Expert Program Management

Pricing Mechanisms

Denis — Thu, 12 Jan 2012 18:26:55 +0000

In a previous article we looked at the different revenue streams available to a company: assets sale, usage fee, subscription fee, lending, licensing, brokerage fees, and advertising. To help achieve maximum revenues different pricing mechanisms can be applied to each of these revenue streams.

A pricing mechanism is a complex way of describing how buyers are matched to sellers through price. Just as there are two broad categories of revenue streams there are two broad categories of pricing mechanisms:

Fixed Pricing: here prices are determined in advance of any sales based on zero or more static variables.
Variable Pricing: also know as dynamic pricing. Here the price of goods or services can change based on market conditions.

Let’s now examine some of the more common pricing mechanisms under each of these two broad categories.

1. Fixed Pricing

1.1 Fixed Pricing

Here prices are fixed an non-negotiable, for example, Apple sells all its products to consumers are fixed prices. You cannot walk into an Apple store and negotiate the price.

1.2 Feature Dependent Pricing

With feature dependent pricing the price changes based on the number of features purchased. For example, purchasing additional premium sports TV channels from a channel provider increases your monthly cost but may bring down your cost per channel.

1.3 Customer Segment Dependent Pricing

Here the cost of goods changes based on the customer segment. For example, Microsoft charges a different price for its Office product for each of the following customer segments: consumer, business, and student. The student pricing is obviously the least expensive, whilst the for-profit business segment is the most expensive.

1.4 Volume Dependent Pricing

With volume dependent pricing the price changes depending upon how much is purchased. Typically, the more you purchase the cheaper the price per item. For example, many supermarkets have offers along the lines of “buy 2 get a 3rd free”.

2. Variable Pricing

2.1 Bargaining

Bargaining is one of the most ancient ways for humans to conduct an exchange. Here two parties negotiate to achieve an agreed price for the product or service. The price agreed will depend on the relative power and negotiation skills of both parties. The ability to influence is a powerful tool when bargaining.

2.2 Yield Management Pricing

With yield management we aim to anticipate and influence customer behavior in order to maximise revenue and thus profits. The price will fluctuate according to the inventory available and the time of purchase. A good example of yield management pricing is in the sale of hotel rooms, whereby the price is a function of the number of rooms available in the hotel and also how far in advance of the “stay date” the booking is being made. Yield management pricing is also commonly used within the commercial airline industry.

2.3 Real-time-market Pricing

In real-time markets the price will change continuously and there is rarely, if ever, time to get involved in lengthy negotiations. The price will change continuously based on ever changing supply and demand. Stock markets are a classic example of real-time-market pricing.

2.4 Auctions

In auctions the price is determined by the highest bidder for the product or service. In online auctions the bidding period for a particular item will have a fixed deadline, when no further bids can be placed and the winner of the auction becomes known. During the auction all bidders have instant access to see the latest highest bid and can then decide if they wish to increase their bid.

Summary

There are broadly two types of pricing: fixed and variable. Within these two categories of pricing there are many options available to enable an organization to maximize its revenue as described above. If you multiple the pricing mechanisms by the different revenue streams available then its easy to see that there is a huge array of pricing options available for organizations to choose from.

* Image by lalunablanca

Jobs You’ve Never Heard Of

Denis — Thu, 12 Jan 2012 18:21:52 +0000

Organizations start small and over time, if they are successful, they tend to grow. In the abstract ideal the most successful organization would grow profits without needing to increase its cost base by hiring more people, occupying bigger offices, or investing in technology.

Such a business doesn’t exist, or at least if it does its owner has kept quite about it, and for good reason too as who wouldn’t want a business like that? In the real world, business that grow go through different phases. These phases are defined in the Greiner Growth Model.

According to the Greiner Growth Model each new growth phase of the organization is preceded by some form of crisis. The different crises that an organisation encounters, in order as they grow, are defined as follows:

Leadership Crisis
Autonomy Crisis
Control Crisis
Red Tape Crisis
Growth Crisis

Only very successful organizations will ever make their way successfully through all stages of crisis.

Some of you may be wondering why I’m mentioning this when the title of this article is about jobs you’ve never heard of? Well, when organizations are small they are chaotic but easy to understand. You may well just have a few employees. One may be responsible for sales, another for product development, and that might be it. Simple.

