SaaS Growth Metrics 101: CAC, LTV, Retention and Churn
Paul Orlando is the founder of Startups Unplugged where he's building an internal incubator and accelerator programs around the world. He's a Professor of Entrepreneurship at the University of Southern California (USC), and he's the author of Growth Units: Learn to Calculate Customer Acquisition Cost, Lifetime Value, and Why Businesses Behave the Way They Do.
This episode is a crash course to help you understand and calculate your customer acquisition cost, lifetime value, retention, and churn (including negative churn and why that's a great goal for your SaaS business).
We cover the common mistakes that founders make when working with these metrics and share some best practices to help you be more successful.
By the end of this episode, you should have more confidence in understanding those metrics and how to use them to help you drive business growth.
I hope you enjoy it.
TranscriptClick to view transcript
In this episode, I talked to Paul Orlando, the founder of Startups Unplugged where he's building an internal incubator and accelerator programs around the world. He's a professor of Entrepreneurship at the University of Southern California, and he's the author of Growth Units: Learn to Calculate Customer Acquisition Cost, Lifetime Value, and Why Businesses Behave the Way They Do.
This episode is a crash course to help you understand and calculate your customer acquisition costs, lifetime value, retention, and churn, including negative churn and why that's a great goal for your SaaS business.
We cover the common mistakes that founders make when working with these metrics and share some best practices to help you be more successful. By the end of this episode, you should have more confidence in understanding those metrics. And how to use them to help you drive business growth. So I hope you enjoy. Paul, welcome to the show.[00:01:28] Paul: Omer, great to be here. [00:01:29] Omer: Tell us about Startups Unplugged. What does your company do? Who do you help? And what's the main problem that you're trying to solve? [00:01:38] Paul: Startups Unplugged is the company that I started about 10 years ago to help startups and also primarily larger businesses grow. And it's through that business that I've built a few different startup accelerators and incubators around the world.
I do a lot of consulting work through it, and I basically take the experience I had as a startup founder and also as a professor of entrepreneurship and try to extend that and bring a lot of those lessons to other companies.[00:02:09] Omer: You teach growth hacking at the University of Southern California. Is that how you came about writing the book? [00:02:16] Paul: It is. So the content in that book Growth Units, it really comes out of the class, the class I've been teaching. And I, this is not an academic textbook. This is a really straightforward, useful guidebook to how you can approach lifetime value, customer acquisition cost, retention, and some mini case studies there.
It did grow out of that class and it forced me to make sure that I was really getting to the most essential parts of these topics and presenting that and really, I think straightforward way.[00:02:53] Omer: All right. So today we're going to talk about obviously the book and our goal here today is to help listeners understand and to be able to calculate their customer acquisition costs, lifetime value, retention, and churn.
And as we go through that process, we're going to talk about some of the common mistakes that founders make and also some of the best practices that they should follow. And the goal that Paul and I have is that by the end of this episode, you'll have more confidence about how to use those metrics to help drive growth with your business.
So with that, let's, start talking about customer acquisition cost. Now I think people, most people listening to this show know what CAC is, but let's start from the top with the basics and just, can you just help us understand what is customer acquisition cost and why should we care about it or bother measuring it?[00:03:58] Paul: Absolutely. So customer acquisition, cost or CAC, that is a measure of how much it costs you to get somebody in who's a paying customer. And maybe I'll first talk about the, in the book, what I call like the unhelpful way that we often see CAC presented. So a pretty typical way. If you speak to a business owner, That they will be thinking about CAC is they might say, well, in the past month I spent whatever $10,000, $50,000 on all those acquisition activities, your ad campaigns, my marketing budget is that number.
And I then signed up ten, a hundred whatever the number of customers is. So they're just taking that top line, spending, dividing it by the new sign-ups and. From there they get a result, therefore it costs me $50, a hundred dollars, whatever the number is to acquire a paid customer. That is a way that you'll see people do this calculation. To me it's not super helpful. And it goes back to like the old advertising joke. I know I waste half my ad budget. I just don't know which half. What I try to get people to do is let's actually try to break this down on a per-customer basis or a per action or a per-channel basis. So what I prefer to do where it's possible is something a little different.
I'll give a few examples. So one would be that we start a little different formulation of that calculation. So the simple calculation I'd like to use is the cost to get somebody in the door. And when I say in the door, I could literally be in the door of a brick-and-mortar store, like an ad that drove people in or some other activity. It could also be you're getting somebody onto your website. Like the door is digital in that case.[00:06:03] Omer: And for this show, obviously it's about SaaS. So it's going to be about getting people to a website and landing page or whatever. [00:06:08] Paul: Absolutely, and then into that, you have a conversion rate, every hundred people who land there, what percent actually end up converting to being a customer.
