Startup Killer: the Cost of Customer Acquisition

In the many thousands of articles advising entrepreneurs on what they have to focus on to build successful startups, much has been written about three key factors: team, product and market, with particular focus on the importance of product/market fit. Failure to get product/market fit right is very likely the number 1 cause of startup failure. However in all these articles, I have not seen any discussion about what I believe is the second biggest cause of startup failure: the cost of acquiring customers turns out to be higher than expected, and exceeds the ability to monetize those customers.

In case you are not familiar with the importance of Product/Market fit, Marc Andreessen has a great blog post on this topic:  The Pmarca Guide to Startups, part 4: The only thing that matters.

In this blog, Marc argues that out of the three core elements of a startup, team, product, and market, the only thing that matters is product/market fit. I agree with Marc’s view that product/market fit is extremely important. However after closely watching several hundred startups that have failed, I observed that a very large number of these had solved the product/market fit problem, but still failed because they had not found a way to acquire customers at a low enough cost.

Business Model

I would like to propose that in addition to team, product, and market, there is actually a fourth, equally important, core element of startups, which is the need for a viable business model. Business model viability, in the majority of startups, will come down to balancing two variables:

  • Cost to Acquire Customers (CAC)
  • The ability to monetize those customers, or LTV (which stands for Lifetime Value of a Customer)

Successful web businesses have long understood these metrics as they have such an easy way to measure them. However there is a lot of value in looking at these same metrics for all other businesses.

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.

image

It doesn’t take a genius to understand that business model failure comes when CAC (the cost to acquire customers) exceeds LTV (the ability to monetize those customers.

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

image

Since the above two diagrams are so obvious, you may wonder why I have included them. The goal is give the reader a sense of the balancing act required to create a profitable business. Hopefully the value will become more obvious with the third version of the diagram that shows the different factors that affect the balance.

Another reason for stressing the point using diagrams is that many entrepreneurs have realized that since the web provides some amazing new ways to acquire customers at low cost, several new businesses have become possible. The only thing that you have to consider is can you monetize your customers at a higher level than the cost to acquire them.

The Entrepreneur’s Achilles Heel: Optimism

To be an entrepreneur requires great optimism, and a very strong belief in how much customers will love your product. Unfortunately this same attribute can also lead entrepreneurs to believe that customers will beat a path to their door to purchase the product. This frequently causes them to grossly underestimate the cost it will take to acquire customers.

A common scenario is an entrepreneur that has dreamt up a cool new service that they can offer via the web. As a VC, I have sat through many presentations like this, and in most cases the service is actually interesting and compelling. However in the majority of these presentations there is little or no focus on how much it will cost to acquire customers.  As I ask questions to understand the thinking, what usually comes out is something vague along the lines of web marketing, and/or viral growth with no numbers attached.

A quick look around all the B2C startups shows that, although viral growth is often hoped for, in reality it is extremely rare. When it does happen, the associated businesses are usually extremely attractive, provided they have a way to monetize their customers. (For more on the topic of Viral Growth, refer to my blog post on that topic here.)

Far more common is a need to acquire customers through a series of steps like SEO, SEM, PR, Social Marketing, direct sales, channel sales, etc. that will cost the company significant amounts of money. What shocks and surprises many first time entrepreneurs is just how high the numbers are for CAC using these kinds of techniques.

Some examples of CAC calculations

For example, if you are using Google Ad Words to drive traffic to your site, take a look at the following interactive spreadsheet. This example shows a cost per click of 50 cents, and the resulting website visitors converting to a trial at the rate of 5%. Those trials are then shown converting to paid customers at the rate of 10%. What the sheet shows is that each customer is costing you $100 in just lead generation expense. For many consumer facing web sites, it can be hard to get the consumer to pay more than $100 for the service. And this cost does not factor in the marketing staff, web site costs, etc.

simple-CAC

(To access the spreadsheet, please click here.)

One of the more interesting things that this model shows is how rapidly cost of customer acquisition climbs If your leads require human touch to convert them, (compare cell B23 with cell B22.) This human touch can be as light as email follow ups, or as much as inside sales people doing multiple sales calls and demos. I have seen this cost vary from around $400 to $5,000 per customer acquired, depending on the level of touch needed.

Another shocking computation is to look at the cost of a direct field sales force:

direcs-sales-CAC

(To access the spreadsheet, please click here.)

