Cost of acquisition versus lifetime value

A post on Fred Wilson’s excellent blog about cost of acquiring each customer versus the lifetime value of that customer. And it’s pretty simple: “LTV has to be greater than CPA or you won’t be able to scale – or, for that matter, survive.

This seems obvious. But when you’re preparing a revenues-versus-costs estimate for a business plan, you often overlook how much you earn versus spend per customer over time. Here’s a slight variation of that from a few weeks ago:

The CEO of our firm shot down a recent plan I presented, one that involved both the mobile web and SMS working in tandem. The product was different, compelling, and the estimates said we’d be profitable in a year on the gross. But our SMS costs were 80% of the revenue we would have earned from advertising.

“Keep SMS out; figure out the mobile web part. If you’re spending 80% of your revenue on acquisition and retention, you won’t have enough to spend on content and infra and operations and product innovation – and that’s not even counting people.”

And this was true not just in the month we acquired the customer. Month on month, the SMS costs kept pace with the ad revenue per customer [1], so we’d never have enough money to spare. In other words, the CPA was lower than the LTV. But not nearly low enough [2].

[1] It was also likely, I realised later, that over time the customer would yield less ad revenue as he/she tired of the service, but the SMS costs would be the same. So we would have to evaluate the customer’s worth and adjust SMS quality of service constantly, making things rather complicated.

[2] As an aside, these costs also grew linearly not just over the lifetime of each customer, but also with the addition of every new customer – there were no economies of scale to be had. If there were, the total lifetime value of all customers would have grown faster than the total (SMS) cost of acquisition and retention, and it would’ve been viable after a point of time.