On this podcast, we talk about how variables may change but the tactics stay the same, learning from old/traditional megabrands, calculating, segmenting, and improving CAC and LTV, and so much more!
Paul Orlando has led startup accelerators on three continents.
He runs USC’s on-campus Incubator for businesses founded by students, alumni and faculty and is Adjunct Professor of Entrepreneurship, teaching growth hacking and venture initiation.
He is a former startup founder and was a winner at the TechCrunch Disrupt Hackathon. His book about unit economics is called Growth Units.
In This Conversation We Discuss:
Resources:
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Chase Clymer
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Paul Orlando
Understanding lifetime value... It helps you understand where [I can] push on some of the levers.
Chase Clymer
Welcome to Honest Ecommerce, a podcast dedicated to cutting through the BS and finding actionable advice for online store owners. I'm your host, Chase Clymer. And I believe running a direct-to-consumer brand does not have to be complicated or a guessing game.
On this podcast, we interview founders and experts who are putting in the work and creating real results.
I also share my own insights from running our top Shopify consultancy, Electric Eye. We cut the fluff in favor of facts to help you grow your Ecommerce business.
Let's get on with the show.
Hey, everybody, welcome back to another episode of Honest Ecommerce. I am your host Chase Clymer coming to you through technical difficulties. We're making it happen.
Today I'm welcoming an extremely smart guest. And this is a topic that we have not dove deep into yet. So I'm super excited to chat today with Paul Orlando. Paul teaches Growth Hacking and Venture Initiation or innovation?
Paul Orlando
Venture Initiation, but you can call it..
Chase Clymer
Venture Initiation...
Paul Orlando
Either one sounds good, maybe I'll change the name of the class. .
Chase Clymer
But anyways, he's teaching that at the University of Southern California, he runs the University Startup Program. He's built and operated for startup accelerators around the world.
And he just wrote a book, Growth Units. It's sitting on my desk, and I am terribly sorry, I haven't read it yet.
It's on my to-do list, but he's gonna teach us today all about unit economics, lifetime value, customer acquisition cost and why that can be difficult to calculate. Paul, welcome to the show.
Paul Orlando
Thanks, Chase. Really good to be here.
Chase Clymer
So first and foremost, take me back. What made you an Ecommerce numbers geek?
Paul Orlando
So I'll actually tell you the literal moment that things changed, I guess, for me. So I had been working with startups for a while.
I had a startup of my own in New York for a couple of years where I learned lots of things the hard way, and I was looking at conversion funnels, maybe I'll tell you a little story about that in a bit. But I ended up teaching at USC.
[It's] a coincidence of how I ended up there. And when I first got there, I decided I should really just get to know the campus. And I spent a couple of months talking to as many people as I could.
I talked to probably just like 100 students, when I first got hired, just trying to understand "What's going well, what do you wish you had, how am I going to build something that's meaningful here?" And I always remember this one conversation I had...
He was an MBA student at the time, he had an Ecommerce company that he had been building.
And he said to me, "I had to take this mandatory class in marketing to complete my degree. And last week, I mentioned something about crowdfunding to the professor. And he had no idea what I was talking about; he'd never heard of Kickstarter and things like this."
And this is back in 2015.
So it's not like these are brand new topics back then. So I started just to wonder what the level of access the students had to some of these newer ideas was.
Out of that I basically wrote this proposal to teach this brand new class, a class focused on growth hacking, which I believe was completely new for universities at the time anyway, certainly the first one at USC.
And put this class together and it's been something that I've learned, learned a ton from, I think the students really enjoy it. And the way it works is, I do 2 things in the class.
So half of the work is I bring startups in, they get a student team to work with them on some element of their growth.
It could be a paid ad campaign, it could be split testing marketing copy, it could be trying to improve a conversion funnel on it on the other half, though, more like the classroom half is all the stuff that's not really going to change.
So all the unit economics, the lifetime value, customer acquisition cost, how do you figure that out?
And that's where I hit people most like, those things are gonna remain, regardless of whatever new app comes up and replaces TikTok, --which we weren't talking about not that long ago-- whatever comes and replaces that you, have to know unit economics.
So that's how I got into this space.
