This is the first video installment of airCFO’s North Star Metric Series. During this discussion, we'll cover the following North Star Metrics:
Matt has been with Fika Ventures for four years. He was a member of the founding team at JetBlue and worked as an enterprise sales and Business Development Executive for 10 years. Matt is a Seed Stage startup investor at Fika.
Erik Fogg is the COO and Co-Founder of ProdPerfect, founded in January 2018. Erik has a background in operations and industrial engineering and was brought into ProdPerfect to help revolutionize how software and SaaS companies test their applications for quality assurance.
Be sure to watch the recorded conversation or read the transcript below.
Lifetime Value, Customer Acquisition Cost (CAC) and CAC Payback Period with ProdPerfect and Fika Ventures, hosted by airCFO
Q: How do you measure and track CAC (Customer Acquisition Cost), Payback Period, and LTV (Lifetime Value), and how do you utilize these metrics in operational decision-making and performance tracking?
Erik Fogg: I'll start since I'm the one doing it today. Where we are right now is that we have raised 17M. We have our Series A, and we are moving towards our Series B. For a startup at Series B, that's the time that you're really expected to scale hard - you're taking money and you're just turning it into more and more revenue. We'll talk about when to start tracking these in time, but we are actually in the middle of tracking them now. What we use these numbers primarily for is essentially for turning dials. I think, more important for us than the individual numbers of the Payback Period, Customer Acquisition Cost, and Lifetime Value are the underlying metrics that drive those. Of course, we want to maximize all of these, but for us, the most important part is being able to make decisions about what changes to make and where to focus our engineering and problem-solving resources. So we look at one level below what's driving these. You know, sales, onboarding cost, the human labor, the software conversion rates, etc. We can get into all that but we are constantly prioritizing: "which one of these should we be attacking in order to maximize ultimately our LTV and payback period as we prepare for our Series B?"
Matt Hersh: Another thing that I will add there is it does not make sense to go through the definitions explicitly of CAC, the Payback Period, and LTV, just given the plethora of information available on how to calculate them. From an investor's perspective, it ends up being more around the trending of those metrics. As a seed-stage investor, we're obviously not going to have these metrics. We may have some early signs of what these metrics are from companies that we choose to invest in. We have to basically believe that CAC can go down, LTV can go up, and the Payback Period can be decreased. In the early days, the best way to understanding these are early wins in the sales front, early customer service scores like NPS, which tend to be more qualitative in nature, but it really gives an understanding of the business health and how customers feel about your business without having the data that you would normally have to track these metrics much more effectively.
Q: How do you factor in the interrelatedness of these metrics when considering whether to adjust operational inputs or how do you consider the connectivity of these metrics and the underlying in deciding which levers to pull?
Erik Fogg: These metrics are all quite interrelated. Your lifetime value is, of course, dependent on both your CAC and your margin. Your Payback Period is related to your CAC and your margin as well. So for us, because both LTV and Payback Period are primarily the factors of CAC Margin, Lifetime Value (also including churn and renewal rate), the way that we deal with these is we look at the margin, we look at our CAC, and we look at our renewal rate, and we focus on those as the levers that we should consider pulling. We actually even look a level deeper than that. Matt outlined that NPS is a key leading indicator for a seed company about the LTV.
For us, it is the leading indicator of our renewal rate or our churn. That's going to be a major factor in our LTV. So, we are focusing on "how do we drive NPS up?" and there's a whole team dedicated to that - our product team. Similarly, for our CAC and our margin, what we are looking at are inputs to operational costs. For us, I think margin is a higher priority than CAC most of the time. Our LTV is pretty good because our churn rate is low, and our renewal rate is so good. So I think it's going to depend on your business a little bit. There are some businesses that are a bit of spreadsheet SaaS and in a very highly competitive market where there's going to be a lot of churn and poaching away of customers by other companies. What this means is that churn is harder to control; there is a higher level of effort, complexity, and cost in doing that.
So the thing to focus on is reducing your CAC as much as possible while improving your margin. Ultimately, the factors that we must take into account about which of these interrelated metrics to go after is really about the total size of the opportunity for us and how much squeeze do we have to do for that juice. This is frankly a very intuitive, kind of holistic call I have to make as a COO. It's very hard to know what that squeeze will be using analysis, but if you really understand your business holistically, you will have a very good sense of which of those three metrics is going to get you the most bang for your buck.
