Similar to Customer LifeTime Value (LTV), Cost of Customer Acquisition (COCA) can tell you a lot about an organization. In addition, the LTV to COCA ratio and trend can provide an indication of financial health, potential profitability, and how long you have to float your company with cash before you can become financially sustainable. Typically your COCA may be greater than your LTV when you launch (losing money), but should come down quickly over the following 12-24 months as you build a customer base. In contrast, LTV should increase over time as you upsell your customers and expand your product line.
Target an LTV to COCA ratio of 3 to 1 or greater for a software company and 5 to 1 or greater for a service company or product development. The greater the ratio, the more finances will be available to run the operations of your company including such things as engineering, research and development, and overhead for general operations and administration. None of these costs are included in the COCA calculation. Once you are up and running, your goal should be to recover COCA within 12-18 months, or you may need additional capital to grow the business.
LTV provides an indication of customer lifetime value in profit while COCA provides an indication of how much it costs to acquire that customer. All calculations are initially just estimates, but provide a solid foundation for validating the viability of your business model and pricing framework. If your business model is not going to work, it’s much better to know up front before you spend any money!
The COCA calculation includes ALL COSTS associated with sales and marketing to acquire a new customer. There is a right way and a wrong to calculate COCA. The wrong way is to calculate COCA from the bottom up, factoring in all the costs (and receipts) to market and make a sale. This would include capturing all expenses on a daily basis including:
- Salary plus benefits
- Internet marketing costs
- All the itemized costs – travel, entertainment, demos, brochures, cell phone, marketing, internet data, adds, trade shows, conferences, etc
- Inside, channel, and field sales
- All associated expenses – % office rent, furniture, computers, Admin, etc
This approach is very laborious, detailed, and painfully difficult and actual costs could be much higher than the number you come up with.
The better way to calculate COCA is a top down approach. Aggregate all expenses over a period of time (one year) and then divide by total number of new customers over that same time period.
How to Reduce COCA
With a high COCA to LTV ratio being one of the biggest reasons companies fail, COCA management and reduction is critical to success. Here are some ways to reduce COCA:
- Use direct sales judiciously – very effective but one of the most expensive forms of marketing
- Automate as much as of the marketing and sales process as possible
- Improve conversion rates at each stage of the sales funnel
- Improve quality of leads
- Increase speed through the sales funnel = decreasing sales cycle
- Choose your business model with COCA in mind
- Stay focused on the Target Market to achieve word of mouth in a tightly bound market.
- Increase Word of Mouth – Your customer is your best salesperson. Word of mouth can help reduce COCA, shorten the sales cycle, and bring qualified leads.
- Customer satisfaction. The best customer is the one you already have. No COCA.
Bringing it all Together
The new unit economics of LTV and COCA can tell a lot about an organization. Individual numbers as well as the ratio between them provide insight into business viability, organizational health, potential profitability, and projected time to sustainability. Initially all numbers are an estimate and will be validated over time. Even more than the health of the organization, these numbers test the knowledge of the business owner and their understanding of entrepreneurship economics.
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Founder and CEO, Leadership Institute For Entrepreneurs