Ada Chen Rekhi started working on a new startup called “Connected”. It provides management without the work. So she decided to share her thoughts on how to choose the right user acquisition channels.
When does ad buying work for SaaS businesses?
She is convinced that a belief that if you build your software as as a service (SaaS), Google AdWords and other networks will help you to outsource your marketing efforts and care less about user acquisition is partly true. There’s a model allowing you to make the right decision whether to buy ads or not.
Paid user acquisition works for you when the following proves true:
- LTV > CAC
As a reminder:
- LTV = Expected Life x Average Revenue Per User (ARPU) x Gross Margin
Pay attention to costs and conversion rate for your funnel to trial and from trial to paid:
- CPC – cost per click to get traffic
- % trial conversion rate – users who convert to a trial of your product
- % paid conversion rate – users who convert to paid account
This is how you can calculate acquisition cost:
- CAC = CPC / (% trial x % paid)
An example of acquisition cost
Ada Chen Rekhi also gives an example of acquisition cost assuming you have:
- $20/monthly subscription
- 5% paid conversion rate – from trial to paid
- 10% trial conversion rate – from visits to trial
Take 2 different points CPC:
- $0.50 CPC
- $2.50 CPC
In order to get a user at these CPC points
- CAC = CPC / (% trial x % paid)
- CAC = $0.50 / (10% x 5%) = $100
- CAC = $2.50 / (10% x 5%) = $500
As a result, one paying user at $20 per months costs $100-$500. Trying to get 100 users ($2000/month) at $0.50 and $2.50 CPC will cost you $10k and $50k correspondingly.
Compare it with LTV
You should compare the result with LTV or the profit you plan to get from people who use your product. Ada Chen Rekhi points out: “This value should factor in the churn that you’re seeing from users canceling their subscription over time as well as what the payback period and working capital which you expect.”
Returning back to the above-mentioned example, there are 2 users who cost:
- $100
- $500
If there’s zero churn and zero operating costs on $20/month subscription, you’ll get the cost back in:
- $100 / $20 = 5 months
- $500 / $20 = 25 months
You may either set the value at the amount of revenue you receive in a definite period of time or push users to prepay for longer periods.
Make it work
Ada Chen Rekhi says that “The path to achieving profitability looks like making the model of having your cost of acquisition beneath your lifetime value work.” You can easily understand whether paid acquisition works for you.
You can adjust the model taking into account:
- virality
- traffic source
- retention
- working capital
- churn
- etc.
Trying paid acquisition
So if it works for you, great! If it doesn’t, think about how far off it is.
Ad arbitrage is very sensitive to any changes in the steps of your conversion funnel (along with traffic source). If there are only several points that keep you off, you may spend some time on refining your funnel and optimizing the traffic channel.
Does it work for you?
If after a launch you understand that the math doesn’t work, don’t get frustrated. You may try to make metrics work by optimization of landing pages, increasing conversion along funnel steps and traffic source optimization.
Does your product belong to an existing or new market?
Intent-based paid acquisition channels (for example, search advertising) suit perfectly environment where users know the problem and search for solutions. Use Google AdWords Traffic Estimator to find out potential search terms and volumes or experiment with targeting websites.
How much budget do you have?
Although there may be a situation when you may want pay up to full user LTV, Ada Chen Rekhi writes that “you may want to limit the amount you’re willing to pay based on a fixed time period, for example the expected value from the user over 6 months. This may be because at some point you run into working capital issues paying for users who may take years to break even.”