by Bill Aulet
There is great detail on how to estimate the LTV in the Disciplined Entrepreneurship book, so I will not repeat all that information here. I encourage you to review the material and use it as a reference when completing the worksheets below.
GENERAL EXERCISES TO UNDERSTAND CONCEPT
See the back of the book for answers to these questions.
Pet Rock: In 1975, Gary Dahl is credited with inventing the Pet Rock. It sold for $3.95 and provided a pet that required no maintenance. It became a craze, but then it died almost as quickly and there was no lasting company. It seemed to be a failed business idea. Why do you think that is? ______________________________________________________________________________
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Estimate the LTV and the Drivers: Estimate what you think the LTV range is for customers of the following businesses and what drives them: Google______________________________________________________________________________
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Bicycle shop______________________________________________________________________________
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Used-car dealership______________________________________________________________________________
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A new Lamborghini sales and service dealership______________________________________________________________________________
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WORKSHEET
Inputs to the Worksheet
One-Time Charge(s)
What will your one-time charges be for each customer (e.g., initial purchase price of product)? _________
What is your estimated profit margin on your one-time charges? _________
(One-Time Charge - Marginal Production Cost)/One-Time Charge = ProfitMargin
For example, if your one-time charge is $100 and the cost to make that one unit of product is $20, your profit margin is (100-20)/100 = 80%). (General estimate is fine; don’t add more precision than is appropriate at this point—it can be misleading.)
What is the life of the product before a customer has to repurchase the product? _________
What percentage of customers will repurchase? _________
What will your recurring revenue streams be? _________
What is your profit margin on your recurring revenue streams? _________
What is your retention rate for your recurring revenue streams?
After first year: _________
After second year: _________
After third year: _________
After fourth year: _________
After fifth year: _________
What other revenue sources will you have? What will your profit margin be, and is there a yearly retention rate applicable to them?
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What will your cost of capital be, and why? (If you don’t know, assume 50 percent. If you do know, explain below why you think your cost of capital will be different.)
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Calculations to Estimate the LTV
Input t = 0 (Today) t = 1 (1 year) t = 2 (2 years) t = 3 (3 years) t = 4 (4 years) t =5 (5 years)
A. One-time revenue amount
B. One-time revenue profit margin (%)
C. One-time revenue profit (row A * B)
D. Recurring revenue amount
E. Recurring revenue profit margin (%)
F. Recurring revenue profit (row D * E)
G. Other revenue amount
H. Other revenue profit margin (%)
I. Other revenue profit (row G * H)
J. Sum of profit for time period
K. Default cost of capital factor: Discount factor to NPV (@50%/year and assuming units of time = years)2 1.0 .67 .44 .30 .20 .13
L. NPV of each item (row J * K)
M. Sum of all NPVs (sum of all cells in row L) ¯¯¯¯¯¯¯
Interpretation of Estimation
What would you round your LTV estimation to? What range do you feel comfortable with? ______________________________________________________________________________
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Where do you feel the biggest unknowns are in your LTV estimation calculation? ______________________________________________________________________________
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Does the number seem reasonable? ______________________________________________________________________________
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What are the key drivers of the LTV if you want to increase it? ______________________________________________________________________________
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Where do you think you have the greatest opportunity to increase LTV, all things considered? ______________________________________________________________________________
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Wow, that was probably exhausting and you feel you had to make a lot of assumptions that may turn out to not come true. They won’t all come true, count on it. Still, it is better to try to plan for the future and understand where the current path will take you with reasonable assumptions.
As U.S. president and highly decorated general Dwight D. Eisenhower said, it is the knowledge gained from planning that is much more important than the plan itself. You certainly don’t want to go into battle with a new product and no plan and just a belief that it will all work out, because if you had spent some time analyzing first, you would have been able to eliminate a lot of plans and paths that would be unlikely to work.
Now you will take your knowledge forward from the LTV and craft a general direction that has a path to success and glory.