Matt Hersh: I don't want to repeat a lot of what had Eric said but we, as investors, are always challenging companies to focus on their CAC. But again, it's more about how CAC changes or evolves over time than the absolute numbers. Can a business that was sort of initially at a thousand dollar CAC get down to a hundred dollar CAC and in how many months?
I think the critical piece is understanding the "why." The question is around the operational inputs and being able to tweak those. A company that's aware of what they did and how their actions affect things like CAC and other key metrics is critical because only then you'll be able to figure out if that makes sense to put your foot on the gas with regards to one of those sort of operational inputs or investment and show that an improvement on CAC is a sustainable one.
What you don't want to see on your CAC is a roller coaster ride. That is a no-no as it shows that the company doesn't really have a good grip on the factors that affect CAC and what they need to do in order to maximize the LTV. That is ultimately the ratio that you hear everybody is talking about, which is also sort of critical for an investor to get comfortable with. So, for earlier stage companies, it's much better to focus on the discreet CAC, LTV, and the payback period on sort of a project or campaign basis but also know the things that you're doing to affect those discreet metrics. It will then be rolled out into full profitability analysis, which is the ultimate goal.
Q: When should a startup begin monitoring these metrics, which should they start with, and how do you recommend going about finding a starting place to begin measuring and tracking these metrics?
Matt Hersh: We don't expect companies at the seed stage to come in with these metrics in place. It's very hard to do that. If you do have that and you have it in your slide deck and your model, we always poke holes in it because you typically don't have enough data yet to accurately track it. The more critical part is knowing that you need to track them. You need to set up a database to capture that data. Even if it's "collecting dust" and you're not doing anything with it, it needs to be there. It needs to be a system of records. If you can establish what the definition is of your metrics early on, either on your own or with support from a group like airCFO, in ensuring that you're calculating those metrics based on the generally approved standards, you are set up for success.
What's harder is when you do a bunch of things, run a bunch of campaigns, hire a bunch of people but you don't have the basis for knowing which sort of line items you should pull from in order to drive those metrics. It's harder to go back versus just being able to set it up upfront. Most expense model templates have the concept of LTV and CAC better built-in. I think the nuances, however, are that each business is different, the definitions can be different based on the industry vertical. So it's critical to be as vigilant as possible and keep the data up to date. Even if you don't have the numbers in the early days, still make sure that every month you're going back and you're including every input to help you drive what those numbers will hopefully be able to show you over time.
Erik Fogg: I have a controversial position on when startups should really start seriously tracking these metrics or seriously caring about the overall numbers. One of the things I really appreciated when we were fundraising for our seed is that Fika or Matt didn't ask "What's your LTV to CAC ratio?" A lot of investors, however, did! We have only been around for nine months. At that point, asking about our LTV-CAC Ratio is meaningless. I think a lot of investors are pattern-matchers and are looking for the familiar. The hard part about this is that startups are supposed to break the mold of the familiar. What makes a good break-out startup is that the old patterns don't apply. I think at a Series A stage, a startup should be experimenting aggressively, making cash investments to look for opportunities to make breakthrough changes to CAC, LTV, and Renewal Rates. This costs money, yes. But if you just look at, say, your last 3-6 months overall CAC and if you're an investor and you just draw a linear line out and say "Okay, I'm gonna make this and that based on the current growth rate, current CAC-LTV ratio," stuff like that, you're going to potentially miss out on a big opportunity that is unique to these startups.
It really depends on what investment you are making. For example, if you're investing in yet another CRM or another PEO, their competitive advantage is in the margins. This can be economic margins but also product margins or feature margins where early on, the economics do really matter because they just have to raise out to markets. It's a highly competitive field. It's easy for competitors to come in and force down prices which mean that these underlying cost economics really matter early on. But then, there are certain startups - I'd like to think we're one of them - that are making much more revolutionary changes in a wide-open market where the race is to build a product that can essentially create a monopoly. If you're doing that, there are heavy investments that can even make margin or your LTV-CAC ratio look bad early on.