This shows is that it is not unusual for the cost of acquiring a customer to be as high as $100,000. This number is heavily dependant on the productivity of your sales teams. In the model above, this was set to 10 deals per year per team. Given the need to cover R&D and G&A costs, the average gross margin on a deal needs to be at least $150k.

Lessons Learned – Business Planning Stage

My advice to entrepreneurs working on a new business plan is to build a model similar to those above to estimate the cost of customer acquisition. This is going to show you the dependency on several critical variables:

  • Cost per lead
  • Conversion rates at each stage of your sales process
  • Level of touch required

Then compare this to your expected monetization. As a very rough rule of thumb here are two guidelines that you might find helpful:

  • LTV > CAC. (It appears that LTV should be about 3 x CAC for a viable SaaS or other form of recurring revenue model. Most of the public companies like Salesforce.com, ConstantContact, etc., have multiples that are more like 5 x CAC.)
  • Aim to recover your CAC in < 12 months, otherwise your business will require too much capital to grow. (Banks and wireless phone companies ignore this rule, but they have access to tons of capital.)

In the early days of the business, you will not be able to accurately predict your conversion rates, and the viability of your entire business may depend on this. So I recommend building an execution plan that focuses on finding out what these numbers will be as soon as possible in the lifecycle of the business. Good numbers will enable you to raise funding easily, and bad numbers may indicate that this is not a viable business.

The good news is that if you can monetize your customers at a higher rate than the cost to acquire them, you probably have a great business on your hands.

Next Generation Business Models

Because a number of smart entrepreneurs realized the importance of lowering CAC, they created new business models such as Open Source, SaaS, Freemium, etc. that directly tackled the problem of acquiring customers. Some of the early B2B pioneers in this space were companies like JBoss (story here), SolarWinds, ConstantContact, HubSpot, etc. Once others started to see the success these companies were having, they started copying the techniques.

These new business models focused heavily on how buying behavior has changed because of the power of the web. Think about your own behavior: if you are like me, you hate having to deal with sales people, and greatly prefer to do your own research starting with search engines, and leveraging free trials, on-line videos, blogs, reviews, and your social network. To adapt to this, the new business models make use of a variety of techniques described below:

  • Extensive use of the web to drive lead flow. In particular, the best practices include using Inbound Marketing to build traffic, instead of paying for traffic with search ads. (Read Get Found using Inbound Marketing to find out more.)
  • Use of a free product or service to attract web visitors, and aim for a viral spread as they tell their friends. Examples of free products include Open Source software, services like HubSpot’s Website Grader, free versions of a SaaS service that have limited, but still valuable, feature sets, etc. For more info on this topic refer to The power of Free.
  • Use of a free trial, where the customer can easily download, or use a SaaS version of the full product to see if it works for them.
  • Leveraging the power of your customers’social networks to get viral growth where possible.
  • Use of the touchless conversion to convert trials to paying customers.
  • Using low cost inside sales when the touchless conversion is not possible.
  • Extensive use of software to automate all processes such as SEO, SEM, social networking, lead scoring, lead nurturing, CRM, etc.
  • Metrics on all aspects of the customer acquisition process to find out what can be improved.

These techniques are frequently referred to as the Low Cost Sales model, or as Sales 2.0.

Balancing Monetization with CAC

The way in which these techniques can work together with other techniques to drive up monetization (e.g. recurring revenue) are illustrated in the diagram below:

image

Lessons Learned – Ways to reduce customer acquisition costs

Conversion rates play an extremely important role in your customer acquisition cost. Anything you can do to improve conversion rates is obviously a good thing. For more on this topic, please refer to the Building a Sales and Marketing Machine part of this web site.

  • Consider using A/B testing to improve conversion rates. Web traffic can be easily split so that parts are fed to different landing pages with different offers, and the resulting conversion rates measured.

Look at the level of touch required to complete a sale. Some products are easily understood, while others may require a careful walk-through by a sales person. Sometimes, the customer will want a trial with their own data. With certain complex products, this will need an on-site installation by a sales engineer, which sends costs through the roof. Consider every possible way to minimize this. For example:

  • Create demo videos that answer every likely sales question.
  • List the common sales objections that come up in the sales cycle, and provide answers to these on the web site.
  • Try using customer references to avoid the need for a trial
  • If your customers are going to compare you to the competition as part of their process, consider doing this for them, with a section of your site that has a comparison matrix with appropriate check marks.
  • If you have a light touch sales model, consider setting yourself the goal of a “Touchless Conversion”, i.e. getting rid of, or minimizing the touch required to close the sale. As shown in the model, this has a huge impact on cost of customer acquisition.

