How to build a profit making business?

LTV and CAC

Revenue means money that customers will pay in the entire course of their lifetime to the business; costs include all that is incurred to make sure customers pay to the business.

Instead of using revenue, let’s use the term CLTV/LTV= Customer Lifetime Value or simply lifetime value

CAC= Customer Acquisition Cost

For any business model to be successful

LTV>CAC

To figure put a scalable profit-making model, simply put, we need

  1. To find customers at scale
  2. To make more money from them than the cost incurred to acquire them

Customer acquisition cost is defined as the cost incurred by sales and marketing team to acquire customers. It is generally taken as the sum of the cost of salaries, marketing spends, agency commissions, media spends, etc; the total cost of the marketing and sales team.

Lifetime value of the customer is the gross margin associated with the customer over their lifetime. For businesses with one-time fees, it is pretty straight forward. For businesses with recurring subscription revenue, this needs to be calculated basis the monthly revenue and churn rate in the month.

But we have only taken marketing costs here. There are other functions as well like Product development, engineering, finance, etc. At the business level, we need to include these costs as well while calculating the CAC. Hence, for a business to be profit making LTV should be greater than CAC by significant multiple.

From the marketing perspective, the question is

how to reduce CAC and increase LTV.

 

Some of the ways are outlined:

Reduce CAC

  1. Virality

    - Bringing customers without spending marketing monies. Businesses have seen rapid growth emails, messaging apps, blogs and social media. Some examples being Facebook, Youtube.

  2. Inbound Marketing

    - As per Hubspot, “It is the process of creating and sharing relevant content. By creating content specifically designed to appeal the customers, inbound attracts qualified prospects to the business and keeps them coming back for more.” This also in a way leads to viral growth if inbound marketing is done the right way keeping customers interest in mind.

  3. Free/Freemium model

    - The product/service offered for free should be of high value to the customer so that they should be ready to play after sampling. This should result in high customer satisfaction and ripple effect leading to virality.

  4. Strategic partnerships

Increased LTV

  1. Recurring revenue

    - Predictable revenue over time. But it starts slowly.

  2. Cross Sell/ Upsell

    - Acquiring a new customer is more expensive than retaining one. Hence, cross-sell and upsell to existing set of customers will help in increased LTV.

  3. Product Line extension

    - Adding more product lines related to what you are already selling so that you can cross-sell/Upsell.

Increased CAC

  1. Sales team

    - It only makes sense for larger deal sizes, predominantly in a B2B segment. Considering the long sales closure cycles, face to face relationship building process, the scale is limited.

  2. Outbound Marketing

    - Outbound marketing is push marketing where we are driving awareness about the product/service and hoping it will result in the customers. This is an expensive strategy to implement.

 

Will talk in depth about calculating LTV and each of the business models in subsequent posts. Keep looking!

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