And if you take that little tweak of the calculation, then it's a little easier to apply it, to say a specific channel that you're using. Like you're doing Tik TOK or Instagram ads, or you have a mailing list or it's word of mouth, et cetera. So you can start to break down CAC by channel. You can also then start to look at other elements there as in, is there a difference in CAC based on type of customer, they end up becoming like, are they on the basic plan on a premium plan? So you can get really fine-grained with it but in general, that's the way I look at it.[00:06:57] Omer: Right. And so I think this is a good process and that you went through in the book and that's why I'd like to follow that same process where we're starting with.
Here's a really simple way you can measure CAC. It's probably not the best way to do it because there's a whole bunch of downsides of doing it that way and it's not going to be that particularly helpful. And then, so now we've taken it to the next level and said, okay, let's try to get a better CAC calculation based on getting people to the door, to our website and then how well we convert them. What's the next thing? How do we then go and make that calculation even better.[00:07:38] Paul: The next thing you could do is write this out by channel of acquisition. Like I was seeing earlier. So looking at your CAC based on how people are coming in, if it's paid ads, you have all the ad platforms that you could be using.
If it is a mailing list, if it's word of mouth, if it's referrals on and on. A theme for me is like, if I ask a company like, what's your CAC, what's your LTV. And they give me a single number for anything. I know that they're just starting to get into this. You probably have multiple numbers for all of these.
And then once we start to tie in the LTV piece, that the connection is, well, how do you know what your CAC should be? No. Is this number good, bad, high, low. You don't really know until we start to answer a few other questions as well.[00:08:29] Omer: Right. Right. And so just talk a little bit more about that. Like why is it beneficial to, to break it down by acquisition channels? [00:08:39] Paul: So there's a couple of reasons. So one is you want to make sure that you understand how the costs are different or, you know, each channel and then a little longer-term say when you're ready to turn on growth, different channels will scale differently. So there'll be a simple example of this is if you're doing a lot of paid ads in the very beginning, it you're figuring out your messaging, you're figuring out your targeting.
It might actually be relatively expensive for you to run those ads. Like you're really sorting things out. You've run a few experiments. Do you know which has performing better that you're optimizing for that? And you can see a decline in CAC as a result. Like you're really targeting people better. You have like a relevancy score that's pretty good.
If you keep pumping more ad dollars there in general, what often happens is you start running out of people. So like you've already hit all the easy wins, like those ideal early customers, like they've already looked at the ad multiple times, you start running out of people. Your relevancy score is going down.
It's become harder for you to acquire customers in your CAC starts going back up. So, and then you have to really be thinking, well, what's the next channel that I use, or what's the next approach I'm going to take or maybe pay it doesn't make sense for right now. I need to like take some other more organic approach.
So once you start breaking this down, see by channel, or just by like the stage your business is at, it'll give you some insights as to what you might expect in the future. So. If you're talking with an investor, for example, and they're asking you these CAC questions, and you're able to tell them like channel by channel, what you're seeing, and then what the result is, of downstream with money coming back in.
That's the question you'll often get like, so what will it mean what's going to change when you do start to turn into the growth on? Which of these channels are going to scale and which are not. So what might I expect CAC becomes in six months when you've pumped our investment into your.[00:10:50] Omer: Right? And then when we talk about LTV a bit later, it becomes even more important because you need to have that granularity to really be able to make better decisions.
And just because you're acquiring a customer from Facebook for $5, And a customer from LinkedIn for a hundred dollars doesn't mean that the Facebook customers are better. They might be the worst customers. They might churn after the first month, whereas LinkedIn customers might. So we can talk about that and we'll fill in the pieces as we go.
But great. So that's helpful to understand that. And then let's talk a little bit about growing versus scaling customer acquisition. That is also a very important distinction you make in the book. And then we can talk about some examples of applying that to different acquisition channels, but just from a top-level, what's the difference between growing scaling customer acquisition?[00:11:48] Paul: Yeah, that's a great question. These terms, they get thrown around a lot often they're interchange people use them in the same way. There is a difference though. So growing is just the businesses becoming bigger. Scaling, however, you're growing, but there's also some other efficiency that is taking place over time.
So you're increasing in size, but you're also becoming more efficient. And that could mean that in terms of customer acquisition, that is becoming cheaper for you to acquire customers, or when we're talking more on the LTV side, the cost of providing value to them is declining. Lots of the businesses that are let's see subscription businesses that are really small. Like one of the challenges that they have is if I'm a new potential customer. And I've never heard of you, like, well, is the trust there? Does this thing really work? Like I have no, I've never really seen this in action before. So it might be relatively expensive for me to decide, or for me to like sign up.