Chase Clymer
No, that's amazing. Now I'm gonna say it out loud on the podcast, so this might become a more real thing but I've always thought about looking into being an adjunct professor.
I feel like I know a few things and it'd be fun to... I always have fun... This podcast is fun.
Educating clients is super fun. So I am truly jealous of what you do it to just be straightforward with you,
Paul Orlando
You could do it. You could absolutely do it and the value of going in as an adjunct... If anybody listening has never heard that term, that basically means...
You're not a career academic. Your value comes from having built something, having worked somewhere.
That expertise that you actually gained out in the marketplace, and now you're bringing it back into, I guess, an academic environment, in a classroom setting. But you're probably taking a totally different approach than a more academic professor.
Chase Clymer
So you said something that really resonated with me as well. So we have a framework that we use for growth for our clients using some of the KPIs that we're gonna talk about here in a minute.
But it's, it's very simple, and it's a framework, because what you said is "Some of the stuff is never gonna change." But then there's the other side of it is like... Within growth hacking, especially, it's like...
It's usually rapidly changing. So the economics behind how you can scale a business is always going to be the same, but the tactic you used to scale it... Facebook ads were huge 5 years ago.
Now, people were diving super into TikTok and whatnot. But that's just the tactic changing. The strategy is still the same.
Paul Orlando
That's... That is exactly it. And that's why I figure... If I look back on the time that I've been just teaching that growth hacking class, the stuff that we were doing in 2015 - 2016, it seems so quaint [compared to] now.
And obviously, just as you said, the platforms that you use are gonna change. Or you might say, the things that used to be cheap --because people hadn't discovered them yet-- become expensive, they stopped working.
But that overall framework, or that thought process is still going to help you, in years to come. So yeah.
So I figure my value add is not necessarily going to be on staying up[dated on] every new thing that you should get into.
But instead, it's going to be "Okay, how do you understand the way these things work?"
And if you want to go and you're now using web3 stuff, or you're using something else that maybe I or others are less familiar with, --I've never done it myself-- yep, that's totally fine.
But the thought process is still going to work for you.
Chase Clymer
Absolutely. So let's dive in here. This one is... I don't know. These are all kinds of difficult concepts, but you're a professor, so you should hopefully be able to explain it the way that our listeners can pick up.
Paul Orlando
We'll see.
Chase Clymer
Let's dive into lifetime value. And, I'll give you an easy one here. Why is this important to the longevity of my brands? I price my products. Why do I care about lifetime value?
Paul Orlando
This is a really important concept for a couple reasons. So first of all, if you're talking about building a sustainable business --I mean, financially sustainable in the sense-- you have to understand this. So lifetime value is...
Well, maybe I'll just step through the parts of it and then out of that comes why it's important. So there's a few parts to it. So you have your unit price - whatever you're charging for this thing, you have the unit costs - and that can...
Those 2 things can dramatically be different, you could price based on the value that you're creating, you could try to move the costs somewhat maybe with your... If it's a physical product, you bulk purchases, if it's software, your cost --in theory-- per unit are very low.
So you have those 2 pieces. And then you also have some measure of retention to repeat purchases, that people are...They're coming back, they're buying again and again whether it's...
They're going your website, your Ecommerce store and they're clicking "buy again", or it's a subscription of some type, and it's a lot more predictable. So you have those 3 parts.
And then if you just stopped there, you could multiply a couple things out, and it gives you this number. And you say, "Okay, lifetime value is... For us, it's $100. It's $1,000." Whatever. What you miss, though, is the timing.
So when I do this exercise for companies and [I've] done it for myself, I like to actually model it out like it's a sequence of flows.
So you could just think about doing this in a spreadsheet if you want to manually do it. That will give you a better understanding of "Okay, when do I get those payments in? Or when am I paying out for things?"
And if you do that, it'll give you a better understanding of "Okay, you used to say lifetime value was $100. Oh, actually, it takes me 2 years to get that $100." Or "No, actually I get that all upfront." Depending on the business type.
But if you're building a business and even if you raise money eventually this has to be a financially sustainable business.
Understanding lifetime value, it helps you understand where [I can] push on some of the levers. "Should I try to increase [the] price? Should I work on retention?" Etc. And, it's just... [It's] the core understanding of how your business works.