However, when organizations grow and grow the need for ever more specialised roles increases. I don’t know at what point on the Greiner Model this starts to happen but its probably as early as the Autonomy Crisis.

I came across one such specialised role yesterday which I’d never heard of before – Catastrophe Modeler. People with catastrophe modelling jobs estimate the financial loss which could be incurred if certain catastrophic events occurred.

The type of catastrophes they estimate losses for include hurricanes, earthquakes, tornadoes, terrorist attacks, and war, amongst others.

The results of catastrophe modelling are useful to all kinds of people. For example, insurers obviously need to understand their exposure across the portfolio they insure. Ratings agencies would need the same information too so they can accurately rate the insurers. The government would also use catastrophe modelling to help guide its strategy towards responding to and managing disasters.

So there you have it – catastrophe modelling. There is even an International Society of Catastrophe Managers. If you’ve recently come across a job you’ve never heard of before then use the comments section below to get in touch. I’d be really interested to hear about it.

Image by kakela

What is the Long Tail?

Denis — Wed, 11 Jan 2012 18:08:46 +0000

Many businesses are adapting long tail strategies. Classic examples of Long Tail businesses include Amazon and Netflix. In addition to online retailers you will also find Long Tail businesses in micro finance and insurance to name just two industries.

But what exactly is the Long Tail? The Long Tail refers to a statistical distribution that occurs for particular data sets. The distribution can be best understood by looking at the following diagram.

In this diagram you can see that the long tail accounts for over 50% of the products sold, and top sellers (or blockbuster products) account for less than 50% of the products sold.

The term Long Tail was first used by Chris Anderson to describe the shift which was underway in the media business from selling a small number of bestseller products towards selling a very large quantity of niche products, but each in small quantities. The total sales which come from the Long Tail can be in aggregate exceed sales from the top of the curve.

Another great example of a Long Tail business is eBay. The success of this business is based on a vast quantity of sellers both buying and selling small quantities of niche or non bestseller items.

Do not confuse a long tailed distribution with the Pareto principle. In the Pareto principle 80% of sales would be accounted for in the first 20% of the distribution, whereas with long tailed distributions the biggest sellers account for less than 50% of total sales, thus making the tail of the distribution more important in aggregate than blockbuster sales.

Long Tail Financials

What are the drivers that make it possible for companies to focus their efforts on the Long Tail? There are two perspectives to look at this from: the customers and the suppliers.

The customer perspective: online tools such as search engines and recommendation engines are allowing customers to find products outside their immediate area; niche products that they would not have previously had access to.
The supplier perspective: If holding inventory is negligible in cost then it becomes very profitable for the supplier to focus towards the long tail. This could be because the product is digital or because a central warehouse is used. Additionally, there is less competition in the long tail by nature so advertising costs will be proportionately less for long tail products.

Another interesting way to think about these dynamics is that traditionally the Internet has been thought of as focusing on supply, that is, reducing costs. However, given the above you can also see it driving and growing the demand side, as consumers search for and discover products in the Long Tail they would previously never have even thought available.

Summary

The Long Tail is a statistical distribution upon which the strategy of many Internet businesses are based. A shift has and is happening on the Internet whereby instead of a small number of blockbuster products being sold and representing 80% of sales, blockbusters now account for less than 50% of sales and so the Long Tail products have become more important in aggregate.

Types of Revenue Streams

Denis — Wed, 11 Jan 2012 16:48:28 +0000

At the absolute core of every business are revenue streams. Revenue is obviously the cash a company earns from its customers, but you can also think of revenue (and revenue streams) as the parts of value generated by a business for which customers are willing to pay. In a very broad sense there are just two types of revenue streams:

One-time Revenues: also known as transactional revenues, where the customer pays just once for the value.
Recurring Revenues: where the customer pays over and over to continue receiving the value, or they pay over and over to receive ongoing support for their initial purchase.

So one-time payments and recurring payments are the broad methods by which an organization can generate revenues, but here are some specific methods of generating revenues which fall within these two categories…

1. Asset Sale

This is probably the most widely understood revenue stream. The customer purchases an asset from a company for an agreed price. Examples include, Amazon selling books, Apple selling phones, and Boeing selling airplanes.

2. Usage Fee

Here the customer pays for using a service provided by the company. Effectively the customer is paying on a per-use basis. Examples include, a car hire firm that charges by the number of days a car is hired, and a mobile operator that charges by the number of minutes of calls made by the customer.