You might have to like really persuade me, or I need to like, have a, like access to a free version for some amount of time. Or I need like a referral from somebody who I trust over time. Ideally, you become better at that. And you have some type of scale effect where in some way you're more efficient at what you're doing and the process improves.[00:13:16] Omer: Okay. So growth is like you're growing, but it might not be the most efficient way to do that. And if it's not efficient, it's not going to scale. So let's share a couple of examples on that. So I know one of the ones you mentioned in the book, obviously like SEO, If you do SEO and you start to rank well for your target keywords, that can drive growth and it can be very scalable as well, but it takes a long time to, to build that up and to rank and all of those things.
Whereas I believe one of the other examples you gave was if you're driving growth from going around and posting in forums or different communities, and you're attracting customers from there, you're growing, but that's not a very scalable channel. You couldn't just throw money at that and say, yeah, we're going to make that efficiently work for right.[00:14:08] Paul: Right, and' so great example, thank you for using that example because that's what I mean, it's certainly a tactic used by a lot of early-stage companies get to know the communities, subreddits, where people are talking about related issues. Get in there in not too sales either way and start to tell people about what you're doing.
You can't really automate that process. It takes that time investment. If you simply, if you do try to automate it, when you just start like copying and pasting, it's very recognizable. Yeah. So that customer acquisition tactic of say posting in an online forum, it can work. I certainly know people who have done that with success, but you know, every, every additional form that you go into.
You have to put that investment of time in there. So, yeah. So that's one that like, it could help you grow. And I, and at least my perspective, it's, it's hard to scale that one, but you know, there's others where in theory, other tactics for acquiring customers where they might be a little more. This could be related to, in some cases, maybe media coverage that gets picked up again and again, if you were lucky, it could be also one where it's more to a degree word of mouth, but then that also starts to reach a limit. Certainly like building an email list, like it can grow, but it's difficult to scale as well. Same with paid ads. These scalable methods are, are less common, you know, I'll say than the ones that can simply grow.
And that's one of the challenges in customer acquisition. It's until you get to that point where you have lots of referrals that are coming in and your own customers are doing the work of marketing for you. It is an effort along the way. There's like every additional acquisition is taken either that time or that monetary investment.[00:16:04] Omer: How do you think about direct versus indirect costs when calculating CAC? One way to look at that is I'm running a Google ad words, and this is my budget and this is how much it's costing me to get people to this site to convert them, acquire those customers, et cetera. Right. But then there's also, what am I people costs, what am I paying marketing? What am I paying my salespeople? How much of that should we be taking into account? Because if we could break down all those activities by channel as well, it would be very simple. Right? The reality of, it's not that clear-cut. So what's your recommendation on how to think about those other costs? [00:16:47] Paul: I almost hate to say it early on we like, we almost avoid that question because there's just too much uncertainty and very early on, say in a SaaS business, you don't really know what a, like a marketing person is capable of doing, or they'll try some things this first month that don't really work the second month they might seem to be improving. They figured something else out, and then it stops working. It's really challenging when you start trying to put those people cost in there, there are metrics around what you can do where it's say a sales team and you're paying a salesperson or what the commission structure is.
And therefore what type of business they must be bringing in just to cover their own costs. So you can start getting more into the detail as you are growing your business, but, but yeah, you're right. That's why, if you're doing something pretty straightforward. Like you mentioned running an ad word campaign.
I put up my budget, I put up my target keywords. I have to ad copy. I've run it. I know exactly the cost of doing that. And if I'm, if my budget is $5 a day, or if it's a thousand dollars a day, like I'm not hiring more people. In relation to that increased ad budget, right? That's that's like the automation taking care of itself.
I personally, I tend to step back from that when it comes to the people costs, at least until you're kind of at a stage where it makes sense to try to figure that out. Early on if it's a small team, you're probably not exactly ready for that just yet.[00:18:23] Omer: Yeah. I think there was a good, good example in the book where if somebody creates a piece of content the team could spend two weeks creating a great piece of content, publish it. And for the next six months, it does nothing. And then suddenly out of nowhere, that content is ranking in Google. It's driving traffic to the site. People are converting through there. So you've got two issues there, right. But one is what was the what's the customer acquisition cost.
And do I include the time the team spent building this piece of content? And I think you said somewhere in the book that in some cases it might be just simpler just to estimate a cost based on what you think you might pay somebody to create a piece of content, right. That's one way to do it, but then that also opens up.
