Video Translation CAC and LTV

We’d just spent over 2 hours on a zoom call and had made moderate progress, but we were still struggling to really understand why the team were reluctant to spend more on growing their user base.

They seemed hesitant to really increase their marketing, and whilst this was sound logic for a traditional business, for a company that was venture funded and growing rapidly, with aspirations to expand abroad this was also highly unusual. Language didn’t help with communication, but at least the team were nice, smart and cooperative with trying to look at the numbers.

We’d asked them to provide some details on the users, how much were they paying, how often were they buying and how much were the team currently spending on marketing to acquire these users. These numbers would allow us to get to the root of our questioning, and allow us to really help them think about growth.

In a traditional business, the primary worry is cashflow to ensure that the business is self-sustaining, money from growth in this case comes from profits re-invested back into the business, therefore, on a unit economics basis, each sale needs to be profitable, which also means that CAC (Customer Acquisition Cost) needs to be a comfortable % of the overall unit cost of a sale.

However, this logic changes when cash-flow is no longer a consideration and growth is prioritised.

Our hypothesis was, CAC could be equal to LTV (LifeTime customer Value) in a scenario where growth was the priority and there was external funding (to cover COGS and G&A, on time of CAC)

In other words, for startups, COGS and G&A should diminish over time and form an ever smaller % of unit economics, so long as there was sufficient scale, an example of this would be a machine in a factory, this machine represents COGs and G&A, to produce a few items its a very high %, but at scale the sheer volume of items sold ‘dilutes’ the cost to a point where its tiny, a point of critical mass if you like. This is the basis for most FMCG businesses. CAC then becomes the larger % of the unit economics, basing on this assumption, VC funding should be focused on helping the company grow as quickly as possible to reaching critical mass.

Another aspect of the hypothesis relies on recurring revenue, FMCGs also understand this, growth is contingent on the business not being a leaky bucket, recurring revenue helps to offset a high CAC, given that for every new customer that becomes a recurring customer is a CAC cost that can be saved, this is where the concept of MRR and Churn comes in. If we have high repeat purchase, then CAC can be very efficient and demonstrates a compounding effect.

For this video business, IF, their customers paid $5 a month for 3 months, then their LTV would be $15, we could afford to go up to this $15 in CAC. If the payments and repeat purchases were impacted enough to be above those of competitors, eg. $10 a month for 12 months = $120, then the CAC could be high enough that we could out-advertise competitors and capture market share.

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