about product market fit and so on. So maybe I can throw it. Maybe I can throw that and then get your interesting takes out. I would just love to stay in that. Why are we doing that for, for just a little bit longer? So I guess for, for large organizations and that’s, or for existing products and for existing products for existing business models, there’s value.
And that’s probably not so much what we’re going to discuss today. So I guess that’s a more forensic look into what is really going on. And, you know, I really scaling well and set of different questions, I guess, sort of what this podcast is interested in and where your main expertise is, but for where you’ve done more work, I believe it’s really to, to, to, to even get something going. So like sure. We could look at the whole business, but what business, right. I think that’s one of the things. So when you don’t even have a business, you can look at yet. So you’re, you’re, you know, it’s your first product, it’s your, you don’t know if you have what we call product market fit. And I would love your take on how you define it. And I think we might be very interesting to challenge my own thoughts on that with your expertise. And so I guess it’s, could you say it is the most useful thing to look at while you’re establishing a business? It’s like, that’s like the customer customer acquisition cost of a customer lifetime value with whatever that is for now. That is like, that’s the thing you’re looking at before you have a business. Is that a way of saying it or
It, it could be so, and it is challenging, right? So you have those, those two pieces. So customer acquisition costs being how much money does it take you to bring a customer in whether it’s taking somebody who is not a customer and turning them into a customer, many different ways. There are customer acquisition costs of zero, right? It could just be word of mouth. And then on the,
Elijah
Like, your book if I may say,
Paul
Oh yeah, sure, there you go. Right. That’s, that’s the best way, right? Somebody, you know, loves the product. They tell another person, the customer, the business doesn’t have to spend anything. And then on the other extreme, of course you have paid advertising and you have sales teams. You have like a lot of the activities that need to go into supporting either much higher priced items or more complex yo sales that require a bit more of a process assess. There’s probably not too much of a lengthy process in deciding to buy a book or not. It’s not a life-changing amount of money. It might be electing to book, but it’s not life-changing amount of money, but for like, you know, for either more complex products or much more expensive products, you know, you might have to invest in that development of a customer. The, so, yeah. So that’s that customer acquisition cost or CAC is one part you often understand that, you know, early, early on, because you can run tests, you can see what does it take to bring somebody through a conversion funnel and turn them into a customer on the lifetime value side. However, that often takes more time to understand,
Elijah
At least you can run early experiments on your customer acquisition costs and, and, and sort of work your way to where it’s, again, I’m saying product market fit without having to find it yet here is that right?
Yes. But this is where it does become difficult to give you a single answer because there’s certainly situations where like a really early stage company, you know, just experimenting, maybe putting up like a smoke test of some type or like one-on-one interviews in some cases, if they are not, well, I’ll say just directly, if they’re not going after, if they haven’t figured out who their real early ideal customer is yet, they might have something that is a value, but they’re just talking to the wrong people. They’re presented it to the wrong people. And it’s impossible to require them as customers. They also might be that, you know what your work is, it’s just not right. It’s not good enough. It’s, you know, it doesn’t have the right. It’s not solving the right problem or the feature set doesn’t feel quite right. So,
Elijah
Oh, your value proposition is not really congruent with what you’re actually offering and then okay. You acquire customers for a moment and then they’ll drop. Right. And then you don’t have any lifetime. Okay. Good point.
So it is a bit of a process, but, but to your earlier point, like maybe there is some, you know, there is some point at which you say, okay, this looks like it’s gonna cost us much more to acquire customers than we expected even factoring in some of the word of mouth, you know, and our best estimates of lifetime value is less than that. Something’s wrong. We need to change doing will be sustainable.
Elijah
It really comes back to for startups. It’s, it’s just, you can do a lot with very few customers to understand your business, to potential of your business. Yeah. Okay.
Yeah. That’s, that’s it that’s it. So you can certainly get insights and you’re probably always tweaking these models as you go along. That’s, that’s also why just understanding different customer types is really important in this process. So I know if I ask a startup what their lifetime value is for this product that they built, if they give me a single number, they better also only have one customer segment, right. Because they are multiple segments In different ways.