The second issue is like, if you're just looking at your spend by month and what you're converting. You're not accounting for work you did six months ago, which is now paying off or longer cycles and so on. Right. So that's another factor. I don't want to complete over-complicate things, but that's another thing to consider when we think about.[00:19:29] Paul: No, it is. I, I basically put that structure out, like, are your customer acquisition costs fixed as in we create the piece of content, it was a one-off it's out there. And then there's some future benefit from that. But that benefit, assuming this is evergreen content, it's not going to go and update immediately. I could get that benefit for months or for years.
I've certainly seen that in various things that I've, I've written things like from years ago, and then people will still discover them and reach out to me. And then there are the more, more easily measured. Types of customer acquisition costs, which are variable and go back to the AdWords that you mentioned.
Like I pay every single time I acquire somebody. I can tell you exactly how much I paid the last day for all that acquisition.[00:20:17] Omer: Yup. All right. So somebody is listening to this. They've got a better understanding of CAC, hopefully, by now you understand how they can get a better calculation of CAC and hopefully by acquisition channel. And then we come to the million-dollar question. How much should my CAC be? [00:20:33] Paul: I love that question because unless you really get into the details of a specific company, it's not a question you can really answer. So what your CAC should be, it depends on the other side of the equation, your lifetime value.
And when we start to talk about that in a little bit, you could look at benchmarks like industry benchmarks. You could ask around what other people are in general pain. That is all helpful. I'm also going at this with the assumption that everyone's situation is a little different. The other reason simply answering that question with it should be this or that is that we're also avoiding something like a payback period.
One of the metrics I talk about in the book is say, you are spending $50 to acquire a customer. And maybe that's like a great ratio for what you're getting returned, but if it takes you years to recoup that $50, you might've already gone out of business by that time. There's a lot of, this is really like this interconnected web of different business metrics that all call on each other. Yeah. I have to say it depends for that one.[00:21:44] Omer: Yeah. And that's a good segue into LTV because I think in the early days of a SaaS business, it doesn't matter what your CAC is as long as your LTV is higher than that. And we can talk about what that, what ratios make the most sense, but when you want to start thinking about, okay, what is my ideal CAC that maybe is a problem you want to tackle further down the line when you're saying, okay, I'm acquiring customers profitably.
Am I leaving money on the table? Could I do a better job? Is my competition doing better, all of that stuff. Right. But, but at this stage, it's just like, yeah, let's talk, let's move into LTV and, and bring in the other side of the equation here. So again, from the top, let's just, I think people listening to this, know what this is, but just explain to us what is lifetime value? What do we, why do we need to measure this?[00:22:31] Paul: Sure. So this is another metric people will ask about the lifetime value, is the flow of contribution margin from the sale of a product. And the way I break it down is when you're selling a unit of anything, you have the price of that product, you have the cost to produce it.
And in not all, but in a lot of SaaS businesses that cost, if we're just looking at the product itself, we're taking away all those other people cost or rent, things like that, that costs might be very small or next to zero if it's purely software and then you have a metric around retention. So like how many people, how many times do people buy?
If this is a monthly subscription, are they staying with you for. 10 months in general until they turn away. You're like, what is that retention like for you so far? So with those three elements, you, you basically take prices, price of the product, subtract out the costs associated with that product. You take that sum, that contribution margin sum and multiply it by the number of times people buy. And that gives you LTV.[00:23:46] Omer: Okay. Let's I know in the book you talked about. But the unhelpful way to do LTV. So maybe we can talk about that first, because that, that is a simpler equation where you're just saying, it's just what people pay for the product and how many times they buy soon as SaaS if somebody pays a hundred dollars a month and they on average customers stick around for 10 months, we're saying that's the lifetime value is a thousand dollars. Right? So the next step on that, how to improve that metric is what you're talking about here. Although it's a little different for SaaS businesses, right? When we think about pricing. [00:24:24] Paul: Yeah, exactly. And this is where, when I wrote this book, I was trying to present formats that would be just generally applicable. And it might be the case in a SaaS business where the variable costs are pretty close to zero. Those two formulas, like the unhelpful one and the more helpful one are basically giving you the same answer. I think it's still useful to put that cost piece in there, but it's probably the smallest part of the equation for like a software-based. [00:24:54] Omer: Unless you have a, I guess if you have a business where your at and you have like high-touch onboarding and you're allocating a certain amount of resources to help customers on board. Then there's probably more of a significant cost there versus a self-serve product-led growth model. People come in, sign up and start using the product. [00:25:16] Paul: That's a great example. I don't talk about this company in the book, but like the like Superhuman, the email company, they do like live onboarding with new people who sign up and you might think like, how is that possibly like a good idea, right?
