Why Real Businesses Don’t Charge $5/month: Part 2

In my earlier blog post on pricing, I talked about how there are two ways to increase profits as a B2B company: increase LTV (which I covered) or decrease CAC (cost of acquiring a customer). Let’s take a look at increasing profits by decreasing your CAC.

Your access to (and the efficiency of) distribution channels has a larger impact on your CAC than just about anything else. The more it costs you to acquire a customer, and the longer it takes to receive a return on that CAC investment, the slower your company will grow if you’re plowing profits back into growth. CAC relative to LTV is the single most important determinant of a successful company in a B2B setting, as it directly determines how fast you can grow. (Note: this is why in competitive, new markets like payments, a well-funded startup has a large advantage. PayPal raised nearly $200m, and paid a $10 referral for every new user. If they had to wait a year to make a profit from that new customer, there’s no way they would have grown as rapidly. To companies like that, CAC is almost irrelevant).

This is a hard lesson I learned with the first iteration of Roommatefit. When I started the company, the idea was to sell a personality-based matching solution to colleges and universities. After looking at the data behind roommate conflicts and student retention (basically, if you have a crappy roommate you’re far more likely to drop out or transfer), I thought there was enough of an opportunity to create matching software and sell it to colleges and universities. I went through the customer development process, got some great feedback, built a product, sold it to a few early customers and raised a small round of funding.

Only one problem – I was totally ignorant of my CAC.

The biggest problem was that there was no way to reach these university decision-makers at a scale that worked. Really, my potential customer base was about 3000 people. This group is extremely small, highly targeted, and not very active online: all of which made it near impossible to reach a sizable portion of them via Adwords, SEO or other traditional online ads. After unsuccessfully testing partnerships, trade shows, email marketing, content, and magazine advertising strategies, the last viable marketing channel was field sales.

Field sales didn’t make sense either… which I figured out after a year doing them. Given the university market’s incredibly long sales cycles, our mid-four-figure pricing, and the cost of making a sale (multiple phone calls, emails, whitepapers and demos), the cost of our time was thousands more than what we’d bring in for every marginal sale. And, as much as I tried, I couldn’t see that changing in the future.

People much smarter than me – people like David Sacks – get this concept. In fact, one of the main reasons David started Yammer was because of the distribution opportunity he saw in applying viral marketing to an enterprise channel. He realized that no other companies (at the time) were applying viral mechanics – which have a near-zero CAC – to reach enterprise adoption at scale. Successfully executing on this distribution channel allowed them to get acquired within 4 years for $1.2 billion dollars. All because Yammer was able to acquire customers basically for free.

The two major ways B2B businesses are drastically decreasing their CAC are through content and email marketing. This growing popularity is largely due to the rising cost of other channels. Now that other platforms are mature, it’s much harder to buy a customer via Adwords or Facebook ads at very low cost. The channels are just too crowded and competitive.

This is why it’s important to test other traction channels: if you start using one early enough, before it inevitably becomes crowded, you can benefit from a low CAC and little competition.

  • Great stuff here Justin. Thought about adding a subtitle: “why monetary AND time related costs are key to your CAC”. That’s ultimately what I get from this: your CAC needs to account for not just money, but time and difficulty. It may be a $1 sell but you have to scale http://gameofthrones.wikia.com/wiki/The_Wall to get there and close the deal.

    This reminds me a bit of a post discussing the most important aspect of going viral NOT being how many friends you share with, but how quickly the loop from you to them and them to someone else occurs. Great stuff, can’t remember where that link is now.

    Also, you hit on something that Ash Maurya likes to talk about which is discussed less often than it should be: how repeatable and scalable are your channels (and why you should try figuring that out from day one. Goes into it here a bit: http://www.ashmaurya.com/2011/01/the-fallacy-of-customer-development/)

    You might have 10 extremely easy and low cost sells and be psyched before you realize that you’re dealing with a bubble of connections you have, and once outside you’re toast.

    Anyway, great stuff here. I’d pose a question: given the main three factors of time, money, and inherent difficulty, do you think people should stop referring to just 1 CAC number and think more of a triple? $5/5 days/5 out of 5 stars

    I realize it doesn’t fit well in spreadsheets and formulas, but would be interesting to me at least from a conversational point of view to not try and wedge everything into a simple dollar amount.

    • justinmares

      Do you mean this post – http://www.forentrepreneurs.com/lessons-learnt-viral-marketing/

      Great points though. What Ash talks about is something we’re covering in the book. A lot of startups basically ignore the scalability of the channels they’re planning to use, and thus struggle to get early adoption.

      That’s actually a really interesting point about the 3 main factors. I think it’d be useful, but pretty subjective. Difficulty and time are entirely dependent on the skill set of whatever team you’re a part of, which would make it tough to compare. Though I think there’s definitely something to be said for metrics to compare channels against each other. If only there was a way to do it.. 🙂

      • Yep, that’s the post, thx for the mind read!

        Good on the subjectivity. I’d say that there’s already subjectivity covered in the typical $ CAC, but your point is still correct. At the same time, if I say it’s a 5/5 difficulty for my team and others in a similar space say 3/5, and you have some belief that they’re able to somewhat objectively judge, still could be valuable, and amongst the same team, then very relevant. Seems rather useful indeed 🙂

  • ExGoogleJack

    I really like how Bitrix24 put own twist on Yammer model and essentially became Yammer for small businesses, despite being less than one year old. You really should have mention NPS (net promoter score) to explain how you can get free customers using this approach.

  • Good point about traction channels — if you catch something really early on (Adwords, Facebook ads, Pinterest, display) when they were cheap and/or non-competitive you could have made a bundle selling your product.. or even snake-oil for that matter.

    • justinmares

      Completely. Personally, I think it’s something not enough people think about.

  • ScottBritton

    Same type of dynamic exists with restaurants. It’s hard to acquire them digitally which is why direct sales for the most part is the best way to go for B2B local in low margin industries