Options for products requiring high touch

The toughest business models are those that employ expensive field sales organizations. The high salaries and commissions for sales people, sales engineers, travel costs, and office costs add up to an extraordinarily high figure. And this is before you factor in the failure rate (the percentage of sales people hired that don’t become productive). It is not too surprising that VCs are not aggressively pursuing these kinds of businesses. There are some ways you can look to address the problem:

  • If you are currently using a field sales organization that sells direct, look at whether it is possible to sign up OEM deals with strategic partners to leverage their customer base and distribution power. What generally works best here is allowing the OEM to sell only a base layer of your product with co-branding. Then you can go back into their customers and upsell them. Owning the customer base is an important way to control your own destiny, and will also earn your company a higher valuation. In addition to distribution power, these kinds of relationships solve the “safe choice” concern of many buyers, and can transform your business.
  • Consider converting to a channel sales model at some stage in the lifecycle of the business. Many times this requires that you “prime-the-pump”, as most resellers won’t sell a product until they see clear customer demand. Channel sales models usually only work when the company commits to them fully, and passes all orders through the channel, so be prepared for the loss of margin this will represent to your current order flow.
  • Another option is to evaluate whether you can move from field sales to inside sales people. Insides sales people are not only less expensive in direct salary costs, but also in travel costs. Other advantages of inside sales people is that they are far more efficient due to remaining in one location, and can contact more people in a typical workday. At a minimum, look at combining inside sales with field sales to improve the efficiency of field sales people.

Conclusions

If you are entrepreneur planning your next business, you can’t afford to ignore the cost of customer acquisition. The earlier you work on this the better, as many of the best techniques require you to build your product differently.

It is also important to ask yourself the question: can my business realistically expect to acquire customers for considerably less than the amount that I can monetize them?

Once you have completed the product, you will want to familiarize yourself with all the latest techniques involved in the low cost sales model, or Sales 2.0.

From a funding standpoint, it is useful to know that your ability to raise capital will dramatically improve as soon as you have proven that you have a viable business model. Think of that as two equations:

  • CAC < LTV   (3x appears to be a rough minimum for SaaS businesses)
  • CAC should be recovered in < 12 months (for subscription businesses)

Once you have proven out the business model, hit the accelerator pedal, and invest as much as you can afford. You’ll want to grow the business as fast as possible before a competitor realizes what you have done, and tries to steal your market!

Follow on Blog Post

If you found this blog post useful, I highly recommend reading the following post which adds a lot of additional thinking around this topic: How Sales Complexity impacts your Startup’s Viability.

Acknowledgments

I would like to thank the management teams at JBoss and HubSpot, Gail Goodman of Constant Contact, Sheila Marcelo of Care.com, for contributing greatly to the ideas in this post.

- David Skok

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  • http://www.1stpagekillerearningsreview.com 1st page killer earningsreview

    Nice blog.
    Thanks for this information.

  • Evan

    When you look at CAC, do you divide your marketing investments by all the customers acquired in a spending period or only the ROI on customers that you directly pay to acquire through program spend?

    I can’t seem to find this in the article, but I imagine that it’s the blended average that matters; that the ROI on each source determines the allocation of budget, but not the actual budget. So if you generate a lot of word-of-mouth business, you can afford to spend more on a per customer basis with program spend because you can average it with the near zero cost of the viral lead gen. But if you’re getting zero organic sales, then every customer must have a positive CAC. Or do you suggest that you ignore the organic business in your denominator and make sure program spend / program customers is positive CAC at all times?

  • http://www.forentrepreneurs.com David Skok

    Evan, Great question. The blended number is the right one to look at for CAC. However the other number, for paid acquisition customers only, is also very useful to understand. What I have seen with most businesses I have looked at is that when they increase their marketing spend, they usually end up getting an increase in their organic traffic, so the blended CAC remains roughly the same. However if you are in a situation where you don’t think that will happen, (i.e. more sales driven, than marketing driven expenditure to increase sales), you will want to know if you get a positive ROI on your paid acquisition customers before hitting the accelerator pedal and investing more in that area.

