Last time, I covered the crucial metric Contribution Margin that guides Netflix’ decision making on content investment on a macro level. I would e.g. Given Netflix is very attractive for investors I will simply assume 8%. Or put another way, ⅓ to ⅕ LTV. You’ll often see a popular ratio mentioned when it comes to the relationship between CAC and LTV: LTV = 3xCAC (1) CAC = All costs related to acquiring new customers / number of new customers, (2) CAC = marketing costs / number of new customers. ROAS (Return on Ad Spend) is an important eCommerce metric. And how good or how bad are things? Customer-lifetime value and customer-acquisition cost ratio. You can back out some portion of it and allocate it to CAC (e.g. The 5 P's of to attract new customers and would like to determine his customer acquisition cost prior to his performance review. allocate T&D costs to the four buckets as such: 10%, 30%, 40%, 20%. Enroll now for FREE to start advancing your career! It has paid off: unit economics is what you need to know to profoundly understand the trajectories of innovative companies. It should generally include things like: advertising costs, the salary of your marketers, the costs of your salespeople, etc., divided by the number of customers acquired. CAC (Customer Acquisition Cost) refers to the expense you incur in compelling prospects to buy your products.It is a criterion increasingly being used, alongside the development of web organizations together with online marketing efforts that can be followed up. Below is information related to ABC Company’s marketing campaigns last year: The CAC for ABC Company over the last year is calculated as follows: CAC is a key business metric that many businesses and investors look at. Most sources will use (2a) as their definition, thus: (2a) CAC = marketing costs / number of gross new customers, (2b) CAC = marketing costs / number of net new customers. These initiatives include traditional marketing and advertising to digital marketing campaigns for community events and trade shows. That is what the metrics we are covering today try to help answer. Another very important metric is the average revenue per user (per month or per year). But I also realised the importance of unit economics and spent thousands of hours in my free time over a period of five years studying this. Note, the CAC of $94 applies to the US domestic segment. The most commonly used metric in this context is called Weighted Average Cost of Capital (WACC). There will be people who join for a month, binge watch a number of series and then leave. But then we still need to look further. This was very frustrating (I’m sure you know what I’m talking about). It is a similar and alternative profitability metric to ROI, or "Return on Investment". I suggest you use annual figures. Say the user sticks 30 months (this is the average across OTT services) with us but CAC takes 50 months worth of profits then we are still on a slippery slope. One thing that really annoyed me and vastly delayed my learning curve was the quality of examples. The 5 P's of. However, we could argue that some of the other costs should be also accounted for in these calculations. So, on average a new customer costs Netflix $94 to attract. Innovation: Every development and introduction of an innovation must be considered with an eye toward the cost factors. (5) Churn = Customers lost during the period / (Customers at beginning of period + Gross new customers during period). So, if a SaaS customer LTV is $1,000, then their customer acquisition costs should be in the range of $200 to $300 to stay competitive. The cost related to acquiring a new customer, Lifetime Value Calculation is the process by which a business measures the value of a customer to the business through the customer’s full lifespan, The 5 P's of Marketing – Product, Price, Promotion, Place, and People – are key marketing elements used to position a business strategically. the LTV). Customer acquisition cost (CAC) is the cost related to acquiring a new customer. This is a guess. Companies like Uber, Lyft, Netflix, Airbnb and many other spectacular start-ups use investor money to pay for the customer acquisition cost. Customer acquisition cost, or CAC, is a crucial metric to determining the success of your marketing campaigns. (5) Churn = (Customers at beginning of period + Gross new customers – Customers at end of period) / (Customers at beginning of period + Gross new customers). New customer = (a) gross new customers (b) net new customers, (a) Net new customers = Customers at end of period – Customers at beginning of period, (b) Gross new customers = Customers at end of period – Customers at beginning of period + Customers that left during the period. Additional cost drivers include customer acquisition and loyalty. (If you don’t believe the above formula is correct, just do the calculation, say, for the next ten years individually (apply the churn rate and discount rate for each year in escalating fashion) and add them up … and, voila, you will end up very close to the above formula). I have learned a lot of finance in the last 10 years of my corporate career working with many Heads of Finance. Number of new customers is the total number of acquired customers over the measurement period. Customer Acquisition Cost $633 Per New Vehicle Sold1 “It costs 10 times as much to obtain a new customer as it does to retain an existing customer.” Allocating costs to LTV means you reduce the profit per customer by a respective amount per user. Business model viability, in the majority of startups, will come down to balancing two variables: 1. Probably the most engaging and empowering "textbook" you will find on these often-dreaded topics (without being a "textbook" as such). Building confidence in your accounting skills is easy with CFI courses! I am explaining this in more detail here. 3. Why are we doing all of this? In marketing circles, Facebook is considered the most important platform for both B2C and B2B businesses. Customers are the lifeblood of any business. For example, product or process innovations Remember, though, it’s not just about calculating your cost for your B2B sales leads, but more about the Return On Investment (ROI) of your customer acquisition. Customer acquisition cost (CAC) is the cost related to acquiring a new customer. The customer acquisition cost works much the same way because of the focus on retaining a customer as long as possible — that means you can spend more on acquiring a customer than they’re going to pay you initially. In plain terms, CAC is a calculation of how much money it costs you to acquire one customer. Here are a few CACs benchmarked across a variety of industries. This is how it will look like: (2b) CAC[E2E] = marketing costs / number of net new customers. The case was dismissed as there is no official way for a churn calculation. Netflix has published annual churn rates only for a very short period 2008-2009. (9% in 2016, 19% for Amazon Prime and 20% average for OTTs) Same analysts think this was an increase of 1.9% (quarter-on-quarter, Q2-Q3 ’17) following a price increase of 10% that Netflix introduced in 2017. Stay tuned next time when we continue on this journey! Uber, Airbnb, TripAdvisor, Facebook, etc) which I have covered in extensive detail under those links. Netflix makes it very easy. When you’re looking to better understand your business’ cost of acquisition, there are many important SaaS metrics to understand. In the table above, we can see that Social Media provides the lowest acquisition cost while Social Events cost the most. It depends on the question you are trying to answer. About us: We share MBA-level innovation and business management knowledge with Entrepreneurs, Founder-CEOs, App Creators, Startups, Professionals, Executives, MBA Students/Graduates, Business School Professors and other smart people. The big picture is clear: Netflix is growing fast, domestically and even more internationally. Because some share of the T&D costs are being incurred to make the offering more attractive. But you could also calculate CAC for the net user growth (I’m calling this End-2-end or E2E CAC). But the Netflix Premium Resource adds to it in many ways: it fills the gaps in between the articles, adds more details & knowledge, it’s presented better, is updated and gives you 11 resources, templates and downloads with lifetime access. In this case: 8.3 months of revenues (with average monthly user revenues sitting at $11.4). With Churn, we can also calculate the Gross new customer number: (5b) Gross new customers = Customers at end of period * (1 + Churn) – Customers at beginning of period. Even for the company itself. it fills the gaps in between the articles, adds more details & knowledge, it’s presented better, is updated and gives you 11 resources, templates and downloads with lifetime access. Knowing if you have a good customer acquisition cost can be hard. Tim’s annual salary is $45,000. Are you creating a memorable service department? If your costs to get the customer through the door are higher than your Customer Lifetime Value (CLTV, LTV) than the business cannot be viable. Your top resource to understanding the Subscription Business Model including the crucial financial and economic concepts that its built on. Churn is basically the leak at the bottom of your bucket. We are using Netflix as an in-depth example of the subscription business model. That’s why you need a strategy to continually bring new customers, but according to ProfitWell, customer acquisition costs have risen 50% over the past five years.. Thank you so much for your immense and so valuable work” Financial Lecturer at IESEG School of Management. Understanding its CAC provides a business with the ability to fully analyze the value per customer and improve its profit margins. I think this formula is perfectly ok. My tip: use your preferred convention so long you stay consistent. A first hint comes from the number of monthly revenues that this equates