That Whose Importance Cannot Be Overstated

Posted: Jun 06 2014

If you happen to have read our last blog post on the subscription box model, you may remember one of the key elements that make the subscription box/traditional online retail model so attractive: the potential for a lower cost of customer acquisition.

One thing that I neglected to explicitly state, but thought was implied, was that a well executed subscription box/traditional retail business model lends itself to lower customer acquisition costs, but the model itself doesn't just lower costs inherently. A business has to successfully execute, drive customers in, retain them, and “upsell them.” Not so easy to do and important to keep in mind when examining the last blog post.

Now this whole notion of “cost of customer acquisition” may seem overblown, but in some ways, in many businesses, including retail, the cost of customer acquisition is “that whose importance cannot be overstated.” Why?

Well, a common metric, but only one of many, used to evaluate one's company is Lifetime Value of a customer : Customer Acquisition Costs. Another common metric used is Customer Payback Period. Both will be explained in time and each help to illustrate why the importance of customer acquisition costs cannot be overstated.

Lifetime Value of a customer : Customer Acquisition Costs is, in simple terms and among other things, a decent way to answer the question, “is it worth my time and money to convince you to shop with me.” That is something that a retailer must always keep in mind and study/monitor closely. And while both elements of the equation are important, the Customer Acquisition Costs are easier to control, easier to monitor, and easier to plan for. Customers are fickle, they are transient, and they aren't always loyal, so the whole notion of projecting Lifetime Value of a customer is undoubtedly vital, but most certainly more of an art than a science. The CAC portion of the equation however, while also a bit of a guessing game, is easier to monitor, plan for, and build around. The two undoubtedly drive one another (if you make kick ass stuff that people want to buy, you don't have to work hard to get them to buy it), but as an owner and operator of a business, one is much more realistic to track, monitor, and minimize when growing a business.

Which brings us to Customer Payback Period. In simple terms, customer payback period hopes to answer the question, “how long does it take for it to be worth spending the money to acquire you as a customer.” This metric is important for a number of reasons, but it also highlights one of the most challenging elements of the retail industry, one that is directly associated with the cost of customer acquisition. That challenge being: it's very, very hard to run a cash flow positive retail business from the start. Don't believe me?

When Amazon bought Zappos, Zappos was doing $1 billion in gross sales and HAD JUST gotten to cash flow positive. In 2005, according to Tony Hsieh, “gross merchandise sales were $370 million, and we made the Inc. 500. We weren't profitable yet, but we were close to breaking even, and our revenue was growing quickly.” Granted Zappos doesn't make their own clothing, but their margins are pretty damn healthy. So, what were these expenses and how does it relate to customer payback period?

Much of this expense was related to marketing expense (i.e. cost of customer acquisition). This is a huge expense for retailers, it's one whose importance cannot be overstated, and it's one that often makes the customer payback period long in duration. That presents issues for a retailer because they need investors, a line of credit, or some sort of outside cash infusion to allow them to grow and develop into a cash flow business. Even then, it's not easy. Actually, strike that. It's fucking hard. Say whatever you want about the quality of Bonobos' goods, but it's hard to argue that it's a very well run, highly performing business run by an extremely savvy, impressive founder and according to articles written at the time of their last financing, they will be hitting/have just hit cash flow breakeven after raising $70 million+ of venture capital money. Not bad given that Fab.com has raised like $300 million, hasn't hit cash flow breakeven, and has pivoted more times than Lebron in the low post, yet still indicative of the fact that cost of customer acquisition is...

that whose importance cannot be overstated.

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