Creating a successful business boils down to one simple formula: charge customers more than it costs you to acquire them and supply them with goods. In software, the cost of goods is close to zero, so all we care about really is the Lifetime Value and the CAC.
If you are a typical early-stage startup or a young small business, you are likely spending your efforts to grow the number of customers even though your customer’s Lifetime value does not warrant growth at your current Costs of Acquisition.
This is a crisis waiting to happen in about 18 months down the road.
When DOES it make sense to grow your customer base even at a loss?
- When you have a high retention rate but a low ARPU. If you can build a strong, loyal customer base, you will likely find ways to upsell and profit from them.
- When you are in a rush to gain market share in a winner-takes-all scenario.
If you are not in one of these situations, you should be closely monitoring the difference between the CAC and LTV. A good online startup has an LTV that is at least 3 times higher than the CAC. While that’s very hard to achieve, one can get there by improving the product-market fit over time.
It’s hard to grow your business and grow your profit margins at the same time. So you got to pick one. Just be aware that if you choose to grow your business first, you might run out of resources by the time you realize you have to fix your profit margin problem.
