Unit Economics: How to Calculate CAC & LTV – It Depends – Podcast Transcript

Innovation Metrics Podcast

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Teaser

As much as possible. I try to stay away from the average. Once you collapse everything into an average, you’re losing information.

Innovation Metrics Intro

Welcome to the innovation metrics podcast, where we bring you the latest on innovation management. We provide insights on how to measure innovation, innovation, accounting, and managing the uncertain process of developing new, sustainable, and profitable business models. You can find links to the main topics covered in this episode and information about the guests and hosts in the show notes, or go to our blog on innovation metrics.co. Your host is Aaliyah island.

Elijah

Hi everybody. Today, Paula is joining us. We’re talking about customer acquisition costs, customer lifetime value and dirty things like that. Well, we hope we can make it a bit of fun along the way. Paul has written a fantastic book called growth units, which will guide us along the podcast today. Welcome to the show Paul

Elijah. I’m so happy to be here to talk unit economics and all things related. Thanks for having me on.

Elijah

Fantastic. Thank you. But would you mind telling listeners a little bit about yourself before we get started? Like your background, what do you currently do in?

So I am a former startup founder and in that experience that I had, I had to start up in New York for a couple of years where I made a ton of mistakes and became really interested in that process of how founders figure things out or often don’t figure things out. And for me, the next step that made sense was that I made that, you know, part of what I did. So since that time I’ve gone on and I focused on building startup accelerator programs and incubator programs around the world, I built Hong Kong’s first funded startup accelerator. I was brought in to build a program in Rome that was themed around environmental tech. I’m now helping a large nonprofit build a community health incubator. And day-to-day, I actually am at the university of Southern California. So I run the, the university startup incubator there and I also teach in the entrepreneurship center.

Elijah

So we’re qualified to talk about the topic. So you wrote this book and as I mentioned earlier, when we spoke before the show, I think it’s fantastic. It’s, it’s like, it’s a really great book to just pick up and, and you’re able to read it. It’s, it’s easy to read and make me smile a little bit, and it gives you also enough, enough to really do something right enough to take a spreadsheet and start calculating things and understanding why you’re doing things. And what questions do you want to ask? Kind of prioritize a little bit of what to learn. So it’s, I think it’s fantastic book, maybe guide us through a little bit about the high level of, of, of this book. And then that can help us then later on, on a podcast to follow through a bit like, so maybe why don’t you write the book and so growth units and what is it about,

I appreciate that. So I wrote the growth units book because I had been working with startups on these unit economics questions for a long time. I had actually been teaching a class at USC that was focused on this topic, you know, largely we would bring startups into the classroom and they would get a team of students to work with them on one element of their growth. But part of that is understanding like where are there levers that you can press on to help that business? And it’s always going to be a little bit of a different answer, you know, you’ll find, so I was teaching that class. I was running these startup accelerators or incubators, and when everything went remote in 2020, you know, a lot of the way that I worked had to change. So I was previously, you know, most comfortable working kind of at the whiteboard in front of a class.

And we would, you know, in a live session, derive formulas and we figured out a conversion funnel. We would figure out basically these elements of unit economics, you know, figuring out lifetime value customer acquisition cost. And, and when that went away or that in-person, you know, you know, environment went away. I didn’t think that I could really transfer that very well, you know, to a zoom session necessarily. So instead I spent some time writing down a lot of these concepts, a lot of the things that I had worked on in built previously, really a series of marathon sessions in writing this out and trying to make it really, you know, just useful, straightforward, but ended up putting this book out there late summer 2020. And to be honest, I, I kind of left it there and I didn’t really do anything else with it. I kind of almost forgot about it for awhile.

And then what happened to me, which, which shows maybe I’m not the best marketer, but what happened in my case was a few months ago, I ended up discovering not because I was really tracking it, but just by accident, I was discovering that people will outside of my network or the students that I had had, or anybody who would have known me personally, people were discovering this book and they were posting that they were also getting value from it or how they were using it. So it kind of made me want to return to this topic, you know, serious way. But, but yeah, the, the approach that I took was let’s first come to an understanding of what we mean by unit economics or specifically lifetime value and customer acquisition cost. These terms are thrown around a lot. I find that people use them in different ways. So I, some, some approaches and why I felt that some were better than others. I go through a number of case studies where we look at the businesses in one of these elements and how they are either doing well or not doing well.

Elijah

You show really well why we’re using the same term. And we come to a different number, what might be the better way and why? And it’s really simple. Like you can actually, yeah, you get it. It’s not too crazy. And I think it’s really due to the way you’re, you know, you presented in a, again, you have done it obviously a couple of times before you wrote, you wrote that book that really shows and makes total sense now why it’s so by flow source. So maybe we start off going into it, unit economics or growth units. Let’s just quickly explain what we’re actually talking about there. Is that a fair way of starting?

Yeah, no, it makes sense. So usually when we’re talking about unit economics, we’re actually trying to look at the, like at the customer level rather than the level of the entire business. So that means we’re not necessarily, or we’re not really looking at like top line, you know, total revenue that a business is, is generating or all the costs that they were generating. Instead, we’re trying to look at that at like for one sale or for one customer over time, what does that business derive? And so there’s a few parts of that on lifetime value.