To spend. It might be even, I don't know, I don't use them, but might be even be like half an hour. They'll spend with you just like, learn about all the tools and how to be the best at using, using the product and for a company like that, it can actually be completely worth it. So you've just created this really positive customer experience.
Sure. You incurred this cost upfront but you're going to keep that customer for some multiple of what they would have been with you otherwise, or that concierge service. I forget what it is now, $30 a month or something, but you might think, well, $30 a month for email is doesn't make any sense these days.
Like I can get that for free. Why would I pay? Well, I'm paying for this premium experience, not only on the software side, but also on like the human side. And then I never turned away. So. That might be entirely worth it, but that company does need to at least be able to get past that first month where they probably are losing money on that customer when you factor in the human cost of that half hour, eventually get it back plus more because people stay very long time. But I have to, like, I have to have that investment in the bank to pay for those upfront costs.[00:26:50] Omer: Now in the book, you said to think about LTV not So much like a single number, but more like a river. [00:26:59] Paul: Yeah. [00:27:00] Omer: Can you explain what you mean by that? [00:27:02] Paul: And this is probably, one of the most important parts of the book, I'd say. Like I mentioned for CAC, if you're talking to somebody about what their lifetime value is and you just get a single number, they haven't really dug into things yet. So it could be that you have multiple LTVs, but you know, one per channel of acquisition or one per customer segment that you have, but even so once you even break it down by channel or segment, I like to think of LTV as a river of flows.
So typically unlike CAC, you don't get LTV all at once. It's not like a single hit. Usually and certainly for subscription businesses, like the whole purpose is I signed somebody up and they stay with me for a long time. So I don't get all that LTV upfront. I have this in this ongoing relationship with a customer and every month they are continuing to pay me or they are upgrading and they're paying me more.
Right. Or eventually, they're turning away. So I present it like it's a river of flows and. Once you model LTV out in this way. And I just, I show it in a spreadsheet format. I show it more visually in the book. Once you model it out that way it helps you understand a few other things that are important to building a subscription business.
For example, how long is my payback period? I incurred this $50 cost of customer acquisition upfront. How long until I can pay back the $50. Also incorporating the churn. I see along the way. So in other words, if I'm charging $10 a month, my payback period is five months only if nobody ever leaves. If I'm losing people along the way, it's going to be something longer than five months.
We could, even in these days with inflation being higher than it was, you might even start to incorporate that in your model, if you say, well, okay, previously inflation was not a concern. Now I might be factoring in 10% inflation. Even if everybody stays with me, if there's paying me the same exact monthly price in a month, sorry, in a year from now. That's worth 10% less. So you can go into so much more detail and have it, then tell you a lot more about the business.[00:29:22] Omer: I mean, it could become a full-time job if you're obsessed with it. Right. I think you've made a point about how many customers who churn will come back. How much will I be able to upsell customers inflation?
Yeah, I think you've talked about like net present value or something like that in the book. Right? So it could become very complicated, but at the end of the day, I think LTV calculation that you described done better broken down by cohort is probably good enough for most early-stage SaaS businesses.[00:29:52] Paul: For early-stage definitely. Yeah, definitely. [00:29:54] Omer: But when you talk about cohorts, can you just explain, like, what are different ways that breaking down cohorts might make sense? I mean, obviously, we talked about customer acquisition cost and looking it by acquisition channels. So that could be one way we could look at cohorts in terms of okay, when it comes to acquiring somebody from SEO versus ad-words versus something else, this is what the lifetime value of each one of those cohorts looks like. And that becomes really useful when you then put the two together and that's cheaper, but those people aren't sticking around. This is more expensive, but these are where the high-value customers are.
So that's one way of looking at cohorts. What are some other ways that might be relevant?[00:30:35] Paul: Another way that's relevant for a subscription business. Certainly ones where you're improving the product over time is to look at cohorts by time. So in other words, and this is something I break down in the book you could look at when people signed up and then compare so that you could have your January cohorts, you have your February cohort and on, and you compare people who signed up in any individual month.
Two people who signed up in other months, what you're looking for there is how does behavior change over time? So if you are continuing to work on your subscription business and you are improving it in some way, or maybe you're just targeting people a little differently over time, if you start to look at cohort metrics, time-based cohort metrics anyway, and you instead of looking at it and you're like everybody who joined in January, February, March, if you instead think of it as, okay, I want to know what is the month one experience. What's the month two experience, month three experience. So I can look at people who joined at any time of the year and then go into my metrics and say like, okay, how many of them are still with us at the month six timeline, how many did we lose?