    So to summarize the answer: you should aim for a positive ROI on your paid customer acquisitions in all situations unless you are sure that your paid efforts are also directly contributing to your unpaid leads. Otherwise you don’t have a model that you can scale by investing more.

    I hope this helps.
    Best, David

  • http://twitter.com/pricingright Rags Srinivasan

    David

  • http://twitter.com/pricingright Rags Srinivasan

    David
    I agree with the need for understanding CAC and most of your arguments.
    Your model does fixed cost allocation to acquired customers. While SEM costs can be treated as marginal, the employee costs are not unless you are only including commission paid per customer.
    -rags

  • http://dlvr.it/ Bill Flitter

    Great blueprint.

    I would add, if you do have a SAAS product that doesn’t require a lot of hand holding to get started, focus on improving the sign-up process including the landing pages, information on the website and balance quality sign-ups with ease of sign-up. We have seen big gains in changing simple words, adding a ‘how to’ video, removing steps in the sign-up process etc. This will lower your cost per customer dramatically. And remember, it is not one time thing, it is an ongoing process and requires constant tweaking.

    Also track each outbound advertising program you do. Make sure you know the cost per acquisition for Adsense vs. Facebook for example. Create specific landing pages if you find each audience responds differently.

    Happy New Year!

    Bill Flitter
    CEO/Founder
    Dlvr.it

  • http://www.forentrepreneurs.com David Skok

    Rags, I believe that the point you are making is that employee costs are a very significant part of CAC. I strongly agree, and make that point in the post, and in the spreadsheets. I have also covered that in this post:

    http://www.forentrepreneurs.com/sales-complexity/

    I hope I understood the point you were trying to make.
    Best, David

  • http://www.disneyadventures.net disney adventures

    Very Useful stuff, thanks for the post!!

  • Marcia Weeks

    The idea of ‘knowing’ to reach the ‘right’ customers.HOW would I accompolish ‘that?”

  • http://www.forentrepreneurs.com David Skok

    Marcia, I couldn’t quite understand your question. Could I ask you to rephrase it so I can try to help. Thanks, David

  • http://twitter.com/StartUpAndGoBiz Matthew Crossett

    Thanks for the great article – great information for new customer acquisition. Just posted something similar – would love to hear your thoughts! If you ever want to link up sometime over GoToMeeting to talk about a possible collaborative article, let me know!
    http://takecareof.biz

  • http://www.forentrepreneurs.com David Skok

    Matthew, I read the post. Spot on! Thanks, David

  • http://www.bleckdesigngroup.com Jbleck

    Hi David,
    Great article and should be read by any start up or operating business. You might remember me from your first US start up.
    We are using Hubspot and it is a great small business tool – love it.

    Small business viewpoint
    We track all our sales and marketing costs by the type of effort and we divide total revenue resulting by the cost = CAC. No one type of marketing or sales can yield enough customers. Also, tracking the timing of the marketing cost to the revenue is needed to create the “pipeline” cost. This is the cost before the sales start. You need to know this cost, as it prevents you from cutting the legs off something that works sporadically (trade shows). Plus you can see a high short term cost with near term sales in context (in-person sales). Any single sales/marketing event can look extremely expensive when the sale happens a year later, but over time might be very effective.

    We are a service business (design services). Some examples: Inbound via Web: 3-5% of resulting sales, telemarketing 20% of resulting sales, trade shows 25% of sales, referrals and customers 0% of resulting sales. What 0% of sales? We multiply % of repeat sales x the total cost of the all marketing and sales. 50% repeat x 25% = 12.5%. Budget a total cost for marketing and sales – say 10% of gross revenue and measure over time the effectiveness. This puts customer service cost in the context of sales. If it costs $10,000 to acquire a customer, why not spend that to retain them?

    Visionaries: We have designed many products and the most successful companies can specifically describe their customer and reason for using their product now, and at a profitable price. The successful companies describe their sales target in one sentence. The unsuccessful companies have very blurry descriptions of the customers, or they plan on some other entity selling them, and you can’t find any real person saying “I will buy that”.

    Free: Free trials might be good for role out marketing, but knowing the tolerable price can only be known by attempting to sell and close a sale. Many mistakes in product development are made by not testing real prices on customers early, and making sure the prices have the right gross margins built in. Development teams might be wasting money on cost reduction that are not needed, or validating a product that is too expensive, or polishing something that is great today, or designing for customers that will be great in three years, but won’t buy at today’s price.

