by Bill Aulet
I have provided a relatively blank worksheet for you to list your expected expenses, because each company will have a very different list depending on what their industry and sales channels are.
Some of your marketing and sales expenses may be related to customer retention and support, instead of new customer acquisition. Do not include those expenses in the calculation of COCA. Customer retention expenses, within reason, are generally money well spent, because your most profitable customers are almost always your existing customers—you have already spent the money to acquire them, and the costs to retain them are not nearly as high as the costs to find new customers. You don’t want to lose your existing customers!
Then, take the grand sum of all the marketing and sales expenses, less customer retention and support for each time period, and divide by the number of new customers in that same time period. That will be your COCA for that time period.
In the remaining worksheets, you will look at ways you can reduce your COCA, graph your LTV against your COCA for each time period to see if your COCA is currently low enough compared to your LTV, and then look at risk factors related to your COCA calculation and how you can mitigate them.
If you stay focused on your target customer and do all the steps well, you should generate positive word of mouth in the advocacy stage of the sales funnel (see Step 18), and that will be the biggest driver to reducing your COCA in the long term.
GENERAL EXERCISES TO UNDERSTAND CONCEPT
See the back of the book for answers to these questions.
Current example—LinkedIn and Groupon: Who do you think has a lower COCA, LinkedIn or Groupon? Which direction do you think the COCA of each company is headed (up or down) and why?______________________________________________________________________________
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Dropbox example—B2C to B2B: Dropbox is moving from strictly a business-to-consumer (B2C) business model for its products to now having a focus on business-to-business (B2B) selling into enterprises. What do you think this will do to their COCA? Do you see any challenges?______________________________________________________________________________
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Amazon.com and COCA: How does Amazon.com keep its COCA so low?______________________________________________________________________________
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Gillette vs. Dollar Shave Club: Why is Gillette’s COCA so high and Dollar Shave Club’s initial COCA so low, despite selling the same product, razors and razor blades? (See the discussion about Dollar Shave Club in Disciplined Entrepreneurship for background information.) ______________________________________________________________________________
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WORKSHEETS
Assumptions for COCA Estimation
What time intervals did you define for the following phases in the Step 18 worksheet “Sales Channels for the Short, Medium, and Long Term”?
Short Term _____________
Medium Term ___________
Long Term _____________
Total Sales and Marketing Expenses List
List the expected sales and marketing expenses, and their costs. This input will be used when estimating the Cost of Customer Acquisition (COCA).
Sales Expenses Short Term Medium Term Long Term
Marketing Expenses Short Term Medium Term Long Term
Estimate the COCA
Time Period (default is year but can customize)
Year 1 Year 2 Year 3 Year 4 Year 5
New customers forecasted
All sales expenses for period
All marketing expenses for period
Total marketing and sales expenses for period
COCA for the period
Convert Estimation into Short, Medium, and Long Term
Understanding these numbers are not precise, estimate your COCA for the short, medium, and long term, based on the time periods you defined in the first worksheet. Make an estimate that you are comfortable with, and express the estimate as a range instead of an exact number.
Short-term COCA range _____________________
Medium-term COCA range ___________________
Long-term (steady state) COCA range ____________
Key Drivers of COCA and Ways to Decrease It
# Item Effect Action Possible to Decrease Risk
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2
3
4
5
Example: Key Drivers of COCA and Ways to Decrease It
#
Item
Effect
Action Possible to Decrease
Risk
1 Field Sales High Decrease number and increase inside sales High in short term—need to see how market adopts product; lack of direct salespeople will definitely slow adoption
2 International Field Sales High Use third-party resellers Low in short term/high in long term because we don’t have direct connection with customers
3 Advertising Budget Medium Build up in-house social media and other capability Medium but probably worth it in long term
4 Field and Inside Sales Medium Supplement and reduce numbers with stronger Internet sales investment Medium in short term and, if works, low in long term
5 Trade shows Medium Eliminate and find a guerilla market approach at 10 percent of expense Medium in that our customers expect us to be at these shows and it gives our company credibility; still something can probably be done here
Comparison of LTV and COCA over Time
Label the axes with the appropriate numbers and units, and then plot the LTV and COCA on the graph based on your calculations from this step and from Step 17, Calculate the Lifetime Value (LTV) of an Acquired Customer. Draw a line to connect the three LTV points, and another line to connect the three COCA points.
Overall Interpretation of Unit Economics—Bringing It All Together
Now that you have done all the hard work, let’s pull it together and consolidate what we know and what we should do now.