Whether it is the pricing side, like you have a basic and a premium version, whether it is on just other metrics such as you have some like incredibly diehard fan too, or just, you know, retain very high percentage retention versus others who I just needed to use this for a short time. And I’m never going to come back and do this again. Right. So, yeah. So you can kind of, you can start to understand how much, how much someone has thought about this question just by seeing, like, what does the response, if the response is a single number, or if they say, well, this segment LTV is, you know, $50 or this one is, you know, 250 for this it’s, you know, 5,000 same thing on customer acquisition cost. And once you start doing that, you know, you obviously need some data or some, you know, time to do that.
But once you start doing that, you can then start to think, all right, well, if I wanted to grow this one segment, what’s going to change, you know, am I going to have to rely more on Pedro? Am I going to be able to, for my existing customers to use word of mouth and refer friends in, you know, there’s like all these questions, like, is the pricing appropriate or is that actually, you know, keeping the retention at a lower percent that it might be, if it were lower price point, all these questions, you know, I guess could be looked at. And of course, once you change one thing, you know, it probably has an impact of changing the behavior in a few other places are changing outcomes and feelings.
Elijah
Yeah. It’s a complex system, so great. And maybe we should actually now take that step back and say, say, so what does, what does, what does customer acquisition costs? And then we talk about what is customer lifetime value. And I think then we should go back to, if we still manage to arrive there one more time, think about what is product market fit in this context? How could it look like, how could it be quantified rather than qualitative or a feeling or a feedback kind of metrics? Like how can we have a more quantitative approach? What is actually customer acquisition cost? How do you calculate it?
CAC? I think of, and it’s two parts. So it has the cost of getting somebody in the door and I use that term in the door because it could literally be in the door
Elijah
Of a shop, right.
It, or it could be in an online door of some sentence, like getting somebody on your websites, your app, and on. So sometimes that’s $0. As in I told my friend and then they, they went to did it themselves, or it could be, you know, I, I ran a paid ad and that’s a factor of, you know, cost per click. And you’re like, how many people are clicking, but I have that cost of getting somebody in the door. And then I divide into that, the conversion rate. So once they are there in the store or on the website, once they’re there, what is the conversion? You know, the likelihood that they actually become a customer of mine. So, you know, that you can also track with, you know, different analytics tools. You can track this time. Those two things,
Elijah
I guess what’s important there. So for your, for the listeners, for your team, or if you’re a single entrepreneur, if your corporate team or if your startup team, it’s probably a good idea at this point to understand that the demarcation line between, what does it mean in the door and what does it mean from here? We converting. So acquisition activation maybe. Is that, is that the point of talking about in the, in the pirate metric framework or,
Yeah, so, so this would land here at the top of the funnel, in that pirate metric framework. In other words, I went from never having heard of you to getting on some property of yours. So maybe it’s not the awareness or the very top. Maybe it’s like, you know, one level in, but you’ve landed on my, you know, my website you’ve landed in, you know, something that is actually, you know, the, the business thing of the product that I’m presenting to you, you haven’t worked through the rest of that funnel. So you’re still not a customer until you pay. I’ll say, you know, you have to pay to become a customer, but now you get to actually see, okay, well, here’s the options, you know, here’s the different tiers. Do you put your, you know, your payment information in or not? Do you,
Elijah
So, so why is it important to differentiate between in the door and then being, you call them activated afterwards once they’re, once you convert them from in the door to, to the next stage, how, what terminology do you use usually?
Okay, great. So if you’re actually looking at a conversion funnel, it depends for the business. So for some businesses just capturing an email has some value I can remarket to you. I have a potential to actually get you to, to a paid customer down the road. So, you know, there is some value you haven’t committed, you haven’t converted yet, but statistically then you could back into, okay, what is the value of a new email address? You know, they haven’t given me anything yet, but I know in general, this percent of people go from, give me the email to actually, you know, pain. I want to encourage at least the email, if I don’t get them to make a decision buying today, at least I get multiple chances to, you know, to communicate with them.
Elijah
Okay. So, so what I take from it and maybe correct me. So we’ll take from that. And so when we calculate customer acquisition costs, traditionally, that is the, the, this, this kind of segmentation is not done, but could you tell us why this is better? And then maybe the other part would be your team should come to the individual conclusion? What is in the door and what is the other part to properly calculate? Well, have a better calculation of extra customer acquisition costs. Is that correct?
