Too often founders and CEOs fixate on CAC (customer acquisition cost) or LTV (lifetime value of a customer), but they fail to consider the cost of a customer. Many people tie this into COGs (cost of goods sold), but I actually think it needs to be a separate line item. To me COGs is just how much it takes to build the product, and often times for technology products and services that is amortized as an R&D investment. Hence, the cost of maintaining the product or service needs to be factored in. We need to shift our thinking because we we’re no longer making shrink-wrapped software! We’re doing SaaS (software as a service).
Unfortunately, CAC and LTV being at the forefront is a phenomenon that especially plagues startups and companies that service a broad base of customers rather than a niche market. However, the reality is that the cost of the customer can actually narrow margins significantly impacting profitability. Hence, the key is to think about what the cost of a customer is, and how it can be reduced.
Cost of a Customer
Calculating the cost of a customer is tricky. You have to begin by seeing what is driving up costs, here are three major factors that contribute to it:
- The type of customer you are attracting.
- Putting a price on servicing their needs.
- The quality of your product or service.
The Right Type of Customer
I actually never blame a customer for asking for too much or driving up costs. The type of customer a company attracts is well within their control. It is up to the company to determine who is and isn’t the right fit for the product. In the event that there isn’t a fit the customer and company shouldn’t bother to do business, it will only cause friction and drive up costs. This is a hard idea for most founders and CEOs to adopt because it causes them to assume that it will limit their company’s growth rate.
To attract the right customer, you of course have to do customer development; understanding their needs, expectations, and what value they are seeking from your product or service. However, if you do customer development correctly, you can then craft a marketing message that is clear and attracts that particular type of customer in mass.
For example, BizeeBee offers a self-service CRM product to independent fitness professionals and businesses (e.g. yoga studios and personal trainers). We don’t service businesses with multiple locations or franchises. In making the product self-service, I knew that the type of fitness professionals we’d be able to service needed to be comfortable enough with technology to get up and running by themselves, or with as minimal customer support from our end. However, despite their degree of tech savviness, because we are focused on making a self-service product, we knew that the product needs to be as simple to use as possible. If a potential customer comes to us asking for a lot of help to get setup we tell them that we’re probably not going to be a good fit. Yes it kills the sale, but it also kills the long term cost.
At BizeeBee, we still talk about having great customer service, but because our product being self-service, lets customers know that they can get setup on their own. They don’t need to wait on us to get started. This might seem pretty obvious to most, but for our customer segment it is important to be clear with the messaging because our competitors products’ are very setup intensive. Our goal is to empower our customers and keep our support costs down.
By baking in customer needs into the design of our product, and conveying for whom and how our product addresses those needs in our messaging we have attracted the right type of customer.
Pricing Your Product
Pricing your product also helps a lot. At BizeeBee, we don’t appeal to the overly price sensitive customer. Instead we’ve concluded that the price point we offer attracts customers that value our product and our time.
If it were a free product or very low cost solution there would be an element of entitlement. The other element to pricing that people often overlook is charging the users of their product directly. Indirect approaches such as affiliate marketing and lead generation or having two users but one customer (e.g. marketplaces or B2B2C), can skew costs.
I’ve actually experienced this at my last startup Mint, because it was a free product it attracted millions of users! This is something people think they want… In reality it drove up customer entitlement (requesting more features), creating the need for support staff to handle customer requests, and put a burden on engineers to spend time building features that weren’t always revenue generating. The amount of money we were making on lead generation per customer, i.e the LTV, was significantly less than the cost of a customer.
Quality of Product
Quality is the #1 driver of customer cost. It manifests itself in the following manner:
- int increases the number of customer support staff you need to address customer concerns
- it increases customer churn and reduces closing rates for sales staff
- it impedes the time engineers spend on creating new products because they are more focused on fixing bugs
Now some companies take the strategy of charging their customers for technical support. I think paying for technical support only makes sense if a customer wants additional maintenance, i.e to add features to a product or receive help/training getting setup. Barring those two, having a customer pay for a defective product will definitely leave them thinking twice about doing business with you going forward.
Finally, the cost of a customer will change as the number of customers go up. This is because servicing more customers means you’ll have more operational expenses such as building or maintaining infrastructure to support the larger number of customers. You can offset the increased costs by looking for services that will support the larger load. But you’ll still have an interim period of growing pains that will need to be addressed.
There isn’t an exact formula to determine the cost of a customer, but the point is to be aware of what contributes to it, and factor it into various aspects of your business namely: product quality and the type of customer you’re attracting through your marketing and pricing.