In the past three years; the Indian startup ecosystem has seen an obvious trend. Set up your startup; raise money from angels; burn through cash to acquire customers; raise subsequent rounds and burn through even more cash. But 2016, saw a change in that trend with fewer startups raising money; numerous startups shutting down their operations and more startups focusing on getting their financial model and projections on track. While acquiring customers is quintessential for a startup to operate and generate revenue; financial modeling and projections are just as important to plan, measure and evaluate the progress of your startup.
While the entire nation tries to wrap its head around the startup ecosystem and keep up with its changing trends, here are four financial criteria that will make sure you generate more than you burn:
- Customer Lifetime Value
Revenue per customer can only be determined if there is an expectation that this customer will repeat purchases from you. There is no sense in having lofty thoughts of the clients using your product forever, and as frequently as you state it is being used, when the reality of the market is that things will get very competitive over a period of time, even if you are the first mover. Try and gauge whether you will get this repeat order, and on what basis, and what will prevent this customer from going to other competitors. Also, try and be conservative in your estimation.
For example; you are trying to figure out the CLV of each customer visiting your restaurant. You need to understand the following:
- Approximately how much a customer pays every time she visits your restaurant – let us assume it is Rs 500 on average (a meal and a non alcoholic drink)
- The cost of producing the meal – this is difficult to ascertain, but worth putting some effort into figuring out – for food the industry norm is that it is usually 70% of the price of the meal (which includes ingredients and the cost of overheads apportioned to the meal) for food, and around 50% of the price of the drink. In this example, let’s say the total cost is Rs 300.
- How long and frequently this customer visits your restaurant on average – this is more difficult. If you have faithful customers, you will tend to imagine these ones, and give the duration of time which they have been visiting your restaurant. The truth is that your loyal customers are a misrepresentation of the reality, so you need to at least divide this by three to get a rough approximation of the frequency of visits. So, if your regulars have been visiting for a year, and say, once a week (52 times in a year), you then need to divide this by 3, and so 17 visits would be a better guesstimate.
This is very much an art, rather than a science. It will vary according to industry, and if you are able to pull out records of customer purchases, then it will be easier for you to conduct this analysis.
If you are a startup without much data, always err on the side of conservatism. Even monthly subscription services like SaaS software may appear like they will have very long usage times, but you need to also remember that for every customer who signs on (and will repeatedly purchase for 3 years), there may be 6 who signed up to the freemium edition, and never progressed beyond that.
Back to the restaurant example,
CLV = (average amount paid per visit – the cost of cooking of producing the meal) X frequency of visits
CLV = (Rs 500 – Rs 300) X 17 = Rs 3,400
- Cost of Acquiring a Customer
The cost of acquiring a customer is fundamentally important for a startup; for this is that you should be able to directly apportion the costs of acquiring a customer to the revenue being generated from that respective customer.
If the costs outweigh the expected CLV, then it probably isn’t worth proceeding, unless you believe that the startup is able to acquire customers who will then be so enamored by your product or service that there will be other forms of generating revenue, through marketing or data gathering.
How do you know what the costs are of acquiring a customer. Let’s work it out with the restaurant example we referred to before.
Assume you wish to acquire new customers and that you want to do this through Facebook marketing. You set up your marketing campaign by designing a pretty advert. Within the advert you state that for the first 100 people visiting the restaurant, they will be entitled to a free drink.
The cost of the Facebook campaign, which you run for 7 days, is Rs 2,000 – Thus, you divide the Rs 2,000 by 100 people who ask for the free drink when they visit the restaurant = Rs 20
The cost of the drink to you is Rs 15
So the cost of acquiring a customer is Rs 20 + Rs15 = Rs35 per customer
- Putting this into Context
What this means is that the CLV of gaining a customer is at Rs 3,400, whilst the cost of acquiring the customer who will generate Rs3,400 is Rs35. Does this mean you can still undertake more acquisition activities? You definitely can! How many marketing campaigns can you carry out? Well, let’s take a look at this:
Your first marketing campaign added Rs 3,365 per customer (Rs 3,400 – Rs 35), and let us assume you onboarded 100 new customers, meaning you have Rs 336,500 surplus.
Remember, this is not what you have in your bank, rather, this is what you will collect over 17 expected visits from customers whose goodwill you have created from the acquisition campaign.
But this is expected surplus, so if you have been conservative in your estimates for CLV and CAC, you are most likely going to get that surplus anyway.
WHICH MEANS YOU HAVE RS 3.3 LAKHS TO SPEND ON FURTHER ACQUISITION STRATEGIES!
- Budget versus actuals
Budgeting is a really, really important part of your startup, because it will help you ascertain how long you have to keep on putting money into the business (cash burn) before it starts to pay for itself, and then, finally pay you back.
In addition, it is important because it allows you to set yourself measurable milestones to achieve.
When you start budgeting, a very simple way of doing so is to assess how you will achieve monetization with your clients, and how frequently.
Place this as well as the CLV and the CAC for business, so that you will get a better understanding of how your business will grow in the future.
Once you start creating these milestones, always do a monthly check on how well or poorly you performed in terms of actual figures.