NOTE
1 Cost of capital is essentially the interest rate you will be required to pay to get more money for your new venture.
2 To calculate the present value (PV) of a future value of cash (FV) where i = the interest rate and t = units of time past, the formula is PV = FV * ( 1 / (1+i)t )
STEP 18
Map the Sales Process to Acquire a Customer
WHAT IS STEP 18, MAP THE SALES PROCESS TO ACQUIRE A CUSTOMER?
Visually show how you will create and fulfill demand for your product over the short term, the medium term, and the long term.
WHY DO WE DO THIS STEP, AND WHY DO WE DO IT NOW?
The sales process is a critical input to estimating the Cost of Customer Acquisition (COCA) in Step 19. The sales process, including selecting your sales channels, will allow you to understand the unit economics of your product and then adjust accordingly to increase profitability. You can intelligently map the sales process now that you have an estimate from Step 17 of the Lifetime Value (LTV), which helps indicate which sales methods are affordable and practical for your startup.
By the Book: See pages 195–201 of Disciplined Entrepreneurship for basic knowledge on this step.
See page 201–202 of Disciplined Entrepreneurship for an example of how a company addressed this step.
Figuring out how to generate demand and to fulfill it with a sales channel strategy is your next key decision.
PROCESS GUIDE
Now that you have a general range for what the LTV is going to be for your product, you can now start to focus on your sales strategy. In Disciplined Entrepreneurship I chose not to call it a channel strategy because the decision should be more thoughtful than a typical channel strategy, but most people still recognized it as a channel strategy. I won’t fight this nomenclature too much, but I think of it as a “channel strategy plus.” It is a dynamic go-to-market strategy to both create demand and then fulfill demand, which are two quite different processes.
There are four main categories of sales channels to consider:
Option Pros Cons
1.Field Sales: Direct salespeople who are employees of the company. They call on prospects in person at some point in the process. They provide high-touch connection and line of communication to the potential customer. Also known as “outside sales.” Excellent for demand generation when creating new markets; may well be the only option for demand generation
High-touch approach creates excellent feedback loop
High-touch approach also generally creates deep customer loyalty
Very expensive (salary, bonus, expenses)
Requires an LTV of $30K or likely higher
Hard to scale up as hiring them is hard and expensive and the success rate is unpredictable
Takes a long time to become productive
A challenge to manage
2.Inside Sales: Also known as “telesales” in the past, but today no longer just telephone sales reps. They use e-mail and other electronic communication to create and continue a dialogue with the customer, but do not visit the customer in person. Much cheaper than field sales
Maintain direct connection with prospects, potential customers, and customers
Able to get nuanced feedback from prospects because a human is in the loop
High productivity because of lack of travel
Good systems exist to further increase productivity and track progress of sales funnel and sales reps
Lower touch, resulting in less customer engagement and less demonstration of the company’s commitment to the customer
Still expensive because the salesperson is interacting one-on-one with customers
Some products just can’t be sold without an in-person demo or meeting with the customer
3.Internet Sales: This is a general catch-all category for sales done by computers through automatically generated e-mails, big data analysis, social media, preference engines, etc. The key differentiator is that there is no human in the loop. Direct interaction with the customer
Ability above all others to systematically capture even more data on the customer and track their progress—as well as spot patterns and make intelligent recommendations
Lowest cost by far
Actually preferred by some prospects
Low touch
Can’t read some nuances that only humans can
Some prospects do not react well to it
Privacy considerations
Can be hard to build customer loyalty
Risk for high LTV prospects/customers that others who use the higher touch channels above will steal these valuable customers
4.Third-Party Resellers: These people sell your product but are not employees of your company. They include Value-Added Resellers (VARs), distributors, stores, catalogues, independent sales agents, etc. Instant geographic coverage
Easy to manage
Understand cultural context and have preexisting contacts in their databases
Lower cost than field sales
Don’t have to hire, fire, and manage salespeople
Good for quick demand fulfillment
Potential temporary solution
Potential good solution for a mature product
They own the customer, not you (very bad!)
