Even though it might seem obvious that a company needs to look at its ROI (return on investments) many start-ups have a business model that doesn’t follow fundamental principles that would make it attractive in the long run.
Economics and business fundamentals can sometimes seem complex or tough to grasp, but I’ve tried to give you simple tools and guidelines here – things you can use every day. Before we get into the rules and tools, though, go through the following terms and their definitions, and make very sure you have a firm grasp of each one.
1. CAC: Customer Acquisition Costs
This includes all the costs involved in acquiring a customer including marketing, commissions for sales people, and indirect costs such as office expenses, salaries, and more.
2. YARPU: Yearly Average Revenue Per User
This is total revenue from one single customer for a period of 12 months (sometimes called ARPU).
3. LTV: Life Time Value
This is the total amount of money the average individual customer will put into your company, over the life of the business relationship.
4. COGS: Cost Of Goods Sold
This is the total cost to you of all the goods and services you will provide an average individual customer over the whole period of doing business with you.
5. CR: Conversion Rate
This is the percentage of visitors to your website who become paying customers.
Overall, a good online company has a low CAC, and the investment is paid back within the first 6-12 months of the customer’s time with the company. What this boils down to is that ARPU should be greater than CAC.
Further, LTV should be at least three times greater than CAC, or total expenses are lower than three times LTV. An online company has a profit, if this equation is fulfilled. These are just general assumptions and they might need to be adjusted to fit your particular business.