The Importance of Customer Acquisition Costs for Startups


I recently came across the blog of David Skok of Matrix Partners and was inspired to write this post by an article on customer acquisition costs. If you have not yet read through his blog’s vast resources for entrepreneurs, I suggest you do so – particularly if you plan to pitch your startup to VCs anytime soon.

After being pitched countless times by startups, as a VC I’d like to identify a common misconception that web-based startups often have about their own growth potential and the costs associated with their plans. Management of web services companies, SaaS companies and mobile (web-based) applications commonly believe that because they are situated online, customers will come across their service, submit a purchase order (or subscribe) and notify friends or other companies to use the service as well. Although this may happen from time to time, it is very rare for any company to experience sustained viral growth.

Many companies don’t understand the difference between viral marketing and viral growth. Viral marketing is essentially “word of mouth” or “person-to-person distribution” and is the latest buzzword. Viral growth implies a K-factor greater than 1 (i.e. for each new person who tries a product/service, they will each invite more than 1 registered user of the product on average). Since true viral growth is so hard to achieve in practice, many companies miscalculate the actual costs it will incur to acquire customers. As David points out in his article, the majority of startup pitches lack detail/emphasis on how much it will cost to acquire customers. I second this statement entirely.

Business Model Viability
For a business to be profitable on each new customer, startups must balance two variables: (1) Cost to Acquire Customers (CAC); and (2) Lifetime Value of a Customer (LTV).

CAC can be calculated by taking the business’s entire cost of sales and marketing over a given period (including salaries and other employee expenses) and divide it by the number of customers that the business acquired in that period.

LTV can be calculated by looking at the Average Revenue Per User/Customer (ARPU) over the lifetime of a business’s relationship with a customer.

As Steve Blank mentioned in his recent post, an early indication that a business has found the right business model is when the cost of acquiring customers becomes less than the revenues generated from the customer. “For web startups, this is when the cost of customer acquisition is less than the lifetime value of that customer. For biotech startups, it’s when the cost of the R&D required to find and clinically test a drug is less than the market demand for that drug.”


Credit: David Skok.

Zynga is a great example of a company that has managed to decipher the business model of online social gaming. After thousands of A/B tests and experiments, Zynga finally found a business model where CAC was less than LTV. Once they cracked the nut, the company spent so much on customer acquisition that it was rumored that they accounted for upwards of 30% of Facebook’s revenue in 2009 though its aggressive social ad buying strategies. Similar business models and opportunities exist in virtual worlds, massively multiplayer online games (MMOGs) and many other online businesses. Many social games, such as those created by Zynga, leverage virtual currency, micro-transactions, emotional response mechanisms and social influence to promote the sale of decorative and functional virtual goods.

Before investing in a web-centric startup, good VCs will look deep into a company’s business model and know to look for CAC and LTV metrics. In fact, Trident Capital recently held a meeting with their online advertising and ecommerce companies to help exchange best practices for customer acquisition and improving LTV. My advice to startups: prove out your business model and you will have a much better shot at raising VC dollars. Skok suggests that two key equations be followed by web startups:

  • CAC < LTV (3x appears to be a rough minimum for SaaS businesses)
  • CAC should be recovered in < 12 months (for subscription businesses)

Startups, if you’ve already figured out your business model and how to make CAC < LTV, stay very quiet and add as much fuel to the fire as you can afford. Your competitors will likely try to hone-in on your tactics and fight back for their share of the market.


Credit: Steve Blank.

Leverage Startup Metrics
Startups are different from larger companies and therefore need different metrics than larger companies. Metrics will give startups a lens into how well the search for the business model is going and help to identify when to scale the company. Besides CAC and LTV, some essential metrics that startups should be familiar with include Viral Coefficient (K-factor)  and Customer Lifecycle. Dave McClure from Founders Fund recently updated his Startup Metrics for Pirates presentation for web sales pipelines. Take a look!

Questions to my Readers
Please consider the following questions and share your perspectives with my other readers and the tech community at large.

  1. What metrics do you consider the most valuable?
  2. Do you use any tools to help measure specific metrics for your business?
  3. What mistakes have you made (and corrected) that can help others succeed?