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Chase Clymer
A follow up question would be there, you said there's a few very variables involved. So from my understanding of it, there isn't a one way to calculate this.
Paul Orlando
That's true, you will see many different ways people do this. The way I have come to like the most is, I guess, it's that way I started to describe.
So you will see people who do it purely using revenue, and not factoring unit cost in, you'll see people who only do it as a single static number rather than as a sequence of flows...
So I like the way I do it because it does let you see those 3 different parts that you could try to push on. And of course if you try to push on 1, you might impact the other 2. But I figure... The biggest difference that I see...
So the most common other way of doing it, I'd say, is just using top line revenue like the unit price, you're losing a lot of information there.
In other words, you could be selling a product at which you are losing money on every sale in the extreme example and yet in that different calculation of lifetime value, it seems like things are great. So I like to add those unit costs in.
Obviously, that's not all the costs you have. Stuff like compensation, rent, things like that that are fixed costs, they don't get baked in typically to a lifetime value calculation.
But at least putting in a unit cost, it helps me understand "Okay, every time I sell one of these things, what's really happening?" Like, "What's that contribution margin I get back?"
Chase Clymer
Absolutely. And I think that one thing I want to highlight about the way that you're approaching this calculation is the time for return. "When am I going to see that money return?"
Because if it does take longer than, I guess, you can float the business with cash on hand to see that money come back from an acquisition standpoint, you could go bankrupt.
And I might have just [gone] to 300 level stuff real fast. So I really want to break that down really easily. Could you try to explain what I just said in the simplest terms?
Paul Orlando
Yeah. So this is what I call in that Growth Units book, I call it like the difference between like static LTV or like "Here's a single number." and dynamic. LTV is a river, like a river of flows that come in.
So yeah, product businesses, especially physical products businesses: We're talking food and beverage, we're talking...
Especially hardware where you are buying components and assembling them, there's typically this lag time that you have just in the normal way the business operates.
You have to buy some type of components or ingredients or you have to pay somebody first. And only after that, do you finally have the ability to sell and get paid. Setting aside things like pre-sales or stuff like that.
But yeah, if you don't consider that timing, then exactly what you just said, if you don't consider it, then you might think, "Oh, this is amazing. I signed up a new customer. As far as I understand, I'm gonna make whatever the number is --$100-- back from them."
But if you don't realize that, yeah, it's gonna take you a year or 2 years to actually get that money back. You've constricted the way you can grow. And then also, especially if you are paying for acquisition...
We haven't talked about acquisition costs yet. But if you're paying for acquisition, then you might actually, like you said, you might already be out of business by the time that you could have received that LTV back. So yeah, understanding timing is really important.
Chase Clymer
Yeah. Let's just segue right into customer acquisition costs. And they're... That one might be a little more straightforward, I think, to explain. But I'll let you do the honors.
Paul Orlando
Sure. So I like to do this on a per customer basis. So here again, a way that you will often see people do customer acquisition cost is they'll say, "Okay. Well, last month, I spent $10,000 on all my marketing, all my customer acquisition efforts. $10,000, I signed up 1000 customers, so CAC is $10.” And that's a little challenging, right?
So first of all, you don't necessarily know if what you spent in that month is directly connected to the people who became customers in that month. So you got that timing issue there as well. But I like to do it a little differently.
So rather than "Here's the aggregate." --that might be all that you can do in some situations-- but I like to do it where I can, based on a customer, per customer sign up.
So for me, it's 2 parts: It's how much it costs to get somebody in the door, what I [like to] call "in the door", which could literally mean in the door of your store or in the door of your website, anything digital, and then divided by the conversion rate, that once they're there, how likely are they to convert to be a paid customer?
So it could be "Okay, it cost me $1, to get somebody to click an ad and land on my website." and then once they're there, they convert at 10% = $10 customer acquisition cost. And if you do it that way...
And I'll say both for CAC, and for LTV, if you do it in this way, you can then start to get like a little deeper into these numbers. So rather than there just being one number, --CAC is $10-- you can say, "Oh well, what we've seen is this channel like Facebook ads, yeah, CAC is like $10. TikTok, it's $5. We have this mailing list that we just organically grew, that's $0."