The reason that I have to give a lot of it depends for businesses have different situations. So there are businesses where, you know, they have users and they have customers, right? So this is like the typical, yeah, this is type, most of the people who are using these, you know, social media, you know, services, they’re not paying anything, but they, you know, they have given an email, they are using the service. You know, they are maybe addicted to the service. And as a result, they’re generating lots of pages, which generate ad revenue for, you know, the business itself. So there again, there’s like you have your conversion funnel of a user, you have a conversion funnel of an advertiser, right? The actual customer there. Then there’s other types of businesses where maybe this is more of a SAS business. I have a, a free version that I let you use.
And it does incur some costs for me as the business owner, but I mitigate some of that expenditure by maybe showing ads to you, or I throttle the, you know, the amount of usage that you could take advantage of. So I throttled the amount of costs that you’re gonna generate for me. And I know a certain percentage of you are going to then upgrade and get the premium version. And that percentage is going to more than make up for all the people who stayed on the free plan. This is why it depends like your conversion funnel is going to be different based on the type of business you have, or just looking at it in terms of the different customer segments that you have customers or users that you have.
Elijah
Okay. So in this scenario, I’m saying, so what you call the unhelpful way of calculating a CAC is a total spend on marketing in a certain period over the number of new customers and the period. Now, probably these numbers are relatively simple to pull for business. And that’s maybe why we do it as well. I don’t know. Maybe it’s easier to jinx that number. I’m not sure, but you say that’s an unhelpful way. So why is that an you say in an unhelpful way or even a bad way,
It’s unhelpful for a couple of reasons. So first of all, it misses that timing issue. So if I look at, you know, the month of January, everything I spent in that month, and then I look at how many customers I signed up, and then I just figure out, well, what’s, you know, how many dollars per customer, the customers who signed up in January might have been responding to all the work that I did in December. Right. So that’s one problem with that now I’m, I’m really, I’m not sure.
Elijah
Perfect. We don’t, we don’t have to dive into everything. I think it’s really good to just like point out a few ones and say, I think, you know, just describe like, otherwise we’re, this podcast takes three hours. I spent too many detail questions. I think this is great. Right? So this is a really good example of like, you know, I think that’s very, very good illustration. Isn’t there, there’s no correlation potentially between those two, two numbers. Okay.
And then the other reason is that we’re not able to then look at it by a segment. So I just know the average video and I might be attracting people from a customer segment that I don’t want, I actually want to exclude in the future.
Elijah
Great. Perfect. And then, so what’s the best sort of better way we touched on it, but just to put it in a, on a formula, I guess. So what, what’s the better way?
So the better way that I like is taking the cost of getting a potential customer in the door and then dividing in the conversion rate. But once they’re in that door and they work their way through the funnel, what’s the percent of those customers that actually are those people that actually become customers. So in other words, if it costs me $10 to get somebody in the door, you know, and then 10% of those people convert, I have a hundred dollars CAC.
Elijah
And so, and then you’re in the book, you say the next, the next level to really help you understand your business, help you to focus on, I guess, where to grow, where your, where your dollars best spend, who are you serving and so on, and then to go by, go by channel. So do what you just said to do those two things and then, but look at it in a segmented way. Right. Is that correct?
That’s correct. So you might have a word of mouth channel, you have a mailing list channel, you have a Instagram ad channel, as many as you want. And they all probably have a different customer acquisition cost associated.
Elijah
Great. Yeah. And you have a nice, like an illustration in your book where, you know, where they, if you’re still looking for the average, then you’re still looking for a time period for the average, how do you do that?
As much as possible? I try to stay away from the average, actually, once you collapse everything into an average, you’re losing information. So without making it overly, because sometimes you have to, you know, you have to analyze that trade off. You don’t want to track too many things, but you might have one channel that performs really well, you know, really low customer acquisition costs and has a great LTV. You might have another channel that has a relatively high customer acquisition, cost and loyalty. Yup. If you average these things together, you lose that information. And so by keeping them distinct, you hopefully start to figure out, okay, what are the better channels? What are the better customer segments? Maybe I actually want to stop attracting people of certain customer segments or stop using a specific acquisition channel.
