Essential Things to Do When Deciding On Your Business Idea(edufire.com)
edufire.com
Essential Things to Do When Deciding On Your Business Idea
http://edufire.com/content/articles/228-5-essential-things-to-do-when-deciding-on-your-business-idea
1 comments
Spoken like someone who's been there. My first business had fantastic NPVs and enjoyed great economics. Only problem was that it took 6-8 months payback period. That put some serious hurt in our growth. The business is doing nicely and makes money but I will never look at acquisition costs the same way again.
#1 - Consider “Allowable Acquisition Costs” (AAC)
If you don't understand #1 thoroughly, you're going to want to do some research until you do. It's one of the most important parts of business. Here's the aspects of it:
1. Lifetime Value of a Customer. What NET PROFIT does the average customer generate for your company after making their first purchase? If you run a monthly billing service, it's the average months subscribed multiplied by net profit/month.
2. Conversion Rates: What percentage of people who find your offer purchase? For a fully optimized site, 1% is a surprisingly robust figure that keeps cropping up for semi-targeted traffic. Hyper-targeted and relevant can do much higher numbers, untargeted can get close to 0. Don't assume 1%, test it, but 1% isn't a bad baseline to start with.
3. Net Present Value is Garbage, use Payback Period instead. So this is just my opinion, and reasonable minds can differ. But NPV is basically voodoo nonsense based on faulty sets of assumptions. Better than nothing, but NPV basically exists to make it look to bankers like you're not pulling numbers out of the air. The basic idea of NPV is that if you had a dollar today instead of a year from now, that's better because you could do something with that dollar right now, and thus have more later. The problem is, you have to choose a multiplier for NPV, and it's a largely arbitrary choice. People were using 11%/year for a while because that's what the stock market consistently did. Oops. And now you can get a whopping 2% interest on your money in a premium money market.
My advice? Use Payback Period instead - it's easy to calculate very fast and not particularly subjective. Payback Period goes like this: "If I spend this money now, how long until I get it back?" Everything after that is gravy.
So let's say your average customer makes you $100/month net profit for 20 months, then their lifetime value is $2000 on average. If your customer acquisition costs are $100, you get it back in one month. If it's $2000, you break even after 20 months. In a bootstrapped company, you NEED to get that payback period short. That's the key number. Long payback period = cashflow problems = need financing. NPV is voodoo. Payback period is easy to figure out. With a short payback period, you're less vulnerable to catastrophe.
If you're more statistically inclined, you can segment out different lifetime values and conversion rates from different sources. But most companies don't know what their LVOC numbers are, are vaguely aware of their conversion rates, don't know what payback period they need to keep the lights on, and don't spend intelligently to acquire customers. I was actually staggered in my last company at how much we could pay for customers compared to industry. The average in industry was around $10/customer, the top dog was spending between $20/customer and $40/customer, and we found it quite profitable to run in the $30/customer - $70/customer range and we grew pretty fast.
God, I love numbers when they work correctly. Seriously, getting intelligent customer acquisition going is one of the most important parts of a bootstrapped business. You get these numbers working for you, you're set and don't get blindsided. Great article here, read, re-read, compare, and learn everything you can about Lifetime Value, Conversion Rates, and do a little research so you can make your own call on NPV or Payback Period, but you should use one of them. Great piece, great insights, strongly recommend heavy focus on his point #1 since it'll make or break you if you're not funded.