The Golden Number of Subscription Commerce
The golden number in all profitable subscription commerce companies is the ratio between your projected lifetime value (LTV) and your customer acquisition cost (CAC). I like to always define the “value” in LTV as profit, not revenue. This is a VERY basic calculation that most entrepreneurs forget to calculate, or even consider. Here’s the deal, if you have a positive ratio, you are in business! The higher this ratio, the more profitable your company will be. If you have a negative ratio, we have some work to do.
Your lifetime value is the value that you can expect from your users based on the average projected length of subscription. Say, we project users to stay on for 4.6 months and your subscription is $50 per month. This would equate to a projected lifetime revenue of $239. This number is alright, but we can do better by calculating the lifetime value in terms of profit. In this case, you would need to factor in your gross profit margin. Your gross profit margin is the % of profit you make each product you sell. To get gross profit margin, you first find your profit per product by taking the product cost and subtracting the cost of goods sold. Then you take you profit and divide it by the sale price.
Now that we know what LTV is, let’s define our customer acquisition cost. This is the cost you pay to transition a click on an ad to a paying subscriber. Let’s use Facebook as an example, if we spend $1,000 on Facebook ads for a 7 day period and you generate 50 sales, your CAC would be $20. You find this by simply taking the $1,000 / 50 = $20. But, how do we know Facebook drove these sales? If Facebook was our only marketing channel and we had 0 organic traffic, this number would be close to true. Sadly, this scenario is very uncommon in marketing. So… we need to figure out exactly how many conversion Facebook drove. You can do this by placing what is called a pixel on the checkout conversion page of your site. This pixel is like magic! It tracks all of the activity from Facebook and counts the number of users that saw or clicked on the ad and made a conversion within your given time period. The pixel will send all this information back to Facebook so you can calculate exactly how much you paid to get a subscriber.
Let’s try an example:
Average subscription value: $45 / month
Average projected length of subscription: 4.5 months
Cost of goods sold: $20
Gross profit margin: ($45 – $20) / $45 = 55%
Lifetime revenue: $45 * 4.5 = $202.5
Lifetime Profit : $111.38
This means that you have at most $111.38 to spend to acquire a purchasing customer to keep your ratio positive and make money! Of course, you want your customer acquisition number to be as small as possible for more profitability. Let’s say we buy media and our CAC is $50. This would make our LTV to CAC ratio equal to +2.23 ( $11.38 / $50). You can also read this number by saying, “For every $1 invested in paid media, I get $2.23 back.” Good deal, isn’t it?
Tactics to increase LTV:
- Increase your margins: As you scale your business, you should get economies of scale on your inventory that will help increase your margin. When you are buying more product, demand lower costs from suppliers.
- Invest in customer experience: Provide a phenomenal experience and your customers will stay on longer, and share with their friends.
- Invest in customer service: Train your team on how to save customers that are wanting to cancel. By saving these customers, your average length of membership should increase. In my opinion, customer service falls under the marketing department and is an extremely important pillar of your business.
- Invest in product: Although this may decrease your gross margin by increasing your COGS, it may allow your customer to stay on much longer by providing a better value.
- Increase value when most users fall off: Analyze what month most of your users are falling off and provide a much higher value during that month. For example, if you notice all of your members are falling off on month 6, add something extra to month 5 box.
- Upsell: When users are checking out, ask them if they want to add something else to their cart. This is the “Do you want fries with that?” theory. Ideally, these upsell product have high margins that will skyrocket your ratio if done correctly.
Tactics to decrease CAC:
- Media Arbitrage: Being the first to the party, will pay off here. Whenever a new ad platform launches, new placements are released or new features are launched within existing ad platforms, you should be experimenting with these as soon as they are released. In these scenarios, you can get a serious discount on media, but only for a short period of time. Sign up for beta programs and stay up to date with the latest online marketing news to find these opportunities.
- Push More Content: Content is the gasoline for online marketing. You continually need new creatives and ad variations to scale any campaign. If you don’t do this, the cost of ads will continue to increase as your ads become stale.
- Perform multivariate testing (MVT): Use softwares or processes to test multiple ads at one time. On average, we launch over 500 unique ad combinations per client, per week! With our systematic approach, we are able to quickly find the winning combinations and iterate from there.
- Launch a Refer-A-Friend Campaign: With a good strategy, you can have your customers do the marketing for you – for FREE! There needs to be a “What’s In It For Me?” (WIFM) to make this work. Provide a great incentive for your customers to share.
- Robust retargeting eco-system: It’s always cheaper to get a customer that has already showed interest in your product to convert to a subscriber. Implement a retargeting net to capitalize on the users that are most likely to convert. Some strategies include, general Facebook and Adwords retargeting, email drip campaigns, abandoned cart or dynamic product ads.
- Optimize your site: Your website should never be completed. It’s a constant work in progress. You want to be constantly tweaking and changing things to increase your conversion rate. Your website is like a slip-N-slide, you want your users to get a running start and slide right through the checkout without hitting any dry spots. Find these dry spots by using tools like Google Analytics and SumoMe Heat Mapping to lube them up. I guarantee you have many dry spots on your site.
So, what’s your company’s ratio? Is it positive or negative? If this ratio is negative, focus on these tactics to improve your business online. This number is GOLD! You should know what it is and use it to help guide your decision making.