The subscription business model is like an invasive species. From subscription boxes like Birch Box to mobile phone service like AT&T, the subscription business model spans across many industries. With the rise of e-commerce, starting your own subscription service became easy, but sustaining this type of business can be challenging. The fundamentals of this business model are simple, but it takes some analytical rigor to truly understand your subscription business.
Customer Acquisition Cost
Also known as CAC, your customer acquisition cost is one of the major components of the the subscription business model. CAC is the amount of money that your business spends in order to obtain one new customer. Your marketing efforts on this front can be anything under the sun. Your business can set up booths at local events, offer referral bonuses to your existing customers, or offer free promotional trial periods to new customers. Each of these marketing tactics will have different CACs for each industry. Testing different types of customer acquisition tactics and the cost associated with them is critical to the success of your subscription business. Your business’s goal is to have the lowest CAC possible. However, this is a catch 22 because you want to acquire good customers. It does not matter how low your business’s CAC is if your customers only stay subscribed for the free trial period. This is why CAC alone is not the only metric that a subscription business needs to monitor.
Customer Lifetime Value
Also known as CLTV, your customer lifetime value is the amount of revenue that each customer will generate for your business. This can be difficult to calculate, and it requires the use of historical data to gain a clear picture of customer trends. The calculation involves knowing how long each customer will stay your customer and what each customer will purchase. Perhaps your subscription business has several subscription services. It is likely that each service that you offer has a different CLTV. Once you are able to calculate the CLTV of your customers you may then want to predict which type of customers are best to acquire by assigning each customer a prospective lifetime value. By creating PLTV your marketing energy can be focused more directly on the customers that could potentially generate the most value for your business.
Subscription Service Optimization
Now that you have nailed down CAC and CLTV it is time to create the magic ratio. CLTV divided by CAC will tell you how much money your business makes for every dollar spent on acquiring customers. Of course your business will have other expenses to cover in order to be profitable, but this ratio should be a major guiding principle for your business. In order for your subscription service to even be viable your CLTV/CAC ratio must be greater than 1. Let’s say that you offer several levels of service and want to know which type of service your business should focus on. Using CLTV/CAC your business can see which service has the highest ratio. The highest ratio will indicate which service provides the most value per dollar spent. These ratios and their corresponding metrics can change over time. It is wise to continually monitor these metrics in order to optimize your subscription business.
DJR Jeeves Consulting understands the subscription business model and can help your business grow!