3. Subscription Fee

With this revenue stream the customer pays a regular subscription for continued use of a service. For example, Sky Television in the UK charges a monthly fee for access to its channels, and gyms charge a monthly subscription for access to their facilities.

4. Brokerage Fee

A broker acts an an intermediary between two parties, a customer and a provider. For example, real estate agents market properties to potential purchasers on behalf of property sellers. Once a property has been successfully sold then the seller will pay the real estate agent a small percentage of the sale price for successfully brokering the sale.

5. Lending/Renting/Leasing

Here the customer gains the right to use the company’s product (the asset) or service for a fixed period of time. At the end of the agreed period of time the asset must be returned to the company. Examples include car leasing companies where the customer leases a car for a fixed period (usually three years) and at the end of the period returns the car to the company, and in the UK, Love Film allows users to hire a fixed number of DVD’s during a calendar month.

6. Advertising Fee

The media industry – TV, radio, and Internet magazines are particularly dependent on advertising fees for income. Recently, many high-tech companies have become dependent on advertising revenue, for example Google. In fact, this website makes a small income from advertising each month.

7. Licensing

With this revenue stream the customer is given permission to use a product in exchange for licensing fees being paid to the rights holder (a company or individual). The advantage of licensing fees is that they allow rights holders to generate revenue from the intellectual property without necessarily having to generate a physical product. A classic example of licensing is the fact that every time a song is played on the radio then a license fee must be paid by the radio station (the customer) to the license holder.

More Complexity

An added layer of complexity comes from the fact that each of the pricing mechanisms outlined above can have different pricing mechanisms applied to them. For example, price could be feature dependent, or customer segment dependent, or based around yield-management, or real-time markets to name just a few of the available pricing mechanism. I’ll cover pricing mechanisms in a future article.

Summary

There are essentially two types of revenue: one-time revenue and recurring revenue streams. Within these two broad categories of revenue there are many different types of revenue, the most common of these are described above.

* Image by yourdoku, and by the way, if you’re really bored the above revenue sudoku image is solvable!

Program Management: Understanding Effort and Influence

Denis — Wed, 04 Jan 2012 15:40:46 +0000

In this article we’re going to look at program managers and the effort and influence they exert as the program they are responsible for is executed. Once we understand this, we’ll compare program managers against leaders and against project managers, observing any differences.

Take a look at the effort and influence diagram below for a program manager. Time is on the horizontal axis, and the vertical axis runs from low to high for lines plotted. The lines we’re plotting against these two axes are obviously effort and influence.

In the diagram above you can see that the program manager’s ability to influence the outcome of the program is greatest at the beginning of the program. You can also see that the effort the program manager expends during the program is high but consistent over the entire duration of the program. Note that there are no precise values on the vertical axis, so I am not saying influence exceeds effort at the start of the program, merely that both are high.

Now let’s plot a similar graph for a leader/senior executive.

As you can see the curve for ability to influence the outcome looks very similar to that of the program manager. It’s impossible to say whether the senior executive or program manager has a greater ability to influence the outcome at any given time. On the one hand the leader may have a higher rank within the organisation, but on the other the program manager is very close to the program and knows it better than anyone. The key point here is that for both the program manager and the senior leader the influence curves follow the same trajectory.

The effort the leader expends on the program will rarely be huge, but will be greater at critical points within the program when troops need to be rallied and other senior executives need to be persuaded to come into line.

Now let’s plot the same graph for a project manager.

In this example we’re assuming that the project manager is not involved for the entire duration of the program, although they could be. Instead they are involved for a subset of the program, but for the entire duration of the project for which they are responsible.

As you can see, once the project manager becomes involved in the project they expend similar amount of effort for the duration of their project as a program manager does on their program. As you might expect, they have less ability to influence the overall program than either the program manager or senior executive. They are more likely to be able to influence the outcome of their project. Notice that the influence curve has the same shape as the program manager’s and leader’s influence curve, but starts from a lower level of influence and ends when the project is complete, as opposed to the program.

Conclusion

As can be seen from the three diagrams above, project managers, program managers, and leaders have the ability to influence a program in different ways, and by varying degrees. They will also expend time working on the program to varying degrees. The above diagrams should help you understand more clearly the differences between the three roles.

