Internet marketing for most companies centers around the economics of customer acquisition. For most companies, it is thought of as a 'one-time event' leading to a conversion or sale. Subscription-based companies have the added benefit of receiving revenue over a longer period of time. In the financial world, a predictable and repeated income stream is called an 'annuity', and there is a very exact method of calculating a 'present value' of an annuity stream.
For the purposes here, we'll avoid the finance theory and focus on the general concepts of subscription economics that matter most to every company offering products, applications or services on a subscription basis. In order to grow any business, it is of first-order importance to first know what your customers are worth - at all times.
Concept 1 - Understand Customer Lifetime Value
A company offering a service for $19.95 per month with healthy customer retention rates, and an expected Lifetime Value (LTV) of 24 months can expect their customers to deliver $479 in revenue on average. (The green line indicates the slope of retention curves and gives an approximation of a 24 month expected timeline).
At this stage, many companies commit this expected customer LTV to memory, and want to 'stomp on the gas' to acquire as many customers as possible.
[For riveting guidance on appropriate ratios of customer acquisition costs to LTV for SaaS companies, see David Skok's post on SaaS metrics here]
Concept II - Understand Customer Retention At ALL Times
Customer retention becomes a very sensitive variable, comprising the "T" in Lifetime Value (LTV). In the chart above, we present anonymized, actual data from a Recurly customer that started with very healthy customer economics. Strong retention rates indicated an expected customer lifetime of 24 months and average customer revenue of $479 over their lifetime. As marketing programs ramped up, channel partnerships were launched, and customers were acquired aggressively to fuel growth. Over this same period, the product did not change substantially, but the average 'quality' of customers declined, and so did customer retention.
Frequent Assessment of Customer Economics is Vital For Success
The example company here demonstrates a very common cycle which is experienced when customer economics are not assessed on a frequent basis. Better yet, they should be assessed on a per channel, per partner, per campaign basis in order to prune the 'losers' and add more profitable marketing programs in a repeatable fashion. It is rare for companies to have resources and infrastructure dedicated to understanding customer economics over ongoing periods of time until they have hundreds of employees.
Much of the recent speculation over the likelihood of Groupon's (NASDAQ: GRPN) success centers singularly around this concept. Their S-1 Filing indicates that they spent $179MM in Q1 of 2011, acquiring 33 MM customers at approximately $5.42 per customer. They surely have teams of people monitoring the value of their customers over time, and while customer acquisition costs are important, customer retention rates ultimately determine whether your business is growing profitably or not.
If your business offers a product, application or service on a subscription-basis and you'd like to have better visibility into your customer economics, have a conversation with us. Contact firstname.lastname@example.org
Recurly can help.