Dose #118: The Metrics You Can't Ignore for a Profitable Subscription Business

Matt here with your weekly Subscription Prescription ??

Subscriptions complicate how we think about metrics like the cost to acquire a customer and their lifetime value (LTV). In this week’s dose, we get into how you should think about CAC (customer acquisition costs), LTV for subscribers, and contribution margin - including some tips to boost LTV - so you know how much you can afford to spend to acquire new customers.

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The Metrics You Can't Ignore for a Profitable Subscription Business

Customer acquisition is expensive and difficult to get right. With subscribers, we often think we have more runway to recoup losses and gain profitability because they’ll order more from us over time.

There is danger in that thinking, however; without a clear understanding of LTV and contribution margin, you may underestimate the cost of acquiring new subscribers.

In this week’s dose, we unpack those metrics, explain how to think about them, and provide some tips for boosting LTV. Let’s dive in!

Understanding Customer Acquisition Cost (CAC)

Let's start with the big one—Customer Acquisition Cost (CAC). CAC is the cost associated with acquiring a new customer through your marketing efforts. It’s a straightforward calculation: divide your total ad spend by the number of new customers acquired.

For example, if you spend $1,000 on Facebook ads and acquire 100 new customers, your CAC is $10. Sounds great, right? But for many, the reality is different. You might spend $1,000 and only gain 10 new customers, making your CAC $100.

The key takeaway? The best e-commerce brands are obsessed with knowing their CAC inside and out. Why? Because understanding your CAC helps you determine how much you can afford to spend on acquiring customers without compromising your profitability.

The Layer of Subscriptions: Balancing Costs and Long-Term Value

Now, let’s add the complexity of subscriptions into the mix. Subscriptions add another layer to your CAC considerations because you’re not just looking at the initial purchase but also at the potential lifetime value (LTV) of the customer.

Here’s a simple scenario: it costs you $50 to acquire a customer, and you're selling your product for $50. At first glance, you’re breaking even. However, once you factor in the product cost, fulfillment fees, and other operational expenses, you're likely operating at a loss. This is where understanding LTV becomes critical.

For instance, if your average subscriber stays with you for three months and spends $100 per month, their LTV is $300. When we’re working on LTV, however, we need another metric to understand how much profit is coming into the business with each order.

Contribution Margin: The Profit You Keep

Beyond CAC and LTV, you need to consider your contribution margin. This metric tells you how much profit you make after covering variable costs like product expenses and shipping. The contribution margin is crucial because it affects your overall profitability.

For example, if it costs you $70 to acquire and fulfill a $50 sale, you're operating at a $20 loss per customer. However, if you know that customer will generate $300 in LTV, you can strategize to minimize upfront losses and maximize long-term gains.

When building out LTV metrics, you should account for the profitability of each order. In this scenario, if we spend $70 on a $50 sale for the first order, and we know that each subsequent subscription order nets us $20 in profit, then we know that we will break even on the first subscription renewal.

The trick here is that by modeling the average number of subscription orders, with an average lifetime value and an average contribution margin, we can figure out how much we can afford to spend to acquire new subscribers.

Strategies to Boost Lifetime Value

1. Prepaid Subscription Options: Offering prepaid subscriptions can help reduce churn and increase upfront cash flow. For example, if you're selling coffee, offering a prepaid three-month subscription at a discount can lock in customers and ensure they stay with you longer.
2. Upselling Post-Purchase: After the first month, offer subscribers a discounted annual prepaid plan. This strategy works well for products like coffee, where customers are likely to use the product consistently over time.
3. Focus on Onboarding: The first few interactions a customer has with your product are crucial. Ensure that your onboarding process educates and engages subscribers, helping them form a habit around your product. This increases the likelihood they will continue their subscription, boosting their LTV.

Recap: The Metrics That Matter

To successfully grow your subscription business, focus on these key metrics:

• CAC: Understand how much you’re spending to acquire each customer.
• LTV: Know the long-term value a subscriber brings to your business.
• Contribution Margin: Calculate how much profit remains after covering your variable costs.

Balancing these metrics will help you make informed decisions on ad spend, pricing strategies, and customer retention tactics, ensuring long-term profitability and growth.

That’s it for this week’s dose! Don’t forget to keep an eye on those numbers at all times. See you next Tuesday with dose #119!

?- Matt Holman ??

The Subscription Doc