In the end, it’s all about converting and growing customers — Part I
At OpenOcean we love looking at exciting start-ups and discussing with ambitious entrepreneurs. When digging deeper into any investment opportunity, one can easily get dragged into an overwhelming complexity of details and unknowns. However, in this series we want to share our take on a rather straightforward approach: analysing the customer acquisition processes and costs, in order to asses an investment opportunity. We will also provide you with examples from our portfolio companies.
There are typically three aspects that impress us early on before we embark on a deeper review of any start-up.
- The Team has an exciting and inspiring vision and a high level of ambition.
- The Product is innovative and disruptive. Making a good positive impact on business, and ideally also to the world.
- The Market provides a playing field where it’s possible to build something of global significance.
Having looked at thousands of start-ups, we are pretty confident that in the end, it’s always about identifying, converting, engaging, and growing customers. So, in addition to the three aspects named above, a simplified — but often a very effective — perspective when assessing a start-up opportunity, is to deeply look at the Customer Acquisition Cost (CAC).
Many founders wonder how an investor like us would like the CAC to be calculated. What is the correct formula to use? Here I would emphasize that an entrepreneur should look at example formulas presented online for their type of business — but then think deeper, and choose the formula that is really representative of your particular situation. What costs are required to be spent on all resources and activities to convert a reasonable number of new customers? You should not try to calculate the best possible number to try to convince the investor — we always want to understand the numbers anyways. It is much more impressive to see a founder present a full understanding of everything that contributes to CAC, and include that in the calculation, even though the resulting number might be higher in the end. For instance, depending on how customers actually take your solution into use, some part of customer success (integrations, training, onboarding) makes sense to include in your CAC.
As an example of this let’s consider our recent investment in Leadoo, a European forerunner in the rapidly growing area of conversational marketing. Leadoo provides lead generation Bots that help customers drive qualified leads from their web traffic (at their websites). While some other providers sell similar technology allowing customers to build their own bots and conversations, Leadoo has put customer service right and center in their strategy and as a core part of the Customer Acquisition Process, Leadoo helps customers define the first bots, get them implemented and live into production, and this all can happen even within an hour on a first call!
In this model, Leadoo only recognises a customer as won when the product is live and actually provides leads, meaning a clear business value to the customer. Thus Leadoo’s CAC is higher than without this service element, but it is clear to us that this is the way to go. By focusing on ensuring that your customers always get value out of the product, you ensure longer term viability in your business. In this case, the end result is clearly higher customer satisfaction and -retention, than that of other players who try to “push” their technology to the market.
We are passionate about data, and around using data analysis for our investment decisions. An early understanding of the CAC is important, and even more exciting is typically the discussion we have with the founders around matters influencing the CAC and customer success, both shorter and longer term. All to help us develop a joint view with the entrepreneurs of what business model and scaling plan could be optimal to strive for.
An initial look at CAC
To understand the current and estimated CAC thoroughly, we start by looking at the go-to-market model. This requires asking several important questions, such as:
- How do users hear about the solution?
- How do they get a perception of the expected value?
- How do they get in touch with the actual software?
- How do they get their first real impression of the software?
It’s also important to think about how the above-mentioned aspects could change over time, both shorter-term and long-term. Other key questions to consider are:
- Is there a low-touch product, e.g. freemium self-serve SaaS or open source distribution, to help drive awareness and adoption?
- What’s the balance between inbound and outbound sales?
- Is the outbound sales telesales, effective field sales, or heavier enterprise sales?
- Do you go direct or through sales channels, or hope to establish sales through more comprehensive partnerships?
Often a start-up has some early business traction and certain parts of the go-to-market and sales model show initial promise. With that as a base, we as investors then quickly start to think about what impact the investment could have on the future development of the start-up. In practice, this means thinking about the positive development that can be achieved by increasing spending to grow the company’s resources around business and product.
Investments driving CAC
Regarding investments on the commercial side, we typically start together with the founders to assess:
- How could an increased marketing spend influence the go-to-market model and lead to more awareness and adoption (at the end more qualified leads)?
- If we invest resources into different sales models, and specific sales expertise, what effect do we believe these will have?
Typically, setting the sales and marketing machinery up and running will initially drive up the CAC, but when it works smoothly it drives down the CAC to both a lower and more stable level. The first part of this is rarely our concern and our focus is mainly on the latter. We naturally strive to establish a model where the CAC holds steady at a reasonable level, not just when the company scales 2–3x in the beginning, but especially as the operation scale 5–10x.
Further, when looking at sales models, it’s relevant to note that direct sales models are typically the safest to build upon in the early days. The direct model is often somewhat predictable and you can adjust it quickly when gaining insights. In the early days, there’s always a lot you can learn from having a close customer-development type dialogue.
Sales channels and partnership sales models are often time-consuming to build up. At early stages, these typically deliver results below expectations and a CAC calculation is often not even meaningful. However, longer-term these can be critical to succeed in a big way (and to keep CAC low), but investments into these approaches need to be done with great care and patience.
That´s why for us it is so impressive to see a founder presenting a full understanding of the full customer acquisition process and related costs that enable building a sustainable and scaling sales model during different growth phases.
In Part II we´ll dive into how we assess whether an investment round would further enhance the technological advantage of a software start-up to increase Customer Lifetime Value and further drive down CAC.
