There are numerous metrics to focus on when launching an e-commerce startup. There are also several hypotheses that you will want to prove during the early months, but the most important hypothesis to make and prove is that your customer’s Lifetime Value divided by your Cost Per Acquisition is greater than 2x. This multiple holds true for numerous other startups, not just those in the e-commerce space.
While it is extremely important to continuously grow your daily Unique Visitors (i.e. shoppers) and number of Unique Buyers (i.e. customers), the LTV/CPA multiple will determine the scalability of your business. Note that 2x is what some would consider the minimum for investing. Aim to be at least in the 2x to 3x range.
My most important piece of advice related to this metric is to focus your efforts on increasing the LTV side of the equation. Too often I meet startups, typically with inexperienced entrepreneurs, that are not concerned about their low LTV because they anticipate using viral marketing to keep their CPA low. The web does make it possible to build a business based on a low LTV and CPA, but it is much harder and not as attractive. The one CPA aspect that you should pay attention to is the time to recover your CPA: aim to recover your CPA within the first 12 months. This will keep your working capital requirements down.
There are several levers you can pull to increase your customers LTV. The obvious ones are: increase cart-size, increase frequency of purchase, and move customers to higher margin products. One of the less obvious ways is to market third party offers to your customers. These are just a few of the things you can do to increase the LTV, which in its simplest form equals your Average Sale Price*Net Profit Margin*Purchases/Customer.
Lastly, their are different variations of an LTV calculations. Agree early-on what LTV calculation makes the most sense for your business, and start hypothesizing about your customers LTV, CPA, and the resulting multiple. Inherently, a large piece of your LTV calculation will be a forecast, and as with other startup forecast, it will be wrong, but the sooner you can create a hypothesis about your customers behavior and begin to test it…the closer you will be to proving your business model and attracting more capital.
Check out this infographic if you don’t know how to calculate your LTV.
And as always, check out some resources from other VCs:
Fred Wilson: http://www.avc.com/a_vc/2011/04/ltv-cpa.html
David Skok: http://www.forentrepreneurs.com/startup-killer/
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