Basic 3X Test: Is your LTV more than three times your COCA for your long-term time period? This is essential because COCA only deals with marketing and sales. The LTV must produce enough excess profit to also pay for research and development (R&D) as well as general and administrative (G&A) costs. The R&D costs can be significant. The 3X rule of thumb was created for software as a service companies, so the specifics of your industry may require a higher ratio in order to be successful. Does your LTV-to-COCA ratio clear the basic 3X threshold by a little, a reasonable amount, or a lot? ______________________________________________________________________________
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R&D Factor: Is your R&D expense going to be above or below that of an average software as a service company? For instance, a biotech company’s R&D expenses will be much higher. If so, then your ratio needs to be higher to compensate for this. For biotech companies it can be over 100x, and for consumer goods it can be less. What is your situation, and do you feel comfortable there will be enough profit to cover R&D expenses? (G&A expenses fluctuate as well if there is a regulatory component, but they do not fluctuate as much as R&D, so we will focus on R&D as the proxy for G&A as well): ______________________________________________________________________________
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Adjustments May Be Necessary, But You Are Ready: There is a good chance that your initial unit economics don’t work. Don’t overreact and don’t underreact. You are prepared now to go back and iterate. Go back and make adjustments like you started to list in the Key Drivers of COCA worksheet. Make adjustments until the numbers work. It is great to be passionate and that is essential, but well thought-out numbers have a stubborn way of telling the truth in business. Don’t ignore them. In the end, if you can’t make the unit economics work, you won’t have a sustainable business no matter how hard you try. But most of the time you can fix it, now that you are equipped with this knowledge.
Once you have iterated and the plan works, like in Step 18, list the top three risk factors for the unit economics and how you plan to deal with them below:
COCA risk factor #1 and mitigation plan: ______________________________________________________________________________
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Metrics to watch:
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Potential intervention strategy:
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COCA risk factor #2 and mitigation plan: ______________________________________________________________________________
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Metrics to watch:
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Potential intervention strategy:
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COCA risk factor #3 and mitigation plan: ______________________________________________________________________________
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Metrics to watch:
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Potential intervention strategy:
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If you are an engineer like me, you are now getting to the fun part. Now you can build the product with confidence that it can be the basis of a great company. That being said, it all makes sense, but you are not sure until it really happens. Now you move to the design and build stage in Step 20, Identify Key Assumptions.
STEP 20
Identify Key Assumptions
WHAT IS STEP 20, IDENTIFY KEY ASSUMPTIONS?
Describe the main assumptions that underpin your plan for your startup so that you can test them before the market tests them for you.
WHY DO WE DO THIS STEP, AND WHY DO WE DO IT NOW?
While you have tested many key assumptions throughout the 24 Steps, now you have all the elements of the marketing analysis plan, so now it is time to survey the full landscape and identify those key assumptions that are crucial to the overall plan before you begin to make the heavy investments in product development and the supporting infrastructure.
By the Book: See pages 219–222 of Disciplined Entrepreneurship for basic knowledge on this step.
See page 222–223 of Disciplined Entrepreneurship for an example of how a company addressed this step.
Before you push into product development, be as efficient as you can by intelligently identifying your key assumptions.
PROCESS GUIDE
You have reached another important milestone in your journey in that you should now be confident that you know who your customer is; that you can create substantial and meaningful value for your customer; that your target end user will acquire your product; that there is an economic buyer who will pay you as a result of the end user acquiring the product; and that the resulting unit economics will make you profitable. Congratulations!
But in the last paragraph you said “you are confident” a lot. You have self-assurance, but you don’t truly know what is going to happen when you start trying to sell your product. It is now time to step back and think holistically about the biggest risks you face and how to mitigate them before you move forward to a stage where the costs and resources you expend will increase dramatically. As they say, “In concept, concept and reality are the same, but in reality, concept and reality can be very different.” You need to test your conceptual comprehensive plan one last time as much as possible before the real battle begins.
All along you have been testing your assumptions with primary market research, so what is the difference now? Until now, you have not had the full picture. Now that you have completed 19 steps worth of product/market fit planning, you can identify those assumptions that stand out overall as the most critical for your success.
There is also the challenge with people that they will say one thing, even with the best intent, and then do something completely different when the decision day actually comes. This is especially true with willingness to pay, but it can also be true in other areas. So even assumptions that seemed accurate until now need to be more thoroughly tested when linked together.
Start by reviewing the work you have done in each step of the 24 Steps thus far and build a list of key assumptions you have made at each step. Prioritize the list and identify the 5–10 assumptions that are the most crucial to the success of your product. Use the provided worksheet to list these assumptions, the related step(s) from the 24 Steps, the risk level of the step (low, medium, high, critical), and briefly describe what will happen to your company if your assumption turns out to be incorrect.
In the next step, you will test these assumptions, but for now, don’t worry about how you will test them, or you will be biased toward easily tested assumptions. Your goal for now is to identify the most important assumptions, regardless of ability to test them.
Here is an example of a prioritized list of top assumptions, which comes from one of my student teams:
GENERAL EXERCISES TO UNDERSTAND CONCEPT
See the back of the book for answers to the first question.
Segway example: What assumptions did Segway make that in hindsight they should have identified and tested before building and launching their product? ______________________________________________________________________________
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Personal example: Identify a product you know that did not do well in the market. In hindsight, what two or three things did the manufacturer assume but should have known not to assume? ______________________________________________________________________________
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