In recent times, the growth of startups has been the top priority, with little regard for profitability or sustainability. They were able to acquire users and dominate markets by relying heavily on venture capital. However, the tides have turned, and the focus now is on “efficient growth,” striking a balance between expansion and profitability to achieve long-term sustainability.
As investors, our primary focus is to identify companies with efficient growth potential at an early stage. To determine the recipe for long-term success and efficiency, we utilize various analyses, some of which are covered in this article.
“The flaws of using LTV/CAC – why we use cohorts to assess sales efficiency”
– An excerpt from the original article
Before diving into our analyses, we would like to address why a commonly used metric can be misleading. The metric in question is LTV/CAC (lifetime value/customer acquisition cost), often used by investors to evaluate a business’s go-to-market engine. However, this metric may not be accurate for early-stage companies due to several reasons:
- There are multiple methods to calculate LTV, making it challenging to determine the accurate value.
- The churn rate is not stable enough to predict the customer’s lifetime accurately. For a startup in its early stages, the churn rate can vary as the company strives to achieve product-market fit. As the product improves and addresses customers’ needs, we can expect the churn rate to reduce. However, external factors like macro headwinds can also influence higher churn rates, which are beyond the company’s control.
- There is a time mismatch in the ratio between today’s sales and marketing spend and the projected, discounted future cash flows of a customer. This inherent estimation can lead to inaccuracies, especially when using metrics collected during unpredictable times like COVID-19.
As investors, we rely on cohort analyses to gain insights into growth mechanisms, retention, and sales efficiency.
Considering the various approaches to calculating LTV, the lack of consistent churn rate data, and the estimated value of the LTV/CAC ratio, it is challenging to determine the key drivers of customer acquisition and retention. Hence, we suggest using cohort analysis to visualize the time taken to recoup the initial sales and marketing spend for each cohort.
But what exactly are cohorts, and why are they crucial?
A cohort analysis involves grouping customers into cohorts based on their acquisition dates and tracking their behavior over defined periods. This analysis tracks metrics such as number of orders, amount of spending, and use of features to understand a business’s performance over time.
This form of analysis is useful for various business models, including SaaS, fintech, and marketplaces. We used it previously to examine a ride-hailing company’s performance. The main benefit of cohort analysis is its ability to reveal insights about revenue, acquisition costs, and churn over a single cohort and across multiple cohorts.
Here’s how we conduct the analysis:
