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SaaS Economics

December 20, 2012

CIR SERIES: BUILDING YOUR ONLINE BUSINESS

Saas Economics

Welcome back! Let’s quickly recap the story so far.

Step 1: Plan and build a great Software-as-a-Service, or e-commerce site.

  1. Define a customer-centric product concept;
  2. Create a workflow to optimize the user experience;
  3. Test your product concept before you build it.

Step 2: Optimize your landing page.
Step 3: Improve your conversion from unqualified to qualified by becoming more trustworthy.
Step 4: Generate lots of leads

Previously, we explored the gamut of lead generation strategies available to online businesses. But clearly, all lead generation strategies are different and some are better than others.  This week, we’ll explore the economics of lead generation and it’s impact on your sales and marketing budget. Specifically, I’d like you to answer the question: How much should I be spending on customer acquisition?

THE ECONOMICS OF LEAD GENERATION

To start with, let’s define some key terms (see here for more information):

Average Sale Price (ASP): The average amount spent by your customers on your website.

Let’s say that a typical customer spends $100/month on your website. ASP = $100/month

Customer Churn Rate (CCR): The percentage rate at which customers stop buying your service.

Let’s say that 1000 people sign up for your service and 120 cancel the service within the first 6 months.  CCR = (120/1000)/6 = 2% per month.

Life Time Value (LTV): The expected lifetime revenue per customer

LTV = ASP/CCR

Let’s say that a typical customer spends $100/month on your website and the Customer Churn Rate is 2% per month.  LTV = $100 / 2% = $5,000

Customer Acquisition Cost (CAC): Your sales and marketing costs to acquire a new customer.

For a sustainable and growing business, your CAC should be less than 33% of your customer lifetime value.

CAC < LTV/3

If your LTV is $5,000 then a sustainable business would have a customer acquisition cost of $1,667.

Any sophisticated investor will ask you these numbers.  Know them off the top of your head.  If you are pre-revenue, they’ll ask your expected values. When they look at your financial assumptions, they’ll study these numbers carefully. If you have revenues already, they’ll ask for your metrics.  Work with your CIR to calculate and present this information most effectively.

Now back to your sales funnel statistics we worked up a few weeks ago here and here.

Let’s say that 1,000 people hit your website; 300 people reach the qualified stage; 10 try your product; and 1 customer buys your product.  Continuing with our example, above, you can afford to spend up to $1,667 to acquire that one customer. Which translates into a budget of $1.67 per visitor to your website.

If you want to generate $1M of new revenue, your lead generation budget should be ($1,000,000 / LTV) * $1,667 = $333,400.  (Note that this $1M is over the customer lifetime.  You can use a modified formula to calculate your lead generation budget based on yearly revenue from new customers. Revenue_Target / Annual_Revenue * CAC.

Using this model:

How much should you be spending on lead generation today?
How much are you actually spending on customer acquisition?

I’m guessing that you need to invest more in customer acquisition.

Talk to your CIR to measure your CAC, establish CAC targets and develop a plan to monitor and hit those targets.

I hope you enjoyed this series.

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