Venture capitalists strongly urge their companies to focus on getting the customer and sale and not to think in terms of marketing, branding and advertising. Part of the logic for their view is that it is difficult to clearly translate these marketing concepts into customers and sales. A preferred way to think about the issue is to focus on customer acquisition cost--all of the costs directly related to closing the sale. Such an approach makes it easy to calculate customer profitability, sales person contribution to EBITDA, and budgets to acquire forecasted new customers (forecasted new customers x customer acquisition cost per customer). Comparing customer profitability or sales person contribution to EBITDA with non-selling overhead quickly gives one an indication of whether the selling strategy is effective. For example, if the sales person contribution to EBITDA is $150,000 per year, the non-selling overhead is $1.5 million and the plan calls for 4 sales people, you know you have a problem.
This is the method I use to determine a budget or target for customer acquisition cost:
- determine the gross margin dollars per customer per month
- determine the useful life of a customer in months (you may have historical data, industry standards, competitor information)
- Calculate the expected gross margin dollars per customer (1 x 2)
- Decide how many months of gross margin you want to invest to get the customer; multiply this number of months by the gross margin per customer per month and you have your customer acquisition cost
For example, in the telephone company I ran the average life of a customer was 18 months, we had a 50% gross margin, average customer revenue per month of $40 and we used 4 months gross margin as the budgeted customer acquisition cost. (Turned out that many companies in the industry used 3-4 months gross margin to calculate customer acquisition cost.) Now I know that I have $80 (4 x $20 gross margin), for example, to acquire each customer. With only $80 to spend to acquire a customer I immediately know I can't use a sales force, can't do advertising and probably need some sort of direct marketing approach (telephone sales, web, etc.). Alternatively, if your competition is using a sales force, you know they must have a more profitable customer than you have and you need to re-consider your product offering. (In the telephone company we started offering data lines (T1) which increased gross margin per customer 15 fold and we sold the data product through a sales force which we could now afford. Customer average life also increased because the customers do not switch data suppliers as easily as they switch voice.)
So--no more discussion of marketing, branding and advertising until revenues reach $30 million--and let's focus on customer acquisition cost.