Elijah

So it’s a one cup of coffee rather than we’re looking at your whole business. We’re looking at, I think we’d use in a coffee shop thing. It sounds you had the book and yeah, like I think restaurants and stuff later as good. And so why are we doing that? Why are we, why is it important to look, maybe you were about to say anyway, but why is it important to, to what is the value of just looking at, at the, at the unit economics rather than, you know, trying to analyze the business?

No, that’s a great question. I like to bring it back down to the unit level, because that’s really where like a lot of the action takes place. So if we don’t do that, we’re kind of looking at the aggregate we’re looking at we’re then at the point of, you know, averages, you know, if we go down to a unit level, I can, I can have a different lifetime value for a specific customer segment. And I might have five different segments that I am trying to serve. They might have different payback periods. They might have different margins. Like that’s where we can get into the, like the granularity of this topic. If you keep it at that like business level, like total revenue, total costs, et cetera, you lose a lot of that helpful detail. And I find like, certainly for startups also, certainly for organizations, you know, it’s, it’s a little bit of a mistake to, you know, leave it at that like top level. So once you go down, we can, maybe I’m diving in a little too soon, but as an example, like lifetime value, the way I like to describe lifetime value is it has three things that help you determine it. It’s price per unit that you’re charging. It’s a cost of serving that unit up. And it’s like the number of times that somebody is going to stay in and buy that unit. So it’s a retention metric.

Elijah

I feel like we should probably pause it there, maybe. So it’d be like customer acquisition costs and customer lifetime value. So these will be the two essential, I guess the most essential terms we’re talking about today. Why are we looking at the unit? I think it will be really if you’re okay with sticking to this. And we spoke about this before the podcast and you know, when we’re, when we’re catching up beforehand about product market fit and so on. So maybe I can throw it. Maybe I can throw that and then get your interesting takes out. I would just love to stay in that. Why are we doing that for, for just a little bit longer? So I guess for, for large organizations and that’s, or for existing products and for existing products for existing business models, there’s value.

And that’s probably not so much what we’re going to discuss today. So I guess that’s a more forensic look into what is really going on. And, you know, I really scaling well and set of different questions, I guess, sort of what this podcast is interested in and where your main expertise is, but for where you’ve done more work, I believe it’s really to, to, to, to even get something going. So like sure. We could look at the whole business, but what business, right. I think that’s one of the things. So when you don’t even have a business, you can look at yet. So you’re, you’re, you know, it’s your first product, it’s your, you don’t know if you have what we call product market fit. And I would love your take on how you define it. And I think we might be very interesting to challenge my own thoughts on that with your expertise. And so I guess it’s, could you say it is the most useful thing to look at while you’re establishing a business? It’s like, that’s like the customer customer acquisition cost of a customer lifetime value with whatever that is for now. That is like, that’s the thing you’re looking at before you have a business. Is that a way of saying it or

It, it could be so, and it is challenging, right? So you have those, those two pieces. So customer acquisition costs being how much money does it take you to bring a customer in whether it’s taking somebody who is not a customer and turning them into a customer, many different ways. There are customer acquisition costs of zero, right? It could just be word of mouth. And then on the,

Elijah

Like, your book  if I may say,

Paul

Oh yeah, sure, there you go. Right. That’s, that’s the best way, right? Somebody, you know, loves the product. They tell another person, the customer, the business doesn’t have to spend anything. And then on the other extreme, of course you have paid advertising and you have sales teams. You have like a lot of the activities that need to go into supporting either much higher priced items or more complex yo sales that require a bit more of a process assess. There’s probably not too much of a lengthy process in deciding to buy a book or not. It’s not a life-changing amount of money. It might be electing to book, but it’s not life-changing amount of money, but for like, you know, for either more complex products or much more expensive products, you know, you might have to invest in that development of a customer. The, so, yeah. So that’s that customer acquisition cost or CAC is one part you often understand that, you know, early, early on, because you can run tests, you can see what does it take to bring somebody through a conversion funnel and turn them into a customer on the lifetime value side. However, that often takes more time to understand,

Elijah

At least you can run early experiments on your customer acquisition costs and, and, and sort of work your way to where it’s, again, I’m saying product market fit without having to find it yet here is that right?

Yes. But this is where it does become difficult to give you a single answer because there’s certainly situations where like a really early stage company, you know, just experimenting, maybe putting up like a smoke test of some type or like one-on-one interviews in some cases, if they are not, well, I’ll say just directly, if they’re not going after, if they haven’t figured out who their real early ideal customer is yet, they might have something that is a value, but they’re just talking to the wrong people. They’re presented it to the wrong people. And it’s impossible to require them as customers. They also might be that, you know what your work is, it’s just not right. It’s not good enough. It’s, you know, it doesn’t have the right. It’s not solving the right problem or the feature set doesn’t feel quite right. So,

Elijah

Oh, your value proposition is not really congruent with what you’re actually offering and then okay. You acquire customers for a moment and then they’ll drop. Right. And then you don’t have any lifetime. Okay. Good point.

So it is a bit of a process, but, but to your earlier point, like maybe there is some, you know, there is some point at which you