

Essential Things to Do When Deciding On Your Business Idea - jbischke
http://edufire.com/content/articles/228-5-essential-things-to-do-when-deciding-on-your-business-idea

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lionhearted
GREAT piece. #1 is key:

#1 - Consider “Allowable Acquisition Costs” (AAC)

If you don't understand #1 thoroughly, you're going to want to do some
research until you do. It's one of the most important parts of business.
Here's the aspects of it:

1\. Lifetime Value of a Customer. What NET PROFIT does the average customer
generate for your company after making their first purchase? If you run a
monthly billing service, it's the average months subscribed multiplied by net
profit/month.

2\. Conversion Rates: What percentage of people who find your offer purchase?
For a fully optimized site, 1% is a surprisingly robust figure that keeps
cropping up for semi-targeted traffic. Hyper-targeted and relevant can do much
higher numbers, untargeted can get close to 0. Don't assume 1%, test it, but
1% isn't a bad baseline to start with.

3\. Net Present Value is Garbage, use Payback Period instead. So this is just
my opinion, and reasonable minds can differ. But NPV is basically voodoo
nonsense based on faulty sets of assumptions. Better than nothing, but NPV
basically exists to make it look to bankers like you're not pulling numbers
out of the air. The basic idea of NPV is that if you had a dollar today
instead of a year from now, that's better because you could do something with
that dollar right now, and thus have more later. The problem is, you have to
choose a multiplier for NPV, and it's a largely arbitrary choice. People were
using 11%/year for a while because that's what the stock market consistently
did. Oops. And now you can get a whopping 2% interest on your money in a
premium money market.

My advice? Use Payback Period instead - it's easy to calculate very fast and
not particularly subjective. Payback Period goes like this: "If I spend this
money now, how long until I get it back?" Everything after that is gravy.

So let's say your average customer makes you $100/month net profit for 20
months, then their lifetime value is $2000 on average. If your customer
acquisition costs are $100, you get it back in one month. If it's $2000, you
break even after 20 months. In a bootstrapped company, you NEED to get that
payback period short. That's the key number. Long payback period = cashflow
problems = need financing. NPV is voodoo. Payback period is easy to figure
out. With a short payback period, you're less vulnerable to catastrophe.

If you're more statistically inclined, you can segment out different lifetime
values and conversion rates from different sources. But most companies don't
know what their LVOC numbers are, are vaguely aware of their conversion rates,
don't know what payback period they need to keep the lights on, and don't
spend intelligently to acquire customers. I was actually staggered in my last
company at how much we could pay for customers compared to industry. The
average in industry was around $10/customer, the top dog was spending between
$20/customer and $40/customer, and we found it quite profitable to run in the
$30/customer - $70/customer range and we grew pretty fast.

God, I love numbers when they work correctly. Seriously, getting intelligent
customer acquisition going is one of the most important parts of a
bootstrapped business. You get these numbers working for you, you're set and
don't get blindsided. Great article here, read, re-read, compare, and learn
everything you can about Lifetime Value, Conversion Rates, and do a little
research so you can make your own call on NPV or Payback Period, but you
should use one of them. Great piece, great insights, strongly recommend heavy
focus on his point #1 since it'll make or break you if you're not funded.

~~~
mediaman
Spoken like someone who's been there. My first business had fantastic NPVs and
enjoyed great economics. Only problem was that it took 6-8 months payback
period. That put some serious hurt in our growth. The business is doing nicely
and makes money but I will never look at acquisition costs the same way again.