Elijah
Okay. That’s right. That makes total sense. Out of the, that least two questions I have, let me pick one. And so when we, when we talk about, let’s say an, a corporate innovation context now less than a startup context, we may want to pick between different, different initiatives is that’s quite, that seems to be quite challenging. If everybody, if we present, you know, Hey, we have like, this is a great, you know, we have like no acquisition costs on Tik TOK or whatever. And, you know, but our total decibels like are like Tam and Tik TOK is like, it’s just like 1% of the customers we can read. Isn’t it. Isn’t that a problem. When you think about, like, we let’s say there is such a thing as an addressable market, and you’re not that, you know, your product is not that innovative that you’re trying to create a market. Like let’s take, I guess some of the people listening to this podcast might, might think about that, but then yeah. Isn’t the value then in the average, when you, when you actually try to push with the entire market, is that again, one of these, it depends answers. And I should just not ask that question right now.
I mean, even then in an existing market, I think you do have your different customer segments and certainly different ways of reaching your, even if it is only one saying that you have different ways of reaching them or that might help you then determine, okay, we should resegment this market. We should be the, you know, the company that focuses on this specific user type. So that’s why I guess I, I pushed back and think, you know, As much as you can try.
Elijah
Yeah. I love it. I guess I must have a tremendous bias there again when you have, when you have, but when you choose between definition initiatives, I guess that’s where, what I was starting out with in my question. So when you have to choose between, you know, you have five initiatives and, you know, you’re trying to pick the best one to go with like this. How do you, how do you navigate that when you look at different channels and not the average,
I mean, in a, in a corporate innovation sense, this is even complicated, I think, right? Cause then you know, this better than me. Like you have, well, you’re navigating everything from something like a, like a business cases, like your payback periods or like your like ROI kind of period to just maybe internal politics of
Elijah
Let’s say there are none
If you were clearly trying to look at this objectively and all you care about is the money and, and there’s no difference in, you know, like the, the cost of serving a different, well, that cost of serving these different segments would be expressed in lifetime value. Then you can look at, you know, highest lifetime value, payback, fastest, you know, so are paid out fastest. So the other thing I’ll mentioned where people try to use CAC and LTV metrics to make decisions and it trips them up is so it’s intuitive to say, LTV has to be bigger than CAC. I have to be running more back from a customer. And
We then often hear about these rules of thumb for like how much bigger. And you’ll hear in general, you will often hear three to one or four to one, which, you know, that’s there for all the other stuff. That’s not like all the fixed costs that typically are not put into an LTV calculation to give you that buffer. But you know, you should really also be thinking about payback time. So, you know, in the book I give this example of here, it looks like we have a really favorable, you know, the $10 CAC and $50 LTV looks like this is a win. Let’s go ahead. But not until we actually model it out. Do we realize that it takes us three years to get paid that $50? So you pay the $10 upfront. It takes you years to get the $50 back you’re out of business, right? Or you can’t grow with that type of model. In the book, I say, LTV is like a river. It’s a river of floats.
And you know, you have that CAC upfront and you should really try to model out how those flows come in. So it might mean you have months of time when you’re actually still continuing to put money out you’re you are like giving that customer a, I dunno, a free basic version. And it costs something for that. Or you are continuing to follow up with them. There’s some excels, you know, cost of that. Not until they get to month six, do they actually convert and become that premium customer? Or they start paying you at a higher level. And then even, so you were losing people along the way. So I kind of, you know, in a more sophisticated models in that book, I do like a weighted gross margin and we get into more of the detail there. That’s why it depends.
Elijah
I assumed it won’t be a lot of fat in the podcast today. So customer acquisition costs, we have your book talks about what is actually a customer and how do we divide that further? What does, what does it cost? Like? You know, those basic things, is it fixed as a variable? Like not so easy, super interesting sound, super simple. Or we take a time period. We do these two things. It’s not a big deal. It’s a big deal. It tells you a lot. If you’re trying to judge a business, if you’re trying to judge a start-up, is she an angel? If you’re a corporate innovation team and so on, like, if there’s a lot of information, if you, if you do it, if you do it differently, if you do it. Yeah. If you do it by the book. Okay. That was a bit of a dad joke.
Because it is expressed over time And you know, I talk about the three elements of it, but those take a while to come out. So businesses that have been around for awhile have a better handle on this than brand new ones. But I can talk about the, like the elements of lifetime value. If that’s a help.
