Over the past 20 years, there is one key element of startups that I was a bit backward in understanding; and used other words to describe it. During the fast few years though, there has been lots written about the two most critical variables.
Twenty years ago the most important phrase was “cash is more important that your mother”. That is true for business. I have seen lots, and experienced a couple where we did not focus properly on the money.
This article is taken from ForEntrepreneurs. http://www.forentrepreneurs.com/startup-killer/ so go to that site for more information. In summary:
In it, David Skok proposes 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)
Read the article directly, or download the pdf and excel files.
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.
Un-Balanced CAC / LTV
A balanced CAC / LTV
What drives That Balance
Startup Killer_ the Cost of Customer Acquisition _ For Entrepreneurs pdf file to read if you can’t get to Davids site.
There are a couple of spreadsheets to download and use as well to calculate out these indicators.
If you are starting a business, ignore these concepts at your peril!