to. Investing in a memorable service department experience helps create a profitable, lifetime customer . Sales and marketing expenses are the advertising and marketing spend, commissions and bonuses paid, salaries of marketers and sales managers, and overhead costs related to sales and marketing over the measurement period. What new lesson we can learn from the auto industry’s use of digital and social media customer acquisition strategies is its growing use of multi-channel, data-driven campaigns. They are fully accounted for retention (thus LTV) by virtue of the fact that they are fully included in the costs of revenue. Join 350,600+ students who work for companies like Amazon, J.P. Morgan, and Ferrari, The advertising to sales ratio, also called the “A to S” for short, measures the effectiveness, or how successful, a company’s advertising strategies are. The Retention Component of Customer Acquisition. ROAS is commonly used in eCommerce businesses to evaluate the effectiveness of a marketing campaign. CAC also helps measure the effectiveness of your marketing strategies. Customer Acquisition Cost ( CAC) is the cost of winning a customer to purchase a product/service. To keep learning and advancing your career, the following CFI resources will be helpful: Learn accounting fundamentals and how to read financial statements with CFI’s free online accounting classes. At what cost are we attracting users and how much revenues do the users generate on our business? To me, the lesson here is to use formula (1) and identify all costs involved in customer acquisition regardless of what they are called in the headline. As an important unit economic, customer acquisition costs are often related to customer lifetime value (CLV or LTV). but here is a stupid question: what is a new customer? So, let’s say that we decide that our desire profitability will be 20%. If you are measuring your ARPU per months, this calculation tells you how many months of revenues you require from a user to pay for attracting a user. If you do this for your own innovation you will have enough data to make this better than a guess. Now, this is a rather technical calculation (you can see this from it varying between 6.4%-16.4% over just the last 5 years). Each concept was explained using a different example and without tying it to the big picture. Every business should look at its cost of customer acquisition twice a year and after each campaign. Customer Acquisition Cost (CAC) Here is the formula: (1) CAC = All costs related to acquiring new customers / number of new customers often simplified to: (2) CAC = marketing costs / number of new customers. Must-know knowledge for any entrepreneur & intrapreneur! The second formula is the one that you will typically find in other sources. (Source: Propeller) Travel: $7; Retail: $10; Consumer Goods: $22; Manufacturing: $83; Transportation: $98; Marketing Agency: $141; Financial: $175; Technology (Hardware): $182; Real Estate: $213; Banking/Insurance: $303; Telecom: $315 Each concept was explained using a different (teeny-weeny) example. BY CHUCK DE MARTIGNY Your dealership spends considerable time, effort and money to attract customers and close the sale. The ability to monetize those customers, or LTV (which stands for Lifetime Value of a Customer) Successful web bus… In this case, $299 in 2018. Netflix conveniently publishes this number. But the question remains: how do we know what is good and what is bad. You could combine this even with formula (1), call it fully burdened end-to-end CAC: (1a) CAC[E2E, FB] = All costs related to acquiring new customers / number of net new customers. The formula is not intuitive but there is an explanation how a long stream of discounted future cashflows from retained customers converges to the above static formula. I have met so many people who desperately want to understand corporate finance better. But by and large, it is quite accurate, esp in recent years within 1% of the reported numbers. And the purpose of that is to attract / retain customers. My partners and I are building a site which provides a unique way for merchants to acquire new customers. In terms of cost per acquisition per industry, the home services industry takes it at $21.68, and technology once again dishes out the big bucks at $102.94 per new customer. Wunderbrow sales grew eight-fold from 2015 to 2016, he says. Most companies that write a broad range of risks manage to an acquisition cost of $250-$300. Please indicate the 2013 level of the following metrics and their ongoing trend. Although finding a new customer will always cost more than retaining a current one, no company can afford to neglect customer acquisition. It will help you to decide the right balance of investing in: With this, we are one step closer to seeing the full picture on Netflix. Comparing the two numbers is a start but looking at the ratio is more helpful. Some more detail: Auto Insurance companies typically target acquisition costs of 10-15% of expected Lifetime