And then what you're basically looking for in time-based cohort metrics is, are things getting better? But like all this work that we're doing on the product are we actually getting people to the point that they stay with us, like fewer of them churn.
So that's certainly something and that's a question like cohort metrics is something that investors want to know a lot because this helps them understand. Well, all right. I understand how the product has been improving. What's the actual results. In say retention, therefore, what impact is that going to have on lifetime value downstream.[00:32:34] Omer: Great. Okay. So we've covered the fundamentals of customer acquisition cost. We've talked about lifetime value and then again, a very common question is what should my CAC to LTV ratio be. The rule of thumb you often hear. Is CAC to LTV should be something like 1, 2, 3, 1, 2, 4, something like that. And so just basically let's just spell it out for everybody.
So what one to three basically means if I am spending a hundred dollars to acquire a customer, the lifetime value should be about $300.[00:33:16] Paul: Right. That's a metric that you ratio that you hear a lot. It's very much a rule of thumb. So like break this rule whenever it makes sense for you. And the, so the origin of that is a couple of things.
First of all, obviously, LTV has to be at minimum CAC but ideally it's bigger. LTV is also not accounting for a lot of the other costs that you have typically it's some of the people costs some of the, like if you're buying equipment, real estate insurance, things like that. And if we're only using static numbers and we're not using that LTV is a river kind of model.
I don't really know when I get that $300. I know when I paid the a hundred, I paid it upfront. I don't know how long it takes me to get that $300. So that rule of thumb 1, 2, 3, 1, 2, 4, it's basically putting out enough buffer in there for me to keep the business going. You should break that rule of thumb whenever it makes sense for you.
So some reasons might be you're just after market share. And you might say, you know what, I'm willing to pay up to the price of a customer acquisition cost just to acquire customers. I think downstream, I'm going to improve the product. I'm actually going to be able to jack up LTV, or I have this budget now I want to hurt my competitors.
So I want to grab market share. We certainly see behaviors like that from businesses that raise a lot of money and they're either encouraged to do that by their investors, or they just become really casual with how they spend money. Those ratios, if you're really thinking about building a sustainable SaaS business, and you're not thinking about raising money externally, you might want to go a little more aggressive on the LTV side.
So maybe it should be one to five. Maybe it should be something higher or depending on what your payback period is. You're going to adjust it there. But one of the refrains in this book is it depends like everybody's situation is a little different. And I don't really like saying, well, this is the way that you do it. Like avoid everything else.
So everybody who's listening to this, I hope you just think, okay, based on your situation, what should I be doing? What ratio would make sense for me and when might not want to break that rule, because I have some other goal in mind.[00:35:42] Omer: I think that's great. Definitely more of a benchmark is something that you have to do at least you want your LTV to be more than your customer acquisition cost.
But even that is a breakable rule. They could be, as you said, if you're just focused on growing market share and you have the funds, you're not a bootstrap business, maybe that's something that you can afford to do for a while. And I think internet marketers are geniuses are doing some of this stuff and seeing somebody like Russell Brunson, who came from the internet marketing space to come in and build Click Funnels as a SaaS business, which is, I think it's around a couple of hundred million dollars in ARR now.
But his mindset from everything I've seen from him was, Hey, I will even pay more than LTV in terms of direct costs to acquire customers. Because once I acquire that customer, I have confidence that I can upsell, cross-sell. And there's a much higher value on the backend of this relationship. Obviously, that's, it's a slightly different type of business when you're selling product plus training or courses or whatever, but again, it's a good example of, Hey, it's okay to break the rules and sometimes it can work in your favor.[00:36:55] Paul: No, absolutely. And since LTV is dependent on this future series of flows back into the company, there's uncertainty there. If you look at, it's sometimes hard to get data on this, but if you look at like public companies that have some elements that we can learn from, I'll give an example.
If you look at like the annual report of Facebook, you can see per region around the world what the revenue is per user. And if you look at it year by year, what you see is like, it just keeps moving up. It keeps moving up. So this is an example of a business and there's, there's a bunch of them that have this where sure.
I'm losing people over time, but I am making more and more revenue from the ones that stayed. Because I've improved the product or if it's, if it's an ad-based model, like I've optimized ads or I'm showing more of them. So you certainly have a lot to play with, but, but you do need to of course invest back in that business. You can't just let it stay static and build once and let it coast. Yeah, totally.[00:37:57] Omer: Okay. So we've talked about CAC, LTV, the other missing ingredients here are retention and churn. So again, can you just give us a quick definition of what is retention? What is churn?
Sure. Two[00:38:12] Paul: sides of the same coin really retention is how many people who signed up with you in a previous period are still with you.
