So all of you who read this blog probably know: If your LTV is larger than your CAC your company basically can’t fail, right??? B*#@$#++!!!
See what people tend to forget, these generalistic statistical assumptions only work with basically unlimited population sizes (Population size as in your stats class…not inhabitants of your village). An example would be: “App download costs on Facebook“.
But what if your inputs are based on a finite population size? Example:
Imagine the following scenario common to a lot of B2B businesses: You rely with your advertising on sales reps and these sales reps, in turn, have to sell to a finite number of business customers of let’s say, 1,000 potential total customers. Now lets further assume your market is geographically limited. While this makes things easy for you in a way, it also means your sales reps can probably plow through a good amount of potential customers each month. Heck, they might call and meet maybe 10 potential customers a day. If only 1 of these 10 customers bites, your measly looking 10% conversion rate will generate maybe 20 sales per rep each month! If all you do in terms of advertising is sending your sales reps around and you pay these guys I don’t know a handsome USD 10,000 a month then your CAC is US$500.
Not a pretty CAC, but all depends on your LTV, right? Well, what’s your LTV then?
Your LTV (and yeah there are tons of ways to manipulXXX…errr… calculate this) is essentially Gross Profit divided by the Churn for the same time frame.
E.g. you sell software on a yearly subscription basis, then you take your yearly gross profits per average contract and divide it by the early churn.
So if your software costs US$1,000 a pop and your churn rate is anywhere close to healthy territory, which means 10% or less, then your basic LTV is US$10,000.
So your LTV:CAC ratio in this case is 20x!!
REALLY NOT BAD!!
So what’s the problem then?
Welllllll… let’s go back to my original statement, LTV:CAC only works well where your assumptions rest in essentially unlimited population sizes. That means you are too small to buy the entire advertising market and/or there are so many potential customers that you can’t possibly talk to all of them etc.
In our case, this is clearly NOT true! A thousand customers are clearly a finite market! In fact, your hard-working sales reps will be able to bulldoze through 200 leads to arrive at 20 conversions EVERY SINGLE MONTH. That means after a short few 5 months in this example, a single sales rep would have talked with literally EVERY SINGLE POTENTIAL CUSTOMER! Your LTV:CAC would continue to look amazing – right until you run out of potential customers and your CAC goes to infinity!
All too simplistic you say? Nobody only has 1,000 customers! Well, that’s really a question of your market: End consumer businesses can have millions of customers, B2B companies like mass-market SaaS businesses can still have tens or hundreds of thousands of customers and industrial products or even highly specialized software vendors might only have a few governments to sell to.
While your LTV:CAC still means your customers generate more money then it costs to advertise to them, it might just not be enough to pay for your company’s operations. In our little example, this company can only earn a max of US$100,000 per year as we can only dream of one hundred customers. If that’s not enough for you (and it likely isn’t) you need to charge more or somehow increase the market size.
The conclusion is two-fold:
- If your advertising and/or addressable market size is finite, LTV:CAC can be severely misleading
- Any finite customer population product needs to really think of pricing. Its not enough to provide value to your customers, if you can’t charge enough to pay for your bills (and your sportscar)
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