The Essence of A Business Model

June 1, 2015

A simple way to focus on what matters in your business model is look at these two questions:

  • Can you find a scalable way to acquire customers
  • Can you then monetize those customers at a significantly higher level than your cost of acquisition

Thinking about things in such simple terms can be very helpful. I have also developed two “rules” around the business model, which are less hard and fast “rules, but more guidelines. These are outlined below:

The CAC / LTV “Rule”

The rule is extremely simple:

  • CAC must be less than LTV

CAC=Cost of Acquiring a Customer
LTV = Lifetime Value of a Customer

To compute CAC, you should take the entire cost of your sales and marketing functions, (including salaries, marketing programs, lead generation, travel, etc.) and divide it by the number of customers that you closed during that period. So for example, if your total sales and marketing spend in Q1 was $1m, and you closed 1000 customers, then your average cost to acquire a customer (CAC) is $1,000.

To compute LTV, you will want to look at the gross margin associated with the customer (net of all installation, support, and operational expenses) over their lifetime. For businesses with one-time fees, this is simple. For businesses that have recurring subscription revenue, this is computed by taking the monthly recurring revenue, and dividing that by the monthly churn rate.

Because most businesses have a series of other functions such as G&A, and Product Development that are additional expenses beyond sales and marketing, and delivering the product, for a profitable business, you will want CAC to be less than LTV by some significant multiple. For SaaS businesses, it seems that to break even, that multiple is around three, and that to be profitable and generate the cash needed to grow, the number may need to be closer to five. But here I am interested in getting feedback from the community on their experiences to test these numbers.

The Capital Efficiency “Rule”

If you would like to have a capital efficient business, I believe it is also important to recover the cost of acquiring your customers in less than 12 months. Wireless carriers and banks break this rule, but they have the luxury of access to cheap capital. So stated simply, the “rule” is:

  • Recover CAC in less than 12 months

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Robert H. Lane

A seasoned business executive, Bob brings many years of C level management with world-class companies such as GE, NORTEL, Commodore Computers and Acklands. After a successful career, Bob has elected... »

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Derek A. Lackey

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