Elijah
Yeah. Let’s do it. Let me rephrase it. How do we usually do and why is it not so good? And then
You’ll, you’ll often see lifetime value just done on like a revenue metric or a price metric. In other words, I spent, I, I have priced this product out at a hundred dollars. Somebody buys it from me. So lifetime value is a hundred dollars.
Elijah
Right.
And it leaves a lot out. Right? I have no idea what the costs of that product are. I don’t know if they buy at one time if they buy it every single month, every day. So I like to break lifetime value down to those three parts of, you know, the unit price, the unit costs and it retention metrics. So like how many repeat purchases someone is going to generate as long as they are my customer, if you don’t keep those three parts to it. And I, I even say like, keep those three parts in your calculations, like, don’t simplify it into one number or just like just the number, you know, w with the hiding, you know, those three parts. If you hide those three parts, you lose some of the context. So for example, if I say, oh, lifetime value, or like I say, yeah, lifetime value is a hundred dollars and a cost is $99.
And repeat purchases is 100. So price minus costs, a dollar times, a hundred, a hundred dollars like that value. If I just say it’s a hundred dollars and I don’t give you the other context, you have no idea where can you try to push on some part of that puzzle? So in that example, I might say, you know, what could I raise prices by 1% to go from a hundred dollars to $101? And if everything else stays the same, I’m going to say my costs. Aren’t going to really change from $99. If I raise prices 1%, I’ve just doubled my lifetime value, right? I’m not really losing people. I’ll say in this extreme example, I’m doubling lifetime value. And I there’s all that context the same way I might say, like, I bet I could take my, keep the price the same. I could bring costs from 99 to 98.
Again, I’m doubling lifetime value in this weird example. And, and that’s why I like, you know, breaking it down into those three elements. Then the, you know, that I talked about in the book that we mentioned earlier is that, you know, it’s a river of flows. So again, if I, if I just take that number, it’s a hundred dollars LTV. And I don’t know that it takes me actually like, you know, years and years to get that $100, whether in $1 per month you’ll payments or in like one lump sum, a hundred dollars for payments at the end of five years, if I don’t really express that, I just do it in a spreadsheet. And then you can, you can visualize this with like a line of how, you know, things go up and down. But if you don’t do that, then you lose a lot of that information. So it’s one of the themes in this book. And I think you’re, you’re kind of addressing, this is just like, understand how the business works and like actually like dive in a bit more than its typical lifetime value, you know, because it’s not expressed all at one, you know, all at one time typically anyway, you need to express it as a, as like a time series.
Elijah
Great. So, so, so as you conclude in the book, then you have the price of the product minus the cost of the product times, the number of times, the number of times is bought by customer. And that makes the first that makes it better. And then you look at it in a, again in cohorts or in L or in time.
Sorry. Right. And the, the benefit. So what’s a cohort, there’s many ways of Putti Cohort. I, I often will stick to just a time-based cohort. So in other words, I have one product in one customer segment, all the people who became customers in January, all the people who became customers in February customers in March. I have my January cohort, my February corporate Mark’s cohort. I can then look at them over time and see, okay, how do they against each other? So you like did the early cohort actually churn away faster than the later cohorts.
Elijah
So you’re not negating what you said early entrance of stay away from this, from this, from this time in a sense, because it’s, it’s, it’s a, it’s a suck subsegment of the initial segment. Right. So yeah, like you look at your channel and from there you look into, and then you break it down by time within the channel. Right.
Yeah. And that allows you to see, are you getting better over time? So in other words,
Elijah
Yeah, fantastic.
Say my January of last year cohort, you know, by month five, I knew 90% of the people. Right. But then I have my March cohort by month five of the March cohort. So five months afterwards, maybe I only have lost 50% of the people. So I’ve done. I’ll do. Right. Like I am keeping more people. I don’t know if that means the product is better. If my messaging is better to them, like I sent them a reminder, I changed something about the pricing. I am, you know, I’m doing something better if I’m keeping
Elijah
And, and that’s where we bridge between startups, corporate innovation and existing product lines and marketing. Right. So where we talk about, that’s basically very helpful now for your continuous improvement or for, you know, better margins on your product and better that our marketing efforts. Right.
