Business plan presentations and pitches from early stage companies in Web Services, SaaS and Mobile applications have been on the rise (and rightly so). Most pitches seek capital to expand marketing and sales dollars to grow the business. It is always intriguing to see in these presentations, revenue and EBITDA projections along an exponential curve. A common implicit assumption behind those numbers is viral growth (i.e. one signed up user brings in other users/members at no cost to the company), which very few companies can actually accomplish. Most companies typically would have to spend a lot more on marketing and sales to hit their projected revenue numbers and that is where most business models and EBITDA projections break down.
Understanding how much it would cost to acquire and retain customers is critical to the viability of the business. To elaborate, the cost to acquire and retain a customer should be less than the revenues realized from them. Otherwise the venture would not be profitable and managers would need to rethink how they make money.
Say for example a Web Service company drives customer acquisition through online advertising paying $1 for each click and 1 in 5 clicks result in a user signing up. So that makes it $5 to acquire a new user. Let’s assume that the cost to retain a user is 1/5 that of acquiring them (you still want to advertise to your existing customers!). So add another $1 in costs to retain this user over their lifetime. So the cost to acquire and retain a user is $6. Now not all users who sign up will generate revenue for a company. If we say 1 in 10 users who sign up actually pay for the service/buy a product, then the cost of acquiring a revenue generating user/customer becomes $60. So unless the revenue generated from that customer is more than $60 over their lifetime, the business model is not viable and needs to be fixed. SaaS companies might have different types of costs, but the principle is the same.
One can address the situation by reducing the cost of customer acquisition (try something other than online advertising) or tweak the business to generate more revenue per customer by cross-sell or other means. But the key point here is entrepreneurs and managers need to think and understand this clearly before coming up with growth projections. This lends a lot of credibility to the business plan itself. A good practice is to check if your business model supports recovering the customer acquisition costs within the first 12 months. Then you are on safe ground.
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