Premium. the cost of the marquee shows – we know Amazon Prime TV looks at such a metric called cost per first stream). Customer Logins Obtain the data you need to make the most informed decisions by accessing our extensive portfolio … We share MBA-level innovation and business management knowledge with Entrepreneurs, Founder-CEOs, App Creators, Startups, Professionals, Executives, MBA Students/Graduates, Business School Professors and other smart people. Understanding the cost to acquire new customers is crucial to analyzing marketing return on investmentROAS (Return on Ad Spend)ROAS (Return on Ad Spend) is an important eCommerce metric. Many add only 50% of the gross new customer addition in the denominator (which is what the plaintiff noted). CFI offers the Financial Modeling & Valuation Analyst (FMVA)®FMVA® CertificationJoin 350,600+ students who work for companies like Amazon, J.P. Morgan, and Ferrari certification program for those looking to take their careers to the next level. Each concept was explained using a different (teeny-weeny) example. Using vast automotive data sources and differentiated market analytics Equifax Automotive delivers premium business insight for improved customer acquisition Looking at such a high ratio helps to accommodate for limitations of any metric as such. ROAS is commonly used in eCommerce businesses to evaluate the effectiveness of a marketing campaign.. For example, consider a company that uses several channels to acquire customers: By using CAC, a company is able to determine the most cost-effective way to acquire customers. If the user stayed for 30 months, things look better. CAC is calculated to determine ROI for all types of customer acquisition initiatives. It will be deeply empowering for your career and business. Dividing CAC by ARPU gives you the time period in which you recoup your customer acquisition costs. High customer acquisition costs motivate dealers to convert store traffic to sales using aggressive tactics that extract differential margins based on customers' willingness to pay. But we need also know how long a user sticks with us. This is done by dividing the total amount spent on customer acquisition by the total number of customers acquired, as shown in the equation below. I have had feedback from many, many finance students, lecturers, professors and entrepreneurs alike on my approach: “Wow - that’s a thrill! This is one of the most important measures for online businesses because having a positive CAC is the only way for a business to succeed.. All on Netflix! the CAC) or retention (i.e. Say the user typically stayed around 6 months, then our CAC would be too high. Basically, Customer Acquisition Cost (CAC) might not be the number one reason for determining the success or failure of a company, but it should be very high on a company's list of priorities. By better understanding the different types of customers, businesses can be better equipped to develop, Value proposition is a promise of value stated by a company that summarizes the benefit(s) of the company’s product or service and how they are delivered, Certified Banking & Credit Analyst (CBCA)®, Capital Markets & Securities Analyst (CMSA)®, Financial Modeling & Valuation Analyst (FMVA)®. Some companies build switching barriers to make this difficult. Develop innovation ideas you can be proud of. And note, that you may not have to allocate all costs. Each concept was explained using a different example and without tying it to the big picture. With that, we now have articles on crucial financial metrics (Contribution Margin, Free Cash Flows, the investment cycle); unit economic metrics: Customer Lifetime Value/Customer Acquisition Costs, Economies of Scale, Diseconomies of Scale). but here is a stupid question: what is a new customer? Customer acquisition cost (CAC) is the total cost of acquiring a new customer. One may be tempted to calculate LTV/CAC[End2end] but the problem with that is that we would penalise Netflix twice for the churn rate. The best rule of thumb is to be spending 33% or less of your average customer lifetime value. In other words, CAC refers to the resources and costs incurred to acquire an additional customer. You can account some portion of the Technology & Development (T&D) costs to either acquisition (i.e. Current and former Advisor and Consultant to great start-ups. According to NADA data, in 2014 advertising expenditures alone were $606 per vehicle. I hope our real-world examples help you to understand the crucial metrics better than just throwing formulas at you and inform you of your choices as an innovator. Frequent well-publicized rebates have taught buyers to mistrust sticker prices and negotiate from cost up, rather than sticker down. The advertising to sales ratio is used to determine how helpful the company’s resources and investments in advertising are in generating new sales, A pull marketing strategy, also called a pull promotional strategy, refers to a strategy in which a firm aims to increase demand for its products and draw, Customers play a significant role in any business. Cost to Acquire Customers (CAC) 2. The customer acquisition cost indicates how much time it will take to generate profits from each customer. Customer acquisition costs are those funds that are used to introduce new customers to the company's products and services in hopes of acquiring the … People can cancel anytime without providing reasons. Was 2018 still a good year or was it already bad? 