That’s right. And then it also lets you, you know, lets you build like a weighted gross margin, which I explained in the book, which basically, you know, if I’ve lost 90% of people by month five, you know, I, I should be only counting that remaining 10% in my LTV calculations when I’m trying to actually, you know, do that full LTVs of river, you know, a spreadsheet and these kind of metrics, you know, the cohort metrics are just like, yo you know, rated, you know, gross margin. Those are used by businesses. For example, a lot of SAS businesses, SAS businesses know that they’re going to lose people over time,
But the really good ones, they have negative churn. Right. So that’s a concept that, you know, how could you have negative churn? Like turn is the mountain losing weight? How can I be, how can I have like yo people more than one person. Right. But that’s a metric that’s around. Well, okay. You did lose customers. So you lost, you know, like 20% of your customers in this period that we’re studying, but the 80% that remained with you, they’re each spending like, you know, one point, you know, three times as much. So I’m actually earning more from that smaller group of customers than I was from the bigger group of customers. That’s negative churn.
Elijah
Yeah. Amazing. Yeah. It’s just, it’s amazing. Yeah. I think all through your book and I think if you, if you then read, I’m just looking at the outline here to remind me. So when you go into retention behaviors, you talk about like, it’s, it’s better retention actually better. I think that’s that’s when you talk about it and they get to insurance and stuff. It’s really fun. Again. I want to say it’s really fun to read it. It’s it’s just fantastic. Yeah. This is just such a helpful book. It’s just, I’m I’m truly excited. Truly excited. I’m learning when I read it. It’s it’s great. And I mean, you even go into discount rate. Definitely not going to touch it any further in a podcast right now. Cause that’s gonna take us way off track, but yeah, it’s, it’s, it’s really cool. So it really goes from let’s let’s make it a bit better and if we can do that, that’s great. And maybe then we can even make it a bit better so you can come back to it. That’s how I feel like you can really use it really well. And then you also have case studies. So that’s really good. Now when we bring those two together, so customer acquisition costs over lifetime value. Maybe do you want to talk a few minutes about that? And then, and maybe in relation to, does that bring us to a product market fit?
How about, how about this? How about we talk about product market fit and then I’ll try to bring in some of these other things. So do you want me to just start the review went through?
Elijah
I can block. I can, I can talk forever. So yeah please. Yeah.
So we were, okay. So w w we were talking about product market fit, you know, when, when we spoke last week and this is not my term, right? This is a term I think originally from Marc Andreessen, if I remember right. But a lot of people have used this term in startup world. Certainly it’s thrown around a lot.
There’s this enduring question I have found, which is like, well, what really is it? Like, I’m not, I’m never exactly sure that I had it or if I don’t have it, I like to just go to the shortcut of, if you’re asking me if you have it, you don’t have it because It’s relatively rare. I don’t think that I have a really quantitative answer for you. Right. So some of the elements, you know, and again, I’m not my terms, I’m using what I’ve seen other people, you know?
Elijah
No, but I think, but we’d like, but you’re, I think, I think your book can help folks. And it’s just like with innovation, right? We don’t need all, we don’t all need to agree on what innovation is, but if your organization doesn’t agree on what innovation is, you have a very hard time managing it. If your team talks about product market fit all the time, but you don’t have the same concept, then it’s going to be really hard to get to that point, whatever that point is. So I think that’s the way I would like to, I would like to frame it. Okay.
Yeah. So, so product market fit has a few elements. So one is that it’s possible for you to grow organically. So word of mouth, or, you know, zero customer acquisition costs are very close to that. If you’re using an average. In other words, it’s remarkable enough that people are just talking about it, sharing it, you know, the word gets out, you don’t need to invest a lot in the sales or marketing of this business. You can keep growing. Which means that you’re not capping out at very small, like, you know, a small, you know, extreme, you know, ideal customer, you know, that you have find that you’re profitable on a unit basis. So, you know, there’s a lot of startups that we’ve seen that raise a ton of money and they lose money on every single customer that they have, you know, as well. Cause they’re just spending like they’re serving the wrong customer.
