August 16, 2016
There are probably a quintillion articles providing business advice specifically for start ups, not counting even more articles around general business advice. We prefer doubling inbound leads as your primary objective. Which is why we’ve pivoted our agency to focus on being a lead generation agency. Many of these focus on what are the most common reasons startups fail?
But imagine, if you were a sentient AI with the processing power to digest all of them and did so, I would wager you would notice that most of them converge and talk about three common key factors:
Most of the time these so-called startup experts (who usually don’t have a single successful start up to their name, for the record) focus on the importance of product/market fit.
I’m not saying this is a wasted area to focus on and I would agree that failure to get the right product | market fit is probably the numero uno reason startups do fail.
The problem I take issue with is nobody seems to be focusing on what is in my not-so-humble opinion the 2nd most common reason startups end up crashing and burning into oblivion, sending countless people into a tailspin of self-destruction and misery.
So many negative outcomes could be prevented if entrepreneurs from the beginning factored in the cost of acquiring customers. More often than not, as fledgling startups take their first few steps they quickly learn that the cost of acquiring customers turns out to be much higher than they thought, and often surpasses the lifetime value of their customers, thus rendering the startup DOA before it really ever really gets going.
This is a sad story , one that I have experienced multiple times across my many failures. (Luckily I finally learned my lesson)
I would definitely say that experts are right in one way, that product/market fit is super duper important. But, after closely watching several hundred startups that I knew personally or actually took part in that utterly failed with flying colors, I noticed that despite a fair amount of them having solved the product/market fit problem and in some cases solving it very very well, but still ended up failing because they had not created a pipeline to acquire customers at a profitable rate.
Besides your team, market and product, there’s actually a fourth and very important aspect of startup success—having a successful business model. Finding a winning formula for your business model revolves around balancing two important numbers—the cost to acquire new customers and the lifetime value of monetizing each of those customers.
Successful businesses know that in order to stay afloat and later thrive, the value of each of their customers must be at least 3-5 times higher than the cost of finding each customer.
The cost to acquire a customer involves the total cost of your marketing and sales over a given period—including salaries for your marketing team and sales people—and dividing that number by the total number of customers you got in the same period.
On the other hand, the lifetime value of each customer is how much cash flow they inject into your business, minus the cost of maintaining your relationship—such as support costs, maintenance, etc.
You can easily see that businesses that spend a fortune to acquire new customers and aren’t able to monetize them well end up falling off the face of the Earth. But even businesses who are able to monetize new customers—but barely break even—simply will never have the capital to expand and grow.
That’s why well-balanced businesses are constantly looking for ways to drive down their cost to acquire new customers (such as better marketing) and drive up the monetization potential of customers (reducing other costs, upselling and cross-selling).
Founding a startup requires a certain degree of faith. But that same optimism can cause startups to grossly overestimate the ease of which they can acquire new customers, as if people will be lined up around the bloc to buy with little effort.
So many entrepreneurs rely on vague terms like viral marketing and online marketing that they don’t even have solid numbers on how much acquiring new customers actually costs.
In reality, the viral effect is extremely rare, and online marketing is so wide-ranging and broadly defined that businesses aren’t prepared to roll up their sleeves and tackle a menagerie of challenges like content creation, web design, SEO, social media presence, branding, or solid conversion channels.
Effectively marketing a startup requires extensive cash reserves, numbers that many entrepreneurs just aren’t able to comprehend due to boundless optimism.
Sample Calculations of Customer Acquisition Cost
Pretend you’re using Google AdWords to send traffic to your business. With a CPC of 50 cents, your 10,000 visitors are converting at a rate of 5% to your software trial. Of those trials, 10% are converting to become customers. You’re spending $500 per month to get 5 customers, meaning the cost of each customer is $100 just from lead generation.
Add in costs like salesperson salaries and your cost to acquire customers skyrockets, sometimes into the thousands of dollars per customer.
If your product isn’t able to earn back thousands of dollars for each customer, your business is in trouble.
For those of you developing a new business plan, create a model that thoroughly illustrates all the factors involved in acquiring a new customer so you’re not forgetting any huge money sinks. Some of the key variables are:
With that in mind, you should also be aiming for at least 3x but ideally 5x as much lifetime value from your customers when compared to their acquisition cost, and also look to regain that acquisition cost within the first year of getting each customer.
When you’re just getting started, it’s probably impossible to predict your conversion rate with any reliability. That’s why a core component of your business plan should be to figure out your conversion rate ASAP, because your startup depends on it. Good conversion rates mean acquiring funding easier, and bad rates could mean your plan isn’t viable.
Brilliant entrepreneurs realized early on that lowering their cost to get new customers was incredibly important, which is where new models like SaaS, Freemium and Open Source emerged.
New-age business models rely on changes in buying behavior that came about with the advent of the internet. In general, we’d rather not deal with salespeople. No offense. That common theme lead to businesses catering to customers who prefer to do research on their own, expanding to free trials, blog posts, reviews, and social media.
New, successful business models utilize these changes in a few ways:
These low-cost sales techniques (of which there are many, many more) are the basis of Sales 2.0 and are driving digital marketing success each and every day.
Your conversion rates are crucial when figuring out your customer acquisition costs, and improving conversion rate is one of the best ways to decrease your customer acquisition cost.
A/B testing—which can be done easily by splitting traffic between two different landing pages—is a key part of optimizing your conversion rate.
In addition, the amount of human touch to complete a sale can’t be overlooked. While some purchases, like razor blades, are straightforward, others aren’t. More complicated or expensive products might require more guidance from a salesperson, or the customer may need to experience a trial first before they make up their mind.
Ways to minimize the cost of your sales team include:
Products that require a high level of involvement during the sales process, either through your own salespeople or additional sales materials, are a challenge to optimize.
Salespeople and offices can eat into your budget and drive cost to acquire new customers through the roof. Plus, not every salesperson you hire even becomes successful!
If your business relies on heavy involvement during the sales process, consider:
Ignore the cost of customer acquisition at your own peril. Figuring out just how much your business has to invest in each customer is absolutely essential if you want to see success, and the earlier you do so, the better.
If your business can’t realistically obtain customers for much less than you can earn from those customers, your idea isn’t viable.
If you’re still raising capital, demonstrating that you have a viable business model—as in, you’re bringing in much more money per customer than you’re spending on them—you’ll have a much easier time.
Once your business model has proven itself, start investing as much as your business can afford and scale, scale, scale before a competitor sneaks in and starts stealing your ideas.
If your startup needs the agility and power of Sales 2.0 and inbound marketing—but doesn’t have the huge capital needed to hire your own expensive marketing team—give Klicker a shout. We get the results of a huge agency, but without the crippling price. We just do startup marketing better.