So it's usually presented as a percentage turns just one minus that. So in other words, if 100% of people are still with me by definition, if I'm only measuring this once a month and see a subscription business, a hundred percent are with me in one month, who've just signed up and in month, two, 10% leave. Retention is 90%, churn would be 10%.[00:38:42] Omer: Okay. So why is this important? I think intuitively most people understand this, but just lay it out for us because there's a super important factor. [00:38:51] Paul: For a subscription business. This is incredibly important. Subscription businesses are built around retention of subscribers.
So retention is like retention and churn. These are metrics that you're probably really paying close attention to. It's important also in say the lifetime value topic that we discussed in that retention or churn directly play into what your lifetime value is. And if you can improve your retention by just like a small amount, it can have a massive impact on your lifetime value.
So when I break down in the book, know lifetime value as a river, I show a weighted gross margin in the book, which is basically taking that price and cost, but bringing retention return into the mix, like in that earlier example, if you're charging people $10 a month and you can say like, oh, well, after five months, I've earned $50 from a customer.
It might be that individual customer that you've earned $50 from if you're just focused on that one example. But if you're looking at the aggregate and yeah, for example, in an extreme situation that you go to zero after five months, like everybody turns away in five months, that dramatically changes that $50 number.
If I'm losing like say 20%, you know, a month over month. I have like a fraction of the $50 instead. Also I was going to just connect it to the previous topic that we were talking about. If we think about that future potential to say upsell or move somebody from the basic plan to a premium plan or a higher tier plan.
If I have incredibly high churn, I'm losing that opportunity. To help this customer grow with, or like for me to like upsell them into a higher tier of service. And that's the problem of a high churn.[00:40:48] Omer: Yeah. One of the other things you mentioned in the book was this concept of retention behaviors. And you touched on that when you were just talking about this a little earlier, but you talked about like three different models where you said there's a constant, is that annual there's a cliff. Can you just help us understand what those three are? [00:41:10] Paul: Sure. And this is just in trying to understand what we see in other subscription businesses and how this might apply to you and your own subscription business. So in a constant churn model, a churn is pretty much constant month to month. In other words, like, yeah, in general, like 1% of people leave. 3% of people leave every single month.
There's nothing that really triggers something different. There. The ideal example of something like that is like a postpaid mobile phone operator. Most people stick with the same operator for years and years, they don't change the service they're more or less the same.
Those companies can tell you like down to the decimal point, what the return is. And it's probably going to stay like that for the future turns pretty constant year, month over month. On the annual churn this is where you, we have subscription plans that require an annual decision.
Yeah, I signed up for the 12 month plan. I forgot about it and then I get this message. Oh, your car is going to be built again. Like, oh, I forgot. I forgot. I was even using this thing. I was paying for this whole year. Ah, unsubscribe. And so like, you, you see that, like that decision that the customer is forced to make, and then you get this big drop-off.
So things might be like, there's like no change. And then, oh, I have to make this decision, big drop-off or cards expire. People disappear that type of thing.[00:42:41] Omer: Yeah. In that model, its churn looks great for 12 months, right? You're like, yeah. It's like, it's good. And then there are annual renewals come along and it's, that's when things don't look so pleasant if you prepare and then cliffs was a third type of model you talked about. [00:42:56] Paul: Right. So there are some types of businesses. You certainly see this in mobile apps gaming. There are some types of businesses where, Hey, you sign up for the thing it seems really cool. You try it out. Not for me. And they churn immediately. So you see incredibly high churn very soon after the signup occurs and you basically end up losing like most people in the first period, say if you're measuring this monthly, most of them churn away, however, if you can get past that period, you might find that the ones who stay with you are the ones that are going to remain with you for a long time. So having like very high turn upfront, like having this cliff doesn't necessarily mean it's a bad thing. As long as all of the other metrics are working out.
So like, if you're not paying a very high customer acquisition cost, assuming that oh yeah I'm keeping people at a very high retention rate, as long as you understand. The user behavior and that's factored in that can be fine, but, but you know, this, we also sometimes see if a new subscription business gets a lot of media and that media is not really in publications that are a target to the potential customers that it has.
So they're just, just getting a lot of awareness. And as a result, people are signing up. They might be signing up for the free the first month or something and they realize after they sign up, this really is not for me. I misunderstood what this is about, or like I only signed up because it looked cool. And I just clicked the link in this publication, a massive churn after that point.