So why is an investor going to get to the bottom of the holistic story of a startup? That is to understand what this team is doing, what the market is doing, and what the industry is doing around them that's gonna change their broader trajectory. "Is this a company that can really go become a $10 billion per year revenue company?" At which point, the margins today aren't as important. They should go get that revenue, it's going to be capital intensive but they can go dominate a market and then pull the margins in later to improve overall LTV-CAC. So it really depends on what kind of investment you are making.
I agree with Matt that you should track right away. Even if you're highly experimental, you should still know what you're doing so you can see the results of these experiments you're running and understand the impact they're likely to have. Then, decide from there whether to stay in the experimental stage or move on to a different one. Tracking this stuff very early is huge for leading founders in making rapid decisions, rapid experiments that they can finish, and move on to the next steps.
Q: Are there any nuances that founders should be aware of when setting out to begin tracking these metrics?
Matt Hersh: I think with regards to CAC, the definition of Sales and Marketing (S&M) expenses is the one to focus on. Depending on what you choose to include or not include can be indicative of the outcome of the CAC metric. It may appear super rosy or super terrible. If you're presenting that in front of an investor, they might dig deeper and figure out what assumptions you made and will also make their own assumptions of what are those items that should be included or not. So, it's good to make sure to go by certain industry best practices as what should be included in the S&M expenses.
Erik Fogg: I think there are a few nuances. Understanding your Marginal versus your Blended CAC is supercritical in making decisions. You want to know your Marginal CAC because you want to know if it's economical for you to take a channel where you're paying marginal dollars such as advertising and just turn the dial. Your Blended CAC is also very important because you want to understand the impact of your organic, inbound, and other more brand-based, holistic marketing efforts. If the advertising or direct channel CAC is not as economical, you may need to focus on being able to create a more scalable, non-linear growth plan. Ultimately as a COO, it is critical that you understand in what ways your business is unique and does not follow previously drawn patterns. It is also important to have a lot of courage to hold your position when an investor is asking questions. Do not think that the investor is some omniscient teacher that knows everything but instead, someone who knows the industry really well but does not know your business better than you do.
Q: What can these metrics tell about your startup's actual performance and future potential?
Erik Fogg: In my mind, the momentary value is not all that exciting. I think what's exciting are the results of the experimental, contained version of these metrics. Also, the rate of change, the velocity of these metrics tell us more about the future than the current number. Knowing that those metrics are changing, knowing that the founders know why those numbers are changing and that they're changing at the will of the founder rather than in a way that we don't understand - these for me would be big indicators that we're on the right track.
Matt Hersh: From my perspective, at a seed stage, these metrics can help you understand what the revenue growth is. Ultimately, we want to make sure that the company is sufficiently capitalized and has a long enough runway to drive enough revenue during that time to position themselves for the next rounds before they run out of money. If CAC or Payback or LTV are sort of out of whack, it will be a yellow flag for us, maybe a red flag for some investors even. We would then want to dig in and understand "why is that?" and make sure that the company is aware and has steps to improve it over time.
Q: What are some characteristics shared by startups who you've seen as high-performers by just looking at these metrics?
Matt Hersh: It's much more of the awareness. They are super aware of these metrics. They are super aware of the things that they need to do to have an effect on those metrics and how the decisions they make impact these metrics over time.
Erik Fogg: There's a leading indicator that one of these metrics is either is or about to be wildly better than the standard. There should be something that is game-changingly different.
Q: Is there any additional feedback that you can provide to founders who are looking to improve their performance in these metrics?
Erik Fogg: The most important feedback that I can give to other founders is to step away from spreadsheets. Spreadsheets are there to make you aware and tell you how your decisions have changed stuff but you need to get out of that and get your hands dirty. Understanding at every point what people are actually doing is the only way to get insights to be able to make major changes.
Matt Hersh: I agree with that. Also, if you can't figure out all that stuff on your own, go out and get some help. Go to professionals or ask your investors. There is lots of information available online. If you don't understand it, spend the time that you need to understand the drivers of the metrics and if you don't know what to do to change it, then seek out help.
Seeking help from professionals and Fractional CFO providers like airCFO will help track and understand these metrics and improve overall startup performance.