In a recent white paper on using customer lifetime value to value a business, Morgan Stanley noted that a few of the metrics we discuss today are actually flawed when it comes to business valuation.
Though not the most exciting read, it’s a good dose of reality from the sobering world of finance—without having to resort to your finance person being wet blanket (we see this as a good thing).
From the paper:
“Most of the models that companies and analysts use fail to reflect all the costs necessary to properly estimate shareholder value. For instance, LTV/CAC calculations generally include only cost of goods sold and sales and marketing expenses. Research and development and other selling, general, and administrative (SG&A) expenses are rarely considered. Further, investments in working capital changes and capital expenditures are not part of most models.
These expenses and investments vary a great deal from one company to the next based on the type of business, position in the lifecycle, and the resource allocation skills of management. Accordingly, measures such as LTV/CAC may be useful for comparisons and as crude proxies for value, but lack the components to be deemed suitable for valuation.”
Regardless of whether you care much about business valuation via LTV, that middle point—the one about all the expenses that are rarely considered as it relates to CAC—is worth dwelling on. And that’s because retaining customers is more expensive, and more collective of an effort than many often suggest it is.
We discussed this briefly in The Messy Middle, when we suggested a better mindset for marketing to customers is reacquisition and not retention.
While we will continue to repeat this, that exploration missed a point Morgan Stanley hit on in its paper. And that is this: Product—R&D specifically—is as much COGS as it is a retention cost.
A product is required, yes, but the quality of it is also the largest determinant in whether customers stick around.
As noted in the paper, the degree to which some overlooked expenses vary is contextually dependent. But a good product with strong positioning can impact those expenses in your favor.
Your marketing in that case isn’t so much to convince through convincing as much as it is to convince through reminding. And that’s a vital distinction.
When your marketing can be focused on priming and triggering that determinant—as opposed to overcoming that determinant—you’re freed significantly in where you can invest. (Note: invest, not expense.) And, in those cases, it often means those investments can make you more available.
Those investments could be same-day deliveries, they easier refunds and better customer service, they could be easier ways for customers to reorder from you.
How that ends up getting displayed, though, isn’t a metric like CAC and it’s relationship to LTV. To Morgan Stanley’s point, it’s more expensive than that metric—but it’s also more impactful.