Unlikely to have direct interaction with prospects, hence miss important learning about customer needs
Poor at demand generation
Expensive compared to inside sales and Internet sales
Most likely low loyalty to you and your product (just another product in their portfolio)
Within each of these four categories, there can be many different variants, as well as hybrids across the categories. For instance, someone in field sales often spends a reasonable fraction of time on the phone, but their training and expertise is in face-to-face closing the sale, and their pay reflects that.
Other than those caveats, this table will be useful to start to frame your options because it will help you determine what sales strategies are affordable based on your LTV:
Estimated LTV What you can afford for sales channels in the long term
∼$30 Only Internet sales; no human can be in the loop.
∼$300 Predominantly if not all Internet sales, with maybe a very small amount of inside sales for the most important prospects.
∼$3,000 Mix of Internet sales and inside sales and maybe some third-party resellers, especially if the product is mature or requires low support.
∼$30K Mix of all channels, with heavy reliance on inside sales and judicious use of field sales on big accounts. Third-party resellers can play a role in this scenario for geographic coverage and quick scale-up.
∼$300K Likely led by field sales, with support from inside sales and some third-party resellers in selected areas for geographic coverage.
∼$3M Dominated by field sales, with other channels in a supporting role.
∼$30M The field sales representatives are the all-powerful dictators; other sales channels don’t even look at highly qualified prospects or customers without their approval. Customer intimacy and professionalism is crucial in this scenario.
To map your sales process, you will start by determining for the short, medium, and long term what proportion of sales will come from different channels. Use the Sales Channels for the Short, Medium, and Long Term worksheet to define the periods of time and proportions, as well as sales goals to achieve during that period, and assumptions and risks involved. You will also define what milestones you need to reach during each period so that your company is prepared to shift to the sales strategy for the next period.
Short term, medium term, and long term are defined in large part on the progress you make on your product. In the short term, you are figuring out what your product is and creating demand; in the medium term you are refining your product and starting to produce it in a repeatable fashion, fulfilling demand, and building the manufacturing and sales infrastructure you need to be successful; and in the long term, you are scaling your business. The key is that you define and understand what milestones allow you to shift your approach from the short-term sales channels to the medium term to the long term. Typically, short term will map to the first year from your LTV calculation, medium term the second year, and long term the third year and beyond, but this may differ if your product has significantly longer or shorter development cycles, such as new pharmaceutical development.
As is explained in more detail in Disciplined Entrepreneurship, the short term is where you will focus on demand generation and creating market awareness, and you will also still be iterating on your product and marketing, so field sales will be important despite its higher costs. As you progress through the medium term and then the long term, your sales channels should shift away from focusing on field sales, particularly for an LTV less than $1M in the medium term and less than $100K in the long term.
Next, you will take the sales funnel work you did in Step 13 and refine it into second draft sales funnels, one for each of the short-term, medium-term, and long-term time periods. Now that you know which sales chan
nels are viable—and more important, not viable—for the long term, you have enough information to be much more specific than in your original draft from Step 13. Like everything, you will continue refining your sales funnels over time.
You’ll also think through what techniques and actions you can use to maximize conversion between steps. Be creative and draw on the work you’ve done so far in the 24 Steps as well as ideas from other companies and industries. At the end of this chapter, I’ve provided an example from one of my student teams to inspire you.
A disclaimer: These worksheets are comprehensive and may be overdesigned for your situation. Or, if you have a complicated, multisided market, they may be underdesigned. Use common sense and customize this framework to fit your customer/product scenario. For instance, if you are business to consumer (B2C), some of this detail is not necessary, though I would argue it is still good for you to go through all the details so that you fully understand the big picture. Knowledge is a good thing—if you have the time.