    Jim Bleck

  • Jay Revels

    David,

    I’m way late to reading this form the original post but that certainly doesn’t detract from the value of the article. Thanks a million.

    Question for you: Over a year later from the date of this post, do you still believe that these SaaS companies can really by pass traditional high touch sales’ models? I’m in sales at a small open source company and yea, we generate leads, but rarely are they qualified and the number of touches to closure is high. How do you feel about outsourcing lead gen and inside sales? With rising costs of employee benefits etc I would think these services should increase in demand.

    http://www.readwriteweb.com/enterprise/2010/11/enterprise-consumerization.php

    Thanks,
    Jay

  • http://www.forentrepreneurs.com David Skok

    Jay, Not all SaaS companies will have light touch or no-touch sales cycles. It all depends on how complex the sales cycle is, and while SaaS can simplify one aspect of the sales cycle, it may not always lead to light touch selling.

    I wrote another post on the topic of Sales Complexity, that discusses what factors lead to a need for higher touch in the sales cycle, and the impact that has on selling costs. It can be found here: http://www.forentrepreneurs.com/sales-complexity/.

    Regarding outsourcing lead gen and/or inside sales, I believe you are only in a position to outsource this if you have figured out how to do it successfully yourself. Otherwise you will not know how to train the people who are doing the outsourcing. Perhaps they may have more expertise than you in the lead gen area, but it is highly unlikely they will be able to do the inside sales job until you have figured out the process, messaging, objection handling, etc., and can train them.

    I also think that investors will consider your sales and marketing abilities a key skill. If they were outsourced, they are likely to value the company lower.

    I hope this helps!
    Best, David

  • Hoho

    It seems that we have no more access to the spreadsheets…

  • Ryanb

    Thanks for the post. This is very helpful.

  • Ryanb

    I have a question about LTV.

    With a subscription (SaaS) model how do you determine the length of the “relationship”?

    For example if we charge annually and for the most part do not enter in mulit-year contracts BUT have 99% of our clients for at least for 5 years. Do we look at just the first year annual gross margins? Or do we take the average length of a contract and use that as the length of the “relationship”?

    It would be interesting to see both but I am just wondering what others do. Thanks again for the post!

  • http://www.forentrepreneurs.com David Skok

    Ryan,

    The length of the contract does not matter when figuring out LTV. It is the length of the relationship that matters. It looks like you know the lifetime of your customers, but just in case not, to calculate that, you simply divide 1 by your annual churn rate. (i.e. if your annual churn rate was 20%, then you would have an average 5 year lifespan.)

    Let me know if this isn’t the answer you were looking for.

  • Benevans100

    Any chance of getting the interactive spreadsheet re: CAC calculations. It’s not imbedded in the blog (anymore).

  • http://www.forentrepreneurs.com David Skok

    My apologies for the problem. WordPress deleted the links when in WYSIWYG editing mode. They are now restored. Thanks for highlighting the issue.

  • http://www.facebook.com/people/Paul-Giles/100002046638154 Paul Giles

    How would you apply CAC for products where the customers are required by law to buy/use the product?  

  • http://www.forentrepreneurs.com David Skok

    Paul, even if they are required by law to buy the product, it will likely still cost you money to create awareness of your company, and explain your products to them. There may also be competitors creating a more complex sales cycle.

  • Chris

    Hi, thanks for the interesting  article.  Can you point out acquisition costs (ranges) from other internet companies to understand the ranges that exist for different types of companies?

  • http://www.forentrepreneurs.com David Skok

    Chris, take a look at my other blog post on how Sales complexity impacts cost of customer acquisition here: http://www.forentrepreneurs.com/sales-complexity/

  • Gregory

    Hi David,

    I’ll start by saying that I am new to marketing. 
    I am a first-time entrepreneur who is simply trying to come up with a profitable business model & monetization strategy for the technology I thought up, and the value/pain it addresses…

    The business model I am pondering seems to have a good LTV-to-CAC ratio (LTV = 6.5*CAC) and CAC does pay off in 9-10 months.
    However, there are other problems that make my business model unattractive:
     
