Measuring your Startup: Unit Economics, CAC and CLTV

During my studies at ThePowerMBA I was introduced to the concept of Unit Economics. The main goal is to define clear metrics to measure the performance of our business, including the measurement of our costs, our revenues and our profits.

I will present below the main metrics, with a brief explanation for each, and then discuss my personal experience at my own startup company, KashKlik, an innovative Influencer Marketing platform.

Measuring Costs

CAC

The Customer Acquisition Cost (CAC) measures how much we are spending to acquire a new customer. In order to calculate the CAC, for a given period of time, we must know how much was spent on acquiring new customers and how many customers did we acquire.

Customer Based Calculation (CAC):

Total acquisition costs ( time ) / # of new customers per ( time )

We can also calculate the cost per action performed by the customers, which in general is the amount of money we need to spend in order to generate a sale or some other form of conversion (such as a registration or a subscription to our services).

Sales Based Calculation (CPA, “cost per action”):

Total acquisition costs ( time ) / # of new sales per ( time )

Measuring Revenues

CLTV

The Customer Lifetime Value (CLTV) measures how much total value we are getting from every customer. In other words, the CLTV measures the total value that one customer generates over their lifetime as a customer.

CLTV Calculation:

“lifetime” revenues per customer X Gross margin (%)

ARPU

The Average Revenue Per User (ARPU) measures how much revenue we are getting from a customer in a certain time period. The ARPU is a key metric in recurring revenue models.

Calculating the ARPU:

Revenue (per time period) / # of users (per time period)

CHURN RATE

The Churn Rate measures how many customers (percentually) we are losing in a period of time. The Churn Rate is also a very important metric in recurring business models.

Calculating the Churn Rate:

# of customer lost (in the period) / # customers at the start of the period

Measuring Profitability

CLTV – CAC

The difference between the CLTV and the CAC enables us to calculate how much profit we make off of each customer. By increasing this difference, we make our business more profitable.

CLTV / CAC

The ratio between the CLTV and the CAC enables us to calculate how much we multiply our acquisition investment by. This ratio represents our return on CAC investments.

CAC PAYBACK

The CAC Payback measures how long it takes to make back our CAC investment. This is the average amount of time that passes between investing money in CAC (acquiring customers) and getting it back.

The CAC Payback may be calculated as:

CAC / ARPU

The Unit Metrics in Practice

Measuring Costs in Practice

As we defined above, the CAC is a very important metric, and if we are not measuring the CAC we cannot even be sure if our business is profitable (since all the profitability metrics are related to the CAC). However, in practice, there may be multiple customer acquisition channels, and we should be able to measure the CAC for each one of these channels.

For example, one channel may be campaigns on Google AdWords, a second channel may be Facebook Ads and a third channel may be Influencer Marketing campaigns. Each one of these channels will probably have a different CAC, and so we should develop mechanisms to be able to measure it precisely. In other words, we should track where our customers are coming from, and have specific CAC measures per channel, instead of a single generic CAC value.

After we have clear CAC measurements, and we observe that some channels are more expensive than others, we have basically two choices:

  • Continue using only the channel that provides us the cheapest CAC, and stop using the other channels that are more expensive.
  • Try to improve the performance of the more expensive channels, through fine-tuning of the campaign parameters and the targeting.

Measuring Revenue in Practice

In general in order to measure the CLTV we should use several other metrics that depend on the behavior and the kind of transactions being performed by our customers. These are some of the metrics we may need in practice in order to obtain the CLTV:

  • What is the expected lifetime of our customers? For how long do we expect that our customers will be active?
  • What is the observed frequency of transactions? How many transactions do our customers perform in a specific period of time?
  • What is the average amount of money each customer spends on each transaction?

So for example if we measure that the average lifetime of our customers is 10 months, and that they perform transactions twice per month, spending in average U$ 35 per transaction, their CLTV will be: 10 X 2 X 35 = U$ 700

In practice, it may be necessary to do this analysis by separating our customers in different segments. We may discover that we have one customer segment with a very high CLTV while another segment has a much lower CLTV. Then, we should observe which one of these segments is growing faster, and check if the different segments are growing at similar rates.

One common problem for startup companies is that they are able to attract early adopters that are enthusiastic about their product, and thus have a very high CLTV. However, when they try to expand to other customer segments, they discover that these new customers have a very different behavior than the early adopters, and as a consequence a much lower CLTV.

Measuring Profits in Practice

Our profitability metrics are based on relationships between the CAC and the CLTV, but as we observed above, in practice the CAC may be very different depending on the channel being used for customer acquisition, and the CLTV may be very different depending on the customer segment being measured.

So ideally we should try to build a matrix to measure the profits depending on both the customer acquisition channel and the customer segment.

Below I give you an example of 3 acquisition channels and 3 customer segments with the respective profitability computation.

The first table has the CAC per acquisition channel:

Customer Acquisition ChannelCAC
Google AdWordsU$ 10
Facebook AdsU$ 12
Influencer MarketingU$ 18

The second table has the CLTV per customer segment:

Customer SegmentCLTV
Enthusiastic UsersU$ 120
Regular UsersU$ 80
Low-Frequency UsersU$ 40

The third table has the user segments per acquisition channel:

Acquisition ChannelEnthusiasticRegularLow-Frequency
Google AdWords10%60%30%
Facebook Ads20%60%20%
Influencer Marketing40%50%10%

Then we can compute the profit per acquisition channel:

Acquisition ChannelWeighted Average CLTVCACCLTV – CAC
Google AdWords0.1×120 + 0.6×80 + 0.3×40 = U$ 72U$ 10U$ 62
Facebook Ads0.2×120 + 0.6×80 + 0.2×40 = U$ 80U$ 12U$ 68
Influencer Marketing0.4×120 + 0.5×80 + 0.1×40 =  U$ 92U$ 18U$ 74

As you can see in the example above, when we make a detailed analysis taking in consideration the different acquisition channels and the diverse customer segments, we may discover that the most expensive channel is also the most profitable one, because the customers we are acquiring through this channel have a much higher CLTV.

Conclusions

I hope you have enjoyed this discussion about the practical usage of unit metrics such as the CAC and the CLTV, and that my example above has motivated you to try to measure these metrics as accurately as possible. Please feel free to share your personal experience in the comments below.

About Hayim Makabee

Veteran software developer, enthusiastic programmer, author of a book on Object-Oriented Programming, co-founder and CEO at KashKlik, an innovative Influencer Marketing platform.
This entry was posted in MBA, Startups, ThePowerMBA and tagged , , . Bookmark the permalink.

1 Response to Measuring your Startup: Unit Economics, CAC and CLTV

  1. Pingback: Lean Startup Principles: Vanity Metrics and Actionable Metrics | Effective Software Design

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