The Cost of Customer Acquisition.

Way back in April I wrote some pieces about our recommended reading list. One of the books was about Inbound Marketing specifically HubSpot. During that article I talked about how we had to re-engineer the company from a company selling Enterprise level software to one selling SaaS solutions and I talked about the cost of customer acquisition and how important this is to the strategy of any company. Well I thought that this is so important to any company whether starting up or ‘re-engineering’ itself. I will cite two excellent articles and provide the links if people wish to ‘dive’ further into this subject.

When looking at your sales line you should also look at the what the cost of acquiring your customers is. Clearly a customer who provides £1,000 of revenue but who costs £1,001 to acquire (The micawber principle if you like) is not a good bet.

However to do this you need to know the CAC (Cost of Customer Acquisition) and the LTV (Lifetime value) of the customer.

To compute the cost to acquire a customer, CAC, you would take your entire cost of sales and marketing over a given period, including salaries and other headcount related expenses, and divide it by the number of customers that you acquired in that period.  (In pure web businesses where the headcount doesn’t need to grow as customer acquisition scales, it is also very useful to look customer acquisition costs without the headcount costs.)

To compute the Lifetime Value of a Customer, LTV, you would look at the Gross Margin that you would expect to make from that customer over the lifetime of your relationship. Gross Margin should take into consideration any support, installation, and servicing costs.

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It doesn’t take a genius to understand that business model failure comes when CAC exceeds LTV.

A well balanced business model requires that CAC is significantly less than LTV:

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Hardly rocket science but the goal is give the reader a sense of the balancing act required to create a profitable business.

So on the face of it if your CAC is higher than your LTC you need either a more cost effective sales/marketing model or more lucrative customers. The idea of a £0 line sales and marketing model that gets customers with £1m+ LTV is clearly living in cloud cuckoo land so where do you start?

Well you can start by looking at the various levels of sales complexity.

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Freemium

In this model, some version of the product or service is given away, with the goal of up-selling or cross-selling over time. Think Open Source products like JBoss, MySQL, and Asterisk, and web services such as DropBox and SugarSync. (Note that only some portion of the free customers will likely convert into paying customers.)

No Touch Self-Service

Here you drive traffic to the web site using SEM/Pay per Click ads, SEO, Inbound Marketing, Freemium, etc. Visitors convert to paying customers without any need for salespeople. The product needs to be simple to understand, and have a compelling value proposition.

Light Touch Inside Sales

In this model, you might provide some light level of human touch such as email exchange to answer questions and provide customer support. A slightly higher level of touch might involve a phone call with an inside sales person.

High Touch Inside Sales

Here you still sell your product/service over the phone, but the amount of work in closing the deal requires several phone calls, sales engineers, and/or web-based demos.

Field Sales, and Field Sales with Sales Engineer’s

Now you require an on-site visit using a field sales organization. You might also need multiple on-site visits, selling to several decision-makers, use of SE’s (sales engineers), and perhaps on-site proof-of-concept installations that take considerable SE time.

 

 

Obviously the Freemium model is the least expensive and they progressively move more expensive finishing with the Field Sales with Sales Engineer model (ask IBM if you don’t believe me).

Also it is worth noting that companies very rarely fit into just one of these categories but rather straddle a few. For example when the main stream business of Dynamax was selling Enterprise level software we straddled High Touch Inside Sales through to Field Sales with Pre Sales Engineers, but this was clearly the wrong model for a SaaS operation so we now straddle No Touch Self Service through to High Touch Inside Sales as we have a wider variety of customers now from ‘Doris the Florist’ who has one screen through to large organisations that have many hundreds. Each of these client types call for a different level of customer engagement so be prepared for that (while of course still looking at the LTV/CAC ratio).

Now we have taken a look at the CAC side of the equation we will in a future article look at the LTV side of the equation.

This article is a mashup of some of the elements in two excellent articles that are available in more depth here and here.


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