This is actually quite simple and I am surprised how many companies don’t do it.
Knowing your allowable acquisition cost:
- Helps you determine how much you can spend to acquire customers
- Gives you an idea of what marketing channels you can use (some will be cost prohibitive)
- Prevents you from engaging in loss-making activities!
The formula if creating in Excel is:
=-PV(cost of capital,average customer term,average revenue per customer*gross profit)
More detail on the variables:
- cost of capital – I recommend the cost at which you will acquire capital to spend on marketing
- average customer term – How long your average customer stays with you
- average revenue per customer – The average revenue per customer per year
- gross margin – This is your profit margin excluding marketing
Here are some example assumptions:
- cost of capital = 40%
- average customer term = 3 years
- average revenue per customer = $300
- gross margin = 60%
The formula in this case is:
=-PV(.4,3,300*.6)
=$286
So assuming there are no other significant drivers of value (like virality), you should not spend more than $286 per customer. At $286 you are getting a return on your investment that covers your cost of capital.