And you can start to then do CAC by channel. You could also then do it by type of customer. So like, are you getting a... It could literally be the value to them to your business.
So are you getting a premium customer signed up? Are you getting somebody who is... They're on a basic plan. All variations of that. Same on the LTV side. S
egmenting that out by customer type, by channel, gives you a lot of value. And then connecting the 2: LTV and CAC, you could then talk about payback periods.
So you might say okay, "Well, for this type of segment or this channel, LTV is $100. CAC is $10. Seems like we've got a really healthy ratio there: 10 to 1. But in this case, it takes us 2 years to actually recoup that $100. And it takes us --making up the numbers here-- it takes us like 3 months to pay back that $10 acquisition cost. Can I eat that cost: $10 for 3 months? Yes? No? Okay. Do it. don't do it."
So yeah, my whole... The whole reason I go into this detail both with you here and in the book is we hear these numbers, or these terms thrown around a lot.
Once you really want to get into some of the details, you're gonna have to change the way you think a little bit by understanding this framework of okay, "How do I calculate these 2 important metrics for my business: LTV and CAC? And then how do I understand the relationship between them?"
And then therefore, "If I want to try to grow, what do I think's going to happen? Or what might change? If I want to pump more money into an ad campaign, probably, I'm going to not perform very well in the very beginning of just figuring things out. Maybe I improve a little bit, because my ad copy is better or the way I do it is better. And then I run out of people eventually."
And the customers go up again,or run out of the ideal customer. Same thing for LTV. It might work a little differently like, "Hey, I'm improving the product as I go along. Maybe I can actually drive LTV up over time." And that's what you see. If you look at...
Paul Orlando
If you look at companies that have been around for a while and if you can get their numbers or if you talk to people or if they're a public company, you can see their numbers... If you look at a company like Facebook, the most recent annual report that they showed...
If you look at the US region for them, they earn, I believe, it's something like $30 or $37 per user per quarter. So $120 - $130 per year. And maybe that's going to go down a little bit with competition from TikTok.
But if you look at their annual reports from a few years ago, it was like half of that number or maybe even less. So there's an example of a business that even as they grew, they got better at either showing ads more appropriately... They were improving the revenue side of their product.
Whether you are a user like that or not because you're seeing more ads or it's more annoying. But over time, if you stick with this, you should be able to figure out okay, how do I improve some of the levers that make up LTV and CAC?
Chase Clymer
Yeah. And another thing to consider is, once you have an understanding of these numbers, it makes you a lot more comfortable with leveling up on your marketing investments. And the biggest example I can think of this is Starbucks.
They are saying that their customer lifetime values are in the tens of thousands of dollars. So they are... That's why they're on every corner.
That's why you see their marketing everywhere is because they've done the calculation. And they're like, if we can get them through the door once..
Paul Orlando
Mm-hmm.
Chase Clymer
...we should do it 100 cups - 1000 cups more. I don't know how the math is. Starbucks is expensive. (laughs)
Paul Orlando
No, that's such a great example. And we sometimes don't think of big companies that have been around for decades as still experimenting or trying to improve the way they work. But it's so true. Yeah.
And in that Starbucks example, that's why they ended up at least 20 years ago or more saying, "Alright. How do we make this the place that people go and hang out?"
The typical model, you know, before them was coffee is coffee. You go to a diner, you get a cheap cup of coffee, you're out. There's no reason I would want you to sit here for hours. But for Starbucks, it's like, "Well hey, if you sit here for hours..."
The tough thing was actually getting you in. Sit here for hours, you order that second coffee or buy something there, that is a really fat margin that you have in the coffee business.
So it's totally worth it. I even remember, I was talking to the founder of Kinko's a few years ago, and he was explaining how when he started that business.
So Kinko's is they make copies. Basically, you get things printed or bound or whatever. It seems like a really straightforward business. And I believe he was talking to some outside potential investors who at the time were telling him, "You got to stop giving away so many."
Like, somebody comes up and they say, "I wanted this reprinted." You're just doing it for free for them. "You need to start to charge. People can take advantage of you. You shouldn't give away like a free copy."