They are priced way too low. So you’re able to price appropriately. People are happy to pay. And so on a, on a unit basis, you’re profitable and retention is relatively high. So, you know, lots of examples of startups where, you know, they put something out there, it gets a lot of buzz. A lot of people check it out and then like everybody leaves because they’re onto the next thing. So if you don’t have those elements of product market fit, you, you can grow. It will cost you, you know, it’ll cost you a lot in customer acquisition costs. So you can pour money into growth. And one of the tactics I’ll say of startups that raise a lot of money, whether it’s their own tactic or encouraged by investors, one of the tactics that
Elijah
They can raise again, let’s be honest here.
We’re going to raise it. We need to get to that next level.
Elijah
They can exit it. Doesn’t really,
Of course your competitors to go out of business, you know, because,
Elijah
And that, and that’s a reasonable and not sure wholly that, but that’s a very reasonable business tactic and fine. Right. So that’s, that’s exactly in that context. That’s where I would challenge that premise. Yeah. Yeah.
If ultimately you can make a sustainable business. So if even after that, you know, you’re still losing money on every single customer or like you’re not able to push the prices up or you’re not able to become efficient
Elijah
Again, very contextual. Yep.
Definitely because yeah, the like the, the cynical approach then becomes well, as long as I can exit before I have to really demonstrate that this then I can’t, then it stops at some point
Elijah
Or in a corporate context change company.
Oh yeah, absolutely.
I’ll give you one other example. Again, it is still relatively qualitative, but this is from Andy Rockliff who’s, you know, he’s a VC at benchmark. He was founder at Wealthfront. You know, he’s spoken about product market fit quite a bit. He talks about a, kind of like a, a, a product trial, a test that you might run in an enterprise context. So you have an enterprise customer, you give them like a product trial. It’s a 30 day trial. I don’t know, free paid doesn’t matter. And at the end of the 30 days, you turn it off. And if they do not complain and say, well, like, wait, what’s going on. Like, if I want to keep using this, if they don’t complain, you know, you’re not at product market fit.
Elijah
That’s okay. Now I love this. That’s one of the ways we traditionally measure in a sense where we ask that question, how upset would you be? So that is that, is that how it was born? Or is that his time of experiment? No, the question, the question is
Usually as the, is it the Sean Ellis tests? He’s the guy that Write that question, like, how upset would you be if you could no longer
Elijah
That’s right. That’s right. And if a certain percentage says, you know, super upset,
I think his cutoff was like 40% of people don’t say, then he doesn’t work with that client. In other words, he’s, he’s wants to only work with the best clients. If he’s doing growth hacking, you don’t want
Elijah
No, I think, I think that’s actually how he defines product market fit. Like if you don’t have that, then you don’t have product market fit and you need to reiterate and you need to reiterate, iterate on your product before you scale. So that’s sorry. Why are we even talking about product market fit? Because I think that’s a dedication line to scale. Let’s take a lot more money on and grow this thing, I guess. Like, that’s really why, why are we even worrying about this? Right. I guess that’s why we’re worrying about it. Like, what is the dedication to scaling? Is that, would you agree with that?
Yeah. Cause if you don’t have market fit, you’re going to spend a lot of money on customer acquisition. It’s not going to pay off for you. I mean, that could be part of a process where you end up figuring things out and you target better. You’ve improved the product. Like this is like part of your discovery process. If it’s not however, getting you to that point, then yes, you’re throwing good money after that, if you would just keep doing it.
Elijah
So I guess in the show notes, we will try to link through quota. You said, and then link link to a few methods and so on. And there’ve been a few blog articles about this as well. And let’s see if we have to cut this, but about how about simply saying how going to get back to reasonable cattle on the podcast? Maybe we should just say that. So we’ve just, we just went on a tangent here and we spoke about product market fit. We spoke about innovation, accounting and how to, what they have to do with each other and how to better define it. And yeah, we might, we might do another episode on that. That seems to be the most, the fairest thing. And we’re probably going to cut everything we said until now, but it was fun. Thank you. We could maybe talk about a case study. I know we’ve, we’ve been speaking a lot. Some of it will be cut though. So it might not be as long as it feels like right now. I’m not quite sure, but I think at least one case study would be quite beautiful. What do you think?
Sure.