Designing the Perfect Mobile Application Store


I briefly touched on application stores as part of my last post, Creating a Better BlackBerry Experience. After re-reading the post and reflecting on some of the comments, I felt that a more in-depth follow-up was required to discuss why the overarching design of a mobile application store is paramount to its adoption, usability and ultimately, success.

This post will focus on how I believe the design of BlackBerry App World (“BBAW”) can be improved for both enterprises and consumers.

BlackBerry App World for Enterprises

When BBAW was first released, many BES-connected users had problems downloading applications due to permission-based issues. RIM can’t do much to change corporate policies, but RIM can implement a highly-anticipated BBAW for the enterprise. I am proposing that RIM creates an enterprise app store, similar to the app store announced by MobileIron in December 2009. MobileIron’s enterprise app store allows enterprises to create a repository of approved content and apps, which employees can then download and use with the full blessing of IT. In addition, an enterprise can create device or employee categories with permissions for certain types of content. As mentioned by Kevin Fitchard of Connected Planet, “Salesmen, for instance, would find Salesforce.com’s app in their approved storefront, while a field engineer would not. Both field engineers and salesman could have access to vehicle navigation services, and while a desk jockey might be able to download that same application, the company could set usage restrictions limiting when he or she could use it (say, business trips) or require the employee to pay the monthly service fee in a separately generated bill.” To me, this concept sounds like an app store that would help RIM sell more BlackBerry devices to enterprises, help IT administrators and make employees more productive (and happy) when mobile. Obviously, a more tidy billing mechanism will have to be in place, since I’d reckon the majority of enterprise won’t want to pay via PayPal.

BlackBerry App World for Consumers

In creating v2.0 of BBAW, RIM has a lot of work to do. My last post discusses a few elements that need improvement including the billing systems, pre-loads and fewer bugs. I’d like to add a few more points to the discussion. To begin with, the billing system needs to be more dynamic and allow customers to attach credit cards to their profile for frictionless billing. The billing systems should also be flexible enough to power additional business models for application developers including subscription billing and in-application micro-transactions. Why not bring the minimum price-point to $0.99 as well?

Steven Berkovitz chimed-in to mention that with BES 5.0, there’s a full-blown web version of desktop manager; it uses an ActiveX control to connect to your Blackberry for operations requiring a physical connection and personal data is sync’d over-the-air (“OTA”). However, this functionality doesn’t yet extend to previously installed, licensed and configured applications. As a consumer, wouldn’t it be nice to buy your next BlackBerry, insert your SIM card, load your user profile from within an OTA-driven application and click “Restore Profile” to then have your data, applications (auto-detect new BlackBerry OS and download proper build for the new device) and configuration settings loaded onto your new device OTA? That is one step towards a BlackBerry device that can compete with future iPhone models in delivering the experience sought after by the ever-smarter and bells-and-whistles-seeking consumer today.

Many users are also confused by not being able to find certain apps in BBAW that show up for their friends or colleagues. By design, RIM only shows its users the apps available for their device. In a future version of BBAW, it would be nice to show users all the apps and allow users to be notified (by push, email, SMS, etc…) when the app is launched for their specific OS and device model. This could also give developers a sense of what devices are generating the most demand for their product so that they could focus their development efforts on the makes/models and locations that are going to yield that greatest financial rewards or user adoption.

Ubiquitous Access

BBAW needs to come pre-loaded on all (new) handsets. End of story. In cases where mobile carriers have a contractually dominant position over RIM on controlling content or applications available to mobile devices, RIM should provide those carriers with sufficient access and privileges to formally reject specific applications for use by their subscribers for their own reasons. In concert with these changes, RIM should enter into a formal revenue sharing agreement with carriers so that revenues generated from application one-time sales, subscriptions and micro-transactions can be shared. Once these deals are signed, RIM (or the mobile carrier) should push App World down to all BlackBerry devices. IMHO, this would be a win-win-win scenario for RIM, carriers and consumers.

If you were RIM, how would you design BlackBerry App World v2.0?