Step 17: Calculate LTV of an Acquired Customer

Key Inputs to Calculate LTV How to Calculate LTV Outline Overview Key Inputs to Calculate LTV How to Calculate LTV Important Considerations Workshop November 26, 2018

LTV – Lifetime Value of an Acquire Customer This step: Overview LTV – Lifetime Value of an Acquire Customer This step: Add up revenue expected from a single customer Discount revenue based on how much it’ll cost to repay investors over time November 26, 2018

LTV is fundamental checkpoint for venture’s viability Overview Now we do the math aka “unit economics” to determine if venture is sustainable LTV and COCA will help determine how profitable your venture is in beachhead market LTV is fundamental checkpoint for venture’s viability November 26, 2018

Expensive example? Pets.com 1998 Web pet store Overview Expensive example? Pets.com 1998 Web pet store Aggressive advertising (e.g., super bowl) Acquired customers but did NOT analyze unit economics Issue: low margin on products + high cost for ads No clear path to increase LTV and decrease COCA Company was liquidated, $300M in investments lost November 26, 2018

Key Inputs to Calculate LTV How to Calculate LTV Outline Overview Key Inputs to Calculate LTV How to Calculate LTV Important Considerations Workshop November 26, 2018

Key Inputs to Calculate LTV Need to calculate LTV of average customer Not a precise number Not correct the first time (most likely) More important: Understand drivers beyond LTV Analyze underlying factors needed to increase LTV over time LTV is more than just a number! November 26, 2018

Key Inputs to Calculate LTV One-time Revenue Stream Recurring Revenue Stream Additional Revenue Gross Margin for Each Revenue Stream Retention Rate Life of Product Next Product Purchase Rate Cost of Capital Rate November 26, 2018

Key Inputs to Calculate LTV One-time Revenue Stream Up-front price for product Recurring Revenue Stream Subscriptions / maintenance fees Repeated purchases of consumables Additional Revenue Upsell other products Penalty fees November 26, 2018

Key Inputs to Calculate LTV Gross Margin for Each Revenue Stream Price of Product minus costs to make product Costs do NOT include: Sales and marketing (COCA) Overhead from R&D Administrative expenses (e.g. travel, legal, HR, etc.) November 26, 2018

Key Inputs to Calculate LTV Retention Rate % of customers who continue to pay recurring fee Monthly or yearly rate Churn Rate Opposite of retention rate % of customers you lose Include early termination of contracts November 26, 2018

Key Inputs to Calculate LTV Life of Product Length of time expected for product to last Customer will need to purchase replacement or discontinue Next Product Purchase Rate % of customers who buy replacement product from you November 26, 2018

Key Inputs to Calculate LTV Cost of Capital Rate Yearly rate Cost to get money from investors Investors charge premium for their services Usually 35 – 75% interest Assume 50% interest rate in your LTV… November 26, 2018

Key Inputs to Calculate LTV How to Calculate LTV Outline Overview Key Inputs to Calculate LTV How to Calculate LTV Important Considerations Workshop November 26, 2018

PresentValue = Profit * ( 1 – CostOfCapitalRate)t How to Calculate LTV LTV expressed in dollars per customer Will estimate LTV for first five years Formula: PresentValue = Profit * ( 1 – CostOfCapitalRate)t t: is number of years November 26, 2018

Rule of thumb: LTV should be 3 times COCA How to Calculate LTV LTV by itself is not very telling Need COCA as well Rule of thumb: LTV should be 3 times COCA November 26, 2018

Key Inputs to Calculate LTV How to Calculate LTV Outline Overview Key Inputs to Calculate LTV How to Calculate LTV Important Considerations Workshop November 26, 2018

Important Considerations Many secondary factors in LTV: Business model can affect LTV LTV is about profit, not revenue Overhead isn’t negligible Gross margins make a big difference Retention rates are very important Find additional opportunities for upselling November 26, 2018

Important Considerations Business model can affect LTV One-time vs. recurring payments? LTV is about profit, not revenue Gross margins and cost of capital rates are critical! November 26, 2018

Important Considerations Overhead isn’t negligible Overhead excluded from LTV 3:1 LTV to COCA ratio accounts from this Gross margins make a big difference Consider wrapping low-margin core w/ high-margin add-ons Will boost LTV November 26, 2018

Important Considerations Retention rates are important! Longer you keep customer, better the LTV Be realistic, try not to overestimate Find additional opportunities for upselling Can improve profits November 26, 2018

Key Inputs to Calculate LTV How to Calculate LTV Outline Overview Key Inputs to Calculate LTV How to Calculate LTV Important Considerations Workshop November 26, 2018

Goal: estimate how much new average customer is worth to venture Workshop Goal: estimate how much new average customer is worth to venture Not known LTV w/ precision Essential to understand order of magnitude What drives profitability? Initial sale? Consumables? Retention? Gross margin? Volume? Etc November 26, 2018

Cost of capital (interest rate for loans, e.g., 50%) Workshop Inputs to LTV (again) One-time revenue Recurring revenue Other revenue Gross margins Retention rate Life of product Repurchase rate Cost of capital (interest rate for loans, e.g., 50%) November 26, 2018

LTV tells you profitability Workshop LTV tells you profitability How much you will make by acquiring one more customer Minus margin costs (parts + labor) Does not include marketing or sales (COCA) Does not include R&D Does not include administrative expenses (legal, travel, rent) WORKSHEET: LTV November 26, 2018