And his pushback was basically "Look, that costs nothing. Paper is super cheap. The ink is super cheap, I already bought the machine. So if they're idle, they're not generating anything for me, I'm not saving anything, either. So if somebody comes in and wants me to redo a copy for them. I should just do it.”
“Because if I don't, I'm going to upset them, they're not going to come for the next project they have. I might as well just give that away. It cost me pennies. And then in the long run I'm making multiples of that."
So yeah, I think like those big businesses where you see a lot of them, lots of these copy places, coffee shops, where they are thinking long-term... They do have a brand, they can do something that's a little special.
That's also a little different than like the mom and pop coffee store or the mom and pop, "We have a copy of a copy machine, you'll get to come in for the copies."
So yeah, I love looking at traditional businesses because you can actually learn a lot. They've lived this long, so you could learn a lot from how they were successful.
Chase Clymer
Absolutely. You can learn so much from the older school models but that's... The big difference between that and modern Ecommerce is [that] modern Ecommerce is so lean and it goes so fast. And if you don't have an understanding of these numbers, you can't really...
A, you're not gonna be able to scale the way that you want. B, you're not gonna ever be able to get investment because that's the first thing you ask for some of these numbers. So it's fun, it's a fun space to be in.
Paul Orlando
Definitely, definitely.
Chase Clymer
So I got your book right here. For people on YouTube, this is what it looks like.
For people listening to the podcast thing. Please subscribe on YouTube. We're trying to get those numbers up.
So anyways, what else is going to be in this book if they actually want to go and pick it up?
Paul Orlando
So I wrote this to be really straightforward, really useful. My whole...
And I'll even mention, I ended up putting this together because my style of working with startups, these accelerator programs or my style of teaching was always just living in the moment. "
Hey, let me put something up on the whiteboard. Let's work through this. We'll figure this formula out together." [That] kind of thing.
And then when everything went remote with COVID, I just realized that that model didn't work as well or wasn't as natural anymore.
So I wrote this book very much in a, I think, natural, easy to understand way.
So what's in it is a section upfront that helps you understand customer acquisition cost. We kind of talked through some of the elements of that: Conversion funnels, same for lifetime value, looking at churn, looking at different types of retention.
And then also, something that I added in because we ended up seeing this with a pandemic, what happens with inflation increasing that... You weren't expecting that previously and now, you end up getting that.
And then the second part of the book, I go through some mini case studies about specific types of your business types.
So I ended up looking at everything from a mattress, both the physical and digital mattress sales, subscriptions, mobility companies, consumer packaged goods... I even threw in some stuff on organized crime and CAPTCHAs and cryptocurrencies. ..Yeah. So I think it's a fun read, because it gives you this really broad mix of business types.
But upfront with the core of that first half is, "Let's just make sure I can step through this framework and understand how it might work for my business if I'm trying to understand my own LTV and CAC."
Chase Clymer
Absolutely, Paul. And if I'm listening to this show and I want to go and pick up the book, where do I go?
Paul Orlando
Easiest place to go is Amazon. Just search for the title "Growth Units" and you should see it.
Chase Clymer
Yeah, it's a big yellow, black and red cover. It says Paul Orlando on there and you should pick it up. Is there anything I forgot to ask you today that you think would resonate with our audience?
Paul Orlando
I think we covered a lot of the big things here. But yeah. The last thing, it's not that you forgot to ask me.
But the last thing I would say is, if you're coming up with just a single number for any of these metrics, like "Oh, LTV is $100." or "CAC is $10."
That means that you probably are just starting to dig in. And once you go another level in, you'll find that you have multiple answers to that question.
So I hope that your listeners here take that second step, go a little deeper and if you like, check out that Growth Units book. I think it will help you out.
Chase Clymer
Awesome. Paul, thank you so much for coming on the show.
Paul Orlando
It was a pleasure. Thanks, Chase.
Chase Clymer
Alright. I can't thank our guests enough for coming on the show and sharing their knowledge and journey with us.
We've got a lot to think about and potentially add into our own business. You can find all the links in the show notes.
Make sure you head over to honestecommerce.co to check out all the other amazing content that we have. Make sure you subscribe, leave a review.
And obviously if you're thinking about growing your business, check out our agency at electriceye.io. Until next time.