These are the types of things that, you know, that, that can drive a SaaS business owner crazy. But you have to take the step back and try to understand, okay, why did people sign up? Does this behavior represent a problem for us? Even where there's dramatic suture in like the cliffs model. Is that livable?[00:44:57] Omer: Okay. So when it comes to retention and churn, it's pretty clear. Retention is good. Churn is bad, but then there's one other metric that's super. Which is negative churn, which is actually really good. So can you just talk a little bit about that and help us understand what that is? [00:45:15] Paul: Negative churn is really good. It is rare, but subscription businesses that have it are in a great situation. Negative churn is when, even after losing people know the people who have churned away, even after losing them, the ones who remain are more than making up for that loss and the gross margin that they are producing back to the business.
So in other words, I had a hundred customers, 50 of them churn away, I'm left with only 50. Those hundred customers were paying me $10 a month. So I was making a thousand dollars. I'm left with 50 and that later period, but each of those customers are each paying me a hundred dollars a month. Like they've upgraded their, like, just doing more business with me.
Now I'm making $5,000 with a smaller group of customers. So you can actually, you know, calculate how negative churn impacts you like the big subscription businesses, things like box Dropbox, Google drive, anything where you have a, you have a free version and then there's a premium version that's paid for.
And with that, of course, people are turning away over time. Those businesses in general, all have negative churn and it's, it's a great thing because you also have fewer costs often associated with like there's less customer support. Like the worst customers have left. And so yeah. Fewer accounts, but more money being made per account.[00:46:48] Omer: Yeah. Yeah. That's a beautiful place. When you can look at churn and see that, okay, you lost more people, but then you look at your monthly recurring revenue and that's going up, you're in, if you can maintain that, you're in a pretty good place. All right. Great. So there's a lot more, we could talk about this, but we don't have the time.
And of course, if people want to learn more, they can go and read the book or get in touch with you. Let's wrap up. I'm going to go on to the lightning round. So I've got seven quick fire questions for you. If you just try to answer it as quickly as you can. That'd be great. Okay. You ready?[00:47:23] Paul: Let's do it. [00:47:24] Omer: What's the best piece of business advice you've ever received? [00:47:29] Paul: Raise prices. [00:47:30] Omer: What book would you recommend to our audience and why other than yours? [00:47:34] Paul: Oh, my that's a tough one. I'm going to do something. I'm going to recommend a totally different book. I figure they have enough business related things to read, but there's a book called Scene Around Corners by Rita McGrath, looking at future trends. This was interesting to me. [00:47:53] Omer: What's one attribute or characteristic in your mind of a successful founder? [00:47:57] Paul: Being relentless. So not giving up and just every obstacle that's thrown your way, finding some way to jump over it. [00:48:06] Omer: What's your favorite personal productivity tool or habit? [00:48:10] Paul: I have to be honest, I find that being low tech, it helps me be more productive.
I still today have a little scrap of paper that I take every day and I just write some notes on it. Things I need to do, and I'm sticking it in my pocket. I don't wanna have to look at my phone and like, it works for me.[00:48:29] Omer: Yup. If it works. It's good enough. What's a new, crazy business idea. You'd have to pursue if you had the extra time? [00:48:35] Paul: I want to create a series of remote work communities in rural areas around, around the country, around the world. Basically, people will go live there just to enjoy being in a more of a natural setting. And I think you can get like this really eclectic mix of people doing fun stuff in interesting places. [00:48:59] Omer: It's cool idea. What's an interesting or fun fact about you that most people don't know? [00:49:05] Paul: I spent some time in a part of the world that gets negative attention these days, Northwestern, China in Xinjiang province, riding motorcycles with people who I met there. And I hope they are all doing all the right, but yeah, that was an amazing, amazing trip and time I spent there.
And finally, what's one of your most important passions outside of your work? Easy. That's my kids. I love seeing them grow up and just like learning from them radically changed my perspective and a lot of stuff.[00:49:38] Omer: Awesome. Cool. Well, thank you, Paul. It's been a pleasure. I think we covered a lot in a relatively short amount of time.
If people want to learn more about Startups Unplugged they can go to startupsunplugged.com. If they want to check out the book it's called Growth Units, and you can grab that from Amazon. And if folks want to get in touch with you, what's the best way for them to do that.[00:50:02] Paul: Either Twitter or LinkedIn Paul Orlando or the handle is @porlando. So really look forward to hearing from people, seeing what you're up to. [00:50:12] Omer: Awesome. Thanks again. It's been a pleasure and a wish you the best of success. [00:50:15] Paul: Thanks Omer. Great speaking with you. [00:50:17] Omer: Cheers.
- “Growth Units: Learn to Calculate Customer Acquisition Cost, Lifetime Value, and Why Businesses Behave the Way They Do.” by Paul Orlando
- “Seeing Around Corners: How to Spot Inflection Points in Business Before They Happen” by Rita McGrath