So let me bring up one, if you don’t mind was one that I like a lot, because it kind of goes back to something that you were saying earlier about ranges and predictability. So maybe there’s a bit of a future callback for this. If in the book I talk about a case study looking at data storage company. So like Dropbox, or like basically Gmail or Google drive, I’ll count that as like another version of, you know, file storage. Right. And these companies, they came up. So Gmail was in beta, I think in 2004, Dropbox started maybe 2008. These companies started offering what, at the time it seemed like an incredible amount of storage for Gmail. It was a gig, a free gig, 2004 was a big deal. And I think with Dropbox, you could get like some multiples of that. If you invited other friends, I forget exactly what the number and these businesses are predictable in the sense of they have costs that the client on a relatively predictable timeline.
So, you know, if you, you know, or if you’ve been in the computing industry for 30, 40 years, like just like the idea of like buying a gig of storage like 30 years ago was like, ridiculous. Right now. It’s like no big deal at all. It’s like, you, you just give it away. And there’s some predictability, and this is basically Moore’s law, you know, and new fabs that come online and like, you know, also just better access to like, you know, broadband as well for like, you know, transferring these large files. So there’s some predictability that these companies had, which meant that they could launch before the unit economics seem to make sense. In other words, you know, they launched a little too early, but they sign ups. People are using it. They’re losing money for every new person to the sign up. No, this time is coming.
You know, however many months or years in the future that is coming, when the economics are going to be favorable from the cost side, you know, we’re going to be able to put storage online that is significantly cheaper, and it’s better for us to sign people up today. And some of the business models were ad driven and they cover some of that costs. You know, some were more, you know, the freemium model where a certain percent pay a monthly subscription fee, but they know it actually makes sense. Let’s raise money today, get people on board. We basically lock them in, you know, they get used to our system. They don’t want to, you know, move to something else. And we know at this point in the future, things turn favorable, you know, economic wise, they turn favorable. So, and that’s why, again, it’s kind of a, it depends scenario, you know, that’s a, an industry or a couple industries where they are responding to relatively predictable change in their own infrastructure costs. Say that’s not the situation that other business types might be able to take advantage of. But those,
Elijah
Because you burn a lot of money for a while and unless you,
Yeah. So as long as you have good retention, you know, that kind of business can work out.
Elijah
And do you think that’s, your dad is what you would measure in the beginning, right? At least. Yeah. Okay. So you, and that’s how you, that’s how we de-risk that kind of model. So yeah. And you could have pulled, they could’ve pulled the plug early if the retention wasn’t there. Cause that’s, that was the fundamental, fundamental metric for them.
Exactly. That that would have been the perfect example of, well, we’re basically giving this thing away for free it’s, you know, a big deal at the time, a gig is a big deal. Nobody wants to use it. The product must be terrible that we have to work on this product. You know, it doesn’t matter if the cost is going to decrease in the future, we have to work on this product. Otherwise, you know, we’re, we’re even when the unit economics are unfavorable, we’re not going to be able to keep people. But yeah, I, I like, I, I like kind of applying these different models or trying to figure things out, you know, every startup, every, you know, every corporate is going to be a little different. So, you know, you have to think, okay, what makes sense for you? You can gain a lot of insight by looking at other case studies end of the day. You’re probably taking a slate.
Elijah
Otherwise you don’t innovate much, I guess. So everybody’s listening to this podcast will probably have to have to figure out their own way to a degree. Most likely. Yeah. Hey, we spoke for a long time and we could speak easily for another hour, but I guess we start wrapping. I again, want to give a big shout out to your book growth units. We will, it’s available on Amazon, it’s available on other platforms and we will, we will link to it a hundred percent again, I think it is great to get started. So, you know, for corporate teams, for startups, if you want, if you want to get, get started with this topic. It is great to pick up and, and understand the philosophy, understand to maybe even inform your next experiment and where you want to work on what you want to do. And it goes further.
It goes further into, you know, for folks who currently calculate lifetime value and want to make it better, it offers equally that kind of value. I think to me, it does great. And thirdly, maybe even in a forensic sense, so if you, if you’re an angel or if you’re somebody who is in who’s investing, or if you’re in corporate and I think it can help you to dive a bit deeper, and if you want to do that, I think it’s equally a good way to dig that the deeper. And how do you, how do you step away from looking at the business in a meta way and actually looking at it in a deeper way? I think it’s great. Thank you so much for being on being here.
Thank you, this was a lot of fun.
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