    My business model involves brokerage between small businesses (paying customers, touchless conversion) and end-consumers (freemium) who generate demand for my Service,
    and by far the largest expense seems to lie not in the area of “paying customer” acquisition (CAC) but rather in the area of consumer acquisition (excluded from CAC). 
    This is because the amount of consumers I need to acquire to become profitable is measured in millions and tens of millions.
    Realistically speaking, such a business model will not be profitable UNLESS viral growth is achieved because I cannot afford spending money on consumer acquisition.
    Interestingly, I cannot afford spending money on consumer acquisition REGARDLESS of the amount of capital available. 
    This is because the revenue stream generated by an individual consumer is so small (0-15$ annualy) that it will be hard to make a profit and cover the cost of investment.
    As far as classification is concerned, I would attribute my problem to Operational costs.
    Another way of looking at it is that both, end-consumers and paying service vendors ARE customers –  it’s just that I am only monetizing the latter segment…

    What do you make of this problem? Are there ways to mitigate it?

    P.S.
    I have read your other articles and the one on Sales Complexity seems to offer an explanation.
    However, it was written with B2B in mind and I am wondering how applicable it may be to my situation.

  • http://www.forentrepreneurs.com David Skok

    Hi Gregory, it sounds to me like you have a two sided marketplace, and need to acquire two types of customers to make it viable. That means that you have to take into consideration the CAC for both the consumers and the small businesses. As you rightly point out, your business will be likely be rendered non-viable by the cost of acquiring the consumers. The only way to solve this problem would be to figure out something like a viral, or other very low cost consumer acquisition strategy. Virality is unfortunately very hard to achieve. Most consumer internet startups want virality, but only a small number actually ever achieve it. There is another article of mine on this topic here: http://www.forentrepreneurs.com/the-science-behind-viral-marketing/.

  • Gregory

    Thanks David.
    I think you used to have an article under this link but now there is just the slideshare content. …The content is great, don’t get me wrong, but the article about virality was also a big help.

    Regarding your comment – yes, I agree with what you are saying but it seems, the most potent way to proceed for me would be – by establishing and selling a working “prototype” of the service (e.g. a service on a local scale) to those big companies who already have the customer base necessary. All they would need to do to monetize it is – scale it out, simplistically speaking.

    Virality seems to be a high-risk route to success…

  • http://www.forentrepreneurs.com David Skok

    That makes sense if you can get those companies to market this to their customer base. That’s a very powerful way to get to customers. Best of luck with it!
    (The old virality post is still there! http://www.forentrepreneurs.com/lessons-learnt-viral-marketing/ )

  • http://www.webhostings.in/ web hosting companies

    Everything is very open and very clear explanation of your topic.

  • http://financialstatementschool.com/2012/03/05/duration-of-lifetime-value-ltv.aspx Kenpirok

    LTV also has “duration”.  In other words, duration is a measurement used to calculate the weighted average amount of time that it takes for the LTV to be realized.  Duration is borrowed from finance and bond pricing, and it simply measures the timing of the LTV.

    http://financialstatementschool.com/2012/03/05/duration-of-lifetime-value-ltv.aspx
     

  • http://www.forentrepreneurs.com David Skok

    Very true, and a highly important factor.

  • Biplabpal

    I fully agree. That’s why I am working on an Marketing ecosystem model for the start-ups. We have a way to reduce their customer acquisition cost by 70% and risk of bad marketing ROI by 90%. I have 12 start-up companies now and having fun!! Basically a start-up should know how to i) position their product in the market ii) build their beta case studies strong iii) focus on direct lead generation than on spending on marketing iv) create a strong mutual marketing strategy in their ecosystem v) and they have to find a sweet spot with low hanging fruits.  vi)  do not spread thin in marketing-focus on those opportunities which are more near term vii) must have some good PR in the target communities.  All of these activities can be nicely organized by building a micro-social network of the potential clients.  This can be real as well as virtual.I start with lead generation first- that campaign actually exposes all the weakness and helps sealing all the points I have mentioned above. Question is at what cost? Cost can be reduced if it is done in an ecosystem manner and much of the functions are outsourced to cheaper destination. 

  • http://www.futurebooks.com.sg/ Futurebooks

    Thorough explanation. One of the better ones I have read. Cost of acquiring a customer, number of customers acquired in a period of time and the lifetime value of the customer are important financial assumptions in a business plan.

    In a lot of business plans we read, these values are buried somewhere in the financials. Do the investor a favour and highlight these in the executive summary. You can have a great idea that solves a significant customer problem. However, if you under estimate COC, you can run out of money and ultimately fail.

    It is easy to underestimate COC. Companies do market research which tells them the customer loves the product, price and value proposition. However, when it comes to asking them to switch from the competing product, the customers don’t come running.

