[grantsch]

Many many software companies end up spending more money to acquire a customer than a customer will ever pay them. I tend to think this is because the demand and need for many tools is not significant enough to justify the amount of capital allocated to promote them.

Finance spreadsheet alchemists last 10 years saw big gross margins in software (overinflated by not taking into account cost to acquire user), bought into long-term incumbent dominance narrative from founders, and now they're stuck with companies that are willing to spend 10x+ lifetime customer value to acquire a user.

Everyone with a vested interest in these companies/investments always seems to say the real returns are 10 years+ once they are in a dominant position in their industry and have monopolistic pricing power.

How are we supposed to know what happens in 5 years, let alone 10+? Seems like a big carnival trick to me. What's interesting is that this mentality is so engrained that the people promoting it don't seem to even get that they're in on an act.

You could have the best tool on the planet, but if the cost to distribute it is greater than what those customers acquired will ultimately pay you, you don't have a company.

[corry]

I get where you're coming from, but since the dawn of SaaS we've had rules of thumb about LTV-to-CAC, CAC payback period, etc.

Most SaaS founders know that a 3:1 ratio between LTV and CAC is ideal - and while arguments might hold water that a worse ratio is OK for a brief period, I don't think anyone involved doesn't realize that it's difficult to sustain that.

The mental magic trick to justify it probably goes like this - "Yes, we're underwater on the LTV-CAC ratio for now, but once we're in position XYZ we'll be able to launch new products ABC and increase LTV from there". Which isn't wrong. And the new CAC to upsell product ABC to existing clients is going to be very low. So in a sense, you CAN justify (at least in a 'superficially prudent way') a worse ratio with that argument.

And ironically, Salesforce is a GREAT example of this WORKING (up until now?). They have ruthlessly increased ACV and LTV for decades, through increases to pricing, growing features, launching new products, creating the app ecosystem, etc.

[grantsch]

Why does real LTV have to be greater than CAC. Can you explain that to me?

If you’re LTV is actually higher than LTV can’t you finance the difference?

[corry]

The problem is that if LTV <= CAC -- let alone under the 3:1 ratio -- you aren't making any gross margin/profit.

LTV = the expected cashflows on a gross margin basis, for the life of the customer. If you get $100 @ 80% gross margin, you have $80 gross margin profit per year. If you lose 100% of your clients after 3 years, you expect to make $80+$80+$80 = $240 of profit. Ah but you also need to discount those future cashflows (let's use a discount rate of 10%). So you really are making $80 + ($80 x 0.9)+($80 x 0.9^2) = $217.

That's your total LTV. Your total profit from the client before ANY "operating expenses" like Sales and Marketing costs and salaries, Rent, Overheads, R&D costs and salaries, office supplies, professional services, etc.

So OK you have $217 of LTV. But you have to spend $250 of CAC (which is "total sales and marketing spending and salaries divided by total new clients added") then you are losing $33 per customer BEFORE all the money you're spending on everything else required to run the business.

Now, of course, reality isn't this simple. And it's not all VC bullshit. Maybe this LTV is dramatically underselling the value of having that client, because in Year 2, you'll have New Product Module ready to sell them for $75. And your cost to sell (CAC) that module to them is $1 - since you've already done the hard work of getting them as a client. So now you adjust your LTV calculation and it's not quite as bad.

Or... by having 100,000 customers, network effects mean that either the lifetime of a customer is actually 10 years (vs 3) or the network effects mean you can monetize something else or... lots of arguments you could make for "grabbing the real estate now".

So if VCs -- who aren't idiots even if some are morally questionable -- see a path to greater LTV, you can kind of get comfortable with a higher CAC.

BUT AGAIN - the rule of thumb is that 3:1 is healthy, since that provides gross margin profit from the get-go, and any other LTV expansion from upsells is gravy.

[grantsch]

Why would you not price "sales and marketing" into CAC

That's what causes the A in CAC

I really think that's part of what drives a lot the confusion here among companies

[corry]

Sales and Marketing costs ARE the CAC. It's literally (Sales&Marketing Costs) / (Number of Clients Added) for a given period.

[SpicyLemonZest]

The general attitude I've encountered is that you do this as a whale hunting strategy, developing a reputation for passionate overinvestment in your customers because the kind of people who sign eight or nine digit contracts demand it. I don't have the right data to know whether it always works, but multiple times I've seen it produce big deals that would never have come together otherwise.

[grantsch]

Yes that would be one way to justify to others spending more on acquiring customers than they pay you.