Anyone who has attended one of my webinars, an Academy class or one of my talks at an event will have heard me insist on the importance of unit economics a million times.
In fact, I sometimes worry that I repeat it so often that it will end up becoming background noise that nobody pays attention to. However, in this article, I am here to say the opposite: although unit economics are absolutely essential, they are not everything.
A company can have an apparently healthy LTV-to-CAC ratio and still be destroying value.
First of all, the most important thing is the payback period on customer acquisition. And even more importantly, although it is often overlooked, it needs to be analysed from a cash perspective.
In an early-stage startup, churn may still be very low and, as a result, we may assume that customer LTV will be extremely high. As we have mentioned on other occasions, for the sake of prudence, we would cap that calculation at three or five years, depending on the sector and the type of startup.
However, if it takes too long to recover the customer acquisition cost—for example, 18 or 24 months, or even longer—we will not have a sustainable growth system for a very long time.
Funding rounds are there to accelerate growth, but the goal must be for the model eventually to sustain itself. In the future, the returns generated by the business units themselves should finance growth, while the startup continues to cover its central costs and product development.
In a startup that invoices 12 months upfront, the figure can be particularly positive from a cash perspective. The cash arrives early and is available to finance the acquisition of new customers, although this is usually also linked to longer sales cycles.
Another limiting factor is market size.
We can assume that, if we acquire a customer for €1 and that customer returns €7 over time, we have a fantastic business. And, of course, we do.
However, if we are selling to a niche sector within a specific geography, we cannot extrapolate that the one-to-seven ratio will continue indefinitely. It will probably get worse.
Generally speaking, it is much harder to acquire customer number one million than customer number one when you have a good product. But there may also simply not be that many potential customers in the geographies or sectors you are targeting. And, of course, competitors will always capture part of that market.
Another common situation is that sales are not scalable for the simple reason that they are being carried out in a way that is not scalable.
The most typical example is founder-led sales. Founders can close a large number of deals and act as the spearhead of many profitable businesses. But if a company aspires to be truly scalable and investable by venture capital, it must be able to decide, almost arbitrarily, that investing a certain amount in sales and marketing will return a specific number of customers.
When sales depend on the founder, this is either impossible or has not yet been proven. We cannot multiply the founder by ten to generate ten times as many sales.
The fact that unit economics, LTV and CAC are the most important and fundamental metrics for a venture capital-backed business does not mean, of course, that they are the only ones.
Nobody can build a great business without carrying out extremely detailed analysis, keeping every driver of the company and its specific sector under control, and executing almost perfectly.