    Even if the new product is better and priced cheaper, it may not be enough to dislocate a customer from the incumbent.

    Promotions becomes key, and these costs can increase COC substantially.

  • Ali

    Thank you! After struggling for months to find a simple straightforward definition of CAC and LTV, you defined them for me! Appreciate it.

  • Sesbons

    Great post. Really informative. On your first spreadsheet I’m a bit confused. Is your CAC figure for the acquisition of all 50 customers a month, or is it for one of the 50 customers?

  • http://blog.androidhr.com/ Alex Hagan

    This is a great article. I particularly like the “what can drive the balance” graphic… simple and effective. Many thanks.

  • http://www.poweredbysearch.com/ Dev Basu

    There are some real gems in here in terms of smart (almost headsmacking) ways to reduce CAC. We’re currently in the process of adding FAQ modules to every service page on our website so that common customer objections and questions are addressed up-front.

  • Murthy

    a timely one for me. we are into cloud telephony solutions for indian market. we built a good customer base purely based on referrals and through developer community. We found VCs specially in India worried about Cost of Acquisition as we are in B2B space and SMB/SMEs in India are not that wired to internet. Great one. Atleast this will help me in my execution if not VC funding :-)

  • Dave

    I know this post is a few years old but good material doesn’t go out of style! When you are calculating Customer Acquisition Cost do you use the budget of the lead source/client of the current year or of the year when you acquired the lead/client?

    For example: I generated 4 customers from a trade show in 2010. We spent $10,000 on the trade show, but we didn’t close them until 2012. So should I go back for each deal and use the marketing spend of the year when the lead was acquired (2010) or is that not worth it and that in the end, with enough data and activity things will iron out and that I should just use 2012 marketing spend vs 2012 deals since that is when we acquired the client.

  • Anagha

    Sorry…I’m here very late. The zoho links don’t work anymore. Can I get these spreadsheets via some other source?

    Thanks in advance,

    Anagha

  • http://www.forentrepreneurs.com David Skok

    I have just updated the links underneath the place where the embedded sheets should appear, so those should now work. Sorry for the inconvenience.

  • Stan Crawford

    Marcia-

    I don’t want to put words in David’s mouth but here is my take on your question. Knowing how to reach the right customers means knowing and understanding your products market and the type of people or businesses that use it.

    For instance: If you have a SaaS idea for commercial construction, project management; would your customers be Architects, General Contractors, Subcontractors or maybe a mix of all those categories? With a bit of research you can find a lot of information to determine who your customers will be.

    I realize that answer seems a bit obvious; however, sometimes obvious gets looked over. Before you know it, you have a slick product and find yourself lost to who you should be marketing to.

  • http://www.forentrepreneurs.com David Skok

    Good reply Stan. Thanks.

  • Chris Ian Fiel

    Thanks for the article. Love it! :) keep it up

  • Terry

    Dave, I happened onto your discussion, sobering. My situation: extremely competent commercial real estate expert, several business plan submissions over the years, but no one wants a service business startup like brokerage, asset management, etc. The ROI is huge, commissions in the hundreds of thousands. I have a plan, but with 99% of money going to tech, I should have earned an MBA instead of an MS in RE finance. Any ideas or commentary would be appreciated. http://www.linkedin.com/in/terryburka

  • http://www.forentrepreneurs.com David Skok

    Unfortunately there is not much I can say to help you here. I think you have realized the issue: people prefer to invest in product companies where there is a multiplier and intellectual property. Perhaps you can use your knowledge of real estate to figure out an unmet need in that area?

  • http://twitter.com/ramin Ramin

    link broken: The Pmarca Guide to Startups, part 4: The only thing that matters. -> new link: http://caps.fool.com/Blogs/the-pmarca-guide-to-startups/410455

  • http://www.forentrepreneurs.com David Skok

    Thanks. I will fix. Appreciated.

  • Jeffrey Feuer

    My 20 year old firm runs an inside sales incubator where we A/B test different approaches for entrepreneurs having difficulty penetrating the market. In most every case the product is compelling yet reaching decision makers and persuading them to try it is difficult and costly. Kudos to you for identifying this problem and explaining it so well.

    it does not matter how good your mousetrap is if the cost to sell it exceeds the price a customer will pay. Good testing will try various approaches to minimize the time to sale and maximize what the customer will pay.