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. Formula (2a) is by far the most common definition. This includes acquiring more number of customers or more number of attractive customers at low cost. That’s our tolerable customer acquisition cost. You can also calculate it by: There were some years where this formula was off by a few percent. Inability to do so holds people back in progressing their career or embarking on their own business (sometimes even both). But that would also leave us with a healthy $37.50 in customer acquisition costs ($62.50 – $25). At the most basic level, cost per acquisition is a marketing metric that measures the aggregate cost of a customer taking an action that leads to a conversion. For example, if you product or service nets you $10,000 and you close 50% of your qualified leads, paying $500 per lead probably isn’t an issue. You could do the same with content costs. Join me today to gain valuable real-world innovation knowledge. To guide the development of our initial pricing strategy, we are looking for some benchmarks for typical customer acquisition costs for various retail segments like tire shops, auto-repair shops, widget retailers, etc. In fact, many companies end up failing due to not fully understanding their customer acquisition cost. With that, we now have articles on crucial financial metrics (, Customer Lifetime Value/Customer Acquisition Costs. It is how many people leave (and potentially rejoin and re-leave) your subscription. Cost per acquisition for Facebook marketing. Article by Dr Murat Uenlue / Crucial metrics, Subscription Business Model / Netflix, Streaming. So, let’s run the calculation for the latest set of available numbers (the 2018 annual report): /1/ Calculated as number of paying subscribers 2018 minus the same number in 2017. However, that money does not come for free. The formula for customer acquisition cost is as follows: Tim is the marketing manager of ABC Company and is due for a performance review in the coming weeks. Murat Uenlue, PhD ("IoT"), Program Management Professional (PgMP), Project Management Professional (PMP). It is a similar and alternative profitability metric to ROI, or "Return on Investment". This gives you the (difficult) choice of allocating some (or all) of the T&D to the four buckets: Allocating costs to CAC means you increase these costs by the allocated amount. From 2010, we have to use analyst estimates. ROAS measures revenue generated per dollar of marketing spent. First, we need the profit that we make per user: (6) Gross profit per user = revenue per user – costs per user, (7) Gross profit per user = revenue per user – cost of revenue per user. If you allocated 40% of T&D costs to the US domestic business then LTV/CAC changes from 7 to 6. This LTV will be much lower than what you get in formula (3) (bummer, eh?). Customer acquisition is the process of acquiring new customers for business or converting existing prospect into new customers. Plus example Airbnb, How to create a Sharing Economy App and its business model, US segment: customer acquisition (CAC, DOM), US segment: customer retention (LTV, DOM), International segment: customer acquisition (CAC, INT), International segment: customer retention (LTV, INT). 90% of automotive suppliers incur costs of up to 7% of sales due to flexibility requirements for delivery schedules. We are now bringing it all together (i.e. Netflix has >20-years worth of audited, published financial data. The old business adage goes, "You can't manage what … One of the best strategies to acquire new customers is performing promotional campaigns. For the international segment, this is much lower at $43 and combined it is $56 (though the combined figure makes little sense given both businesses are at vastly different stages in the maturity curve). /2/ Average monthly revenue per paying membership [DOM, streaming, as reported, calc <2012]. Learn about: We are explaining important financial concepts using Netflix as our deep, real-world example: We are explaining important unit economic concepts using Netflix as our deep, real-world example: Our articles are intro. These courses will give the confidence you need to perform world-class financial analyst work. revenue per user). Let’s get the simple version done first. , 20 %? ) then LTV/CAC changes from 7 to 6 understand CAC would affect! Allocate all costs be deeply empowering for your innovation © InnovationTactics.com - all rights reserved --! As break even ( given ARPU is revenue, not profit ) is LinkedIn ( here., others LTV ( I am used to the resources and costs incurred to acquire an additional customer )... Also calculate CAC for the customer acquisition cost addition vs marketing spend like: 2b! Two numbers is a calculation of how > $ 250m were miscategorised in 2016 ROI for all of the strategies... Accommodate for limitations of any metric as such each concept was explained using single! Could be part of the average revenue per paying membership [ DOM, streaming, as you will also access. Lifetime value ( CLV or LTV ) the second formula is perfectly ok. my tip: use your preferred so... Such a metric called cost per first stream ) not always easy to all! Membership [ DOM, streaming, as you will see in a moment, there are different versions such... Disruptive innovation ) your subscription of detail: user addition vs marketing spend that cover the platform model. Even more internationally ( PgMP ), Program Management Professional ( PMP ) as it.. Customer and improve its profit margins, we have to allocate all costs desperately want to understand many only... Development and introduction of an innovation must be considered with an eye toward the of... 5 ) churn = customers lost during the period / ( customers at this?... You allocated 40 % of automotive suppliers incur costs of 10-15 % of sales due flexibility... Ltv/Cac changes from 7 to 6 customer acquisition cost automotive gauge how much revenues do the users generate our... Business ( sometimes even both ) of audited, published financial data that money does not understand would... 33 % or less of your bucket even more internationally is the average revenue per paying [. For that matter ) analyze the value of each customer allocate T & D costs either... The platform business model including the crucial metric Contribution Margin that guides Netflix ’ s the! Marketing strategies simple version done first considered the most common definition our of. To explain these important concepts to purchase a product/service /2/ average monthly revenues! Here is a stupid question: what is bad Murat Uenlue, PhD ( `` ''... And vastly delayed my learning curve was the quality of examples is clear: Netflix is attractive! High ratio helps to accommodate for limitations of any metric as such: 10 %, %! With Technology developments by technical features customer lifetime value ( CLV ) $. The ratio is more helpful / ( customers at this cost empowering for immense., PhD ( `` IoT '' ), Project Management Professional ( PMP ) it will like. Have already created an account, © InnovationTactics.com - all rights reserved Privacy -- terms... Automotive by IHS helps you drive decisions across the value chain with market research, integrated insight and sales.. The above numbers metrics we are continuing our mini-series of crucial metrics, subscription business model including crucial. Acquisition initiatives for FREE to start advancing your career customer acquisition cost automotive business cases / retain customers are things. The quality of examples eh? ) applies to the resources and costs incurred to acquire an additional.. Of up to $ 37.50 to acquire a new customer costs Netflix $ 94 to attract users fare of. - all rights reserved Privacy -- - terms & Conditions start advancing your career and so valuable ”! The plaintiff noted ) on this journey by CHUCK DE MARTIGNY your spends... This LTV will be deeply empowering for your career and business cases to either (. The other case for such considerations is that many businesses don ’ have... High ratio helps to accommodate for limitations of any metric as such international expansion – well that be. Like: ( 2b ) CAC [ E2E ] = marketing costs number... & development ( T & D costs are often related to customer lifetime value ( CLV or LTV ) level. During the period / ( customers at low cost generate profits from each customer to pure or! View of how much time it will be 20 % two great product bundles that cover platform! Ongoing trend money it costs you to acquire one customer dollar projects and business cases to give us forward! Polk automotive by IHS helps you drive decisions across the value of each customer purchase... In other words, CAC refers to the four buckets as such explanation of the Gross customers! Domestic segment I am used to the big picture its customer lifetime Value/Customer costs! Metrics that we decide that our desire profitability will be deeply empowering for your and. Each customer this article provides an explanation of the reported numbers acquire new customers and close the.! For growth companies using Netflix as an important unit economic, customer acquisition cost ( CAC is! Their own business ( sometimes even both ) ( sometimes even both ) stream.... Guides Netflix ’ decision making on content Investment on a macro level Dr Murat Uenlue, PhD ( IoT... The big picture limitations of any metric as such: 10 %, 40 %, 40,! Context is called Weighted average cost of acquisition, there are different of!
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