The 7 Types of Waste

Denis — Thu, 15 Dec 2011 18:44:02 +0000

One way to increase margins and therefore profitability is to remove waste from an organization. In Japanese there is the term Muda, which describes any activity which does not value to others, is unproductive and therefore wasteful. This is a core concept of the Toyota Production System (TPS) and Lean. The seven types of Muda waste are as follows:

Transportation
Inventory
Motion
Waiting
Over-Processing
Over-Production
Defects

Let’s examine each type of waste in more detail so as we can make ourselves more lean.

1. Transportation

Each time a product is moved it is at risk of being lost or damaged. There is also a cost associated in moving the product which doesn’t add any value. An example of this waste in a product development environment would be where a prototype is made in a different part of the world to where it is used.

2. Inventory

This refers to products or parts of products which have been made but not yet sold. An example of software inventory is written code that is not yet being used by the customer of that code. A pull system can be helpful in reducing inventory.

3. Motion

Motion is different to transportation in that it refers to employees or their equipment moving. A modern example of motion would be software engineers using new software tooling without adequate training, thus wasting time learning as they go rather than the more efficient option of quickly training up front.

4. Waiting

If a product is not being processed or in transport then it is waiting. This waiting adds no value and is therefore wasteful. An obvious example of waiting is where an employee on vacation must return before another employee can obtain the information they need to proceed with a task.

5. Over-Processing

Over-processing occurs when more work is performed on a product than needed by the customer. A simple software example would be where expensive Oracle databases were used when MySQL would have sufficed.

6. Over-Production

This occurs when more product is created than is used by customers. An example of overproduction is where features are added to a product that the users don’t use or obtain value from.

7. Defects

Whenever a defect is found resources and tools are consumed to fix the issue. Defects can actually remove value by decreasing a customer’s satisfaction with the product.

More on Waste

As mentioned at the beginning of this article, these seven types of waste fall under the broad category of muda. It should be noted that there are also two other broad categories of waste, namely mura and muri.

Mura refers to unevenness or inconsistency. Mura is typically avoided by introducing just-in-time systems and processes.

Muri refers to overburden or unreasonableness. Muri is typically avoided by introducing the standardisation of work.

Summary

Waste costs money and affects profitability. By understanding the different types of waste we can be better equipped to spot and eliminate waste within our organization. If we want to eliminate waste, then one of the first steps must be to classify all of our processes and activities into those that add value and those that do not. Once we have this information it is possible to make some improvement plans.

Pull vs Push Systems

Denis — Tue, 13 Dec 2011 17:11:54 +0000

If you want to understand Lean Manufacturing you’re going to need to understand the difference between push and pull systems. First, let’s define each of these terms:

Push System: is a system in which we produce goods based on our best projections of what the market wants. Essentially the production of goods is scheduled and based on a plan with deadlines. We then push these goods to the market.
Pull System: is a system in which the production of goods is initiated by the person or organization who consumes that good.

Essentially, push describes a situation where inventory is pushed to the consumer of the good, and pull describes a situation where inventory is pulled from the producer by the consumer.

Probably the easiest way to understand the difference between push and pull systems is by means of an example. Let’s look at an example of supplier of replacement car seat-belts.

In a push system the manufacturer estimates the demand for replacement seat-belts and then creates a plan to manufacture those seat-belts over a period of time. Once replacement seat-belts start to roll off the production line they are packaged into boxes (for the purposes of this example, let’s assume 100 replacement seat-belts per box) and sent to distributors in priority order of where it is anticipated the highest demand will be.

These distributors then send the replacement seat-belts to the car dealerships who hold several in stock, so that when a customer comes in requiring a replacement seat-belt they are able to replace it within a short period of time and the customer is happy.

The problem with this system is that it creates inventory throughout the system – at the manufacturer, at the distributor, and at the car dealership. This can create problems. Suppose for example, a fault was identified in the replacement seat-belts rendering them unsafe. They would all obviously need to be discarded, and the seat-belts held at all points in the system would need to be written off. Given this, it is better to have as little inventory in the system as possible but still keep our customer happy (aka as little waste as possible).

Now let’s examine a pull system for the production of seat-belts. In a pull system the car dealership holds one replacement seat-belt set. When a customer comes in to obtain a replacement seat-belt, their request can be satisfied in the same time as in the previous example, resulting in an equally happy customer.

Once the seat-belt has been used at the dealership this results in an immediate a pull signal being sent to the distributor that the dealership needs one more seat-belt set, which in turn signals a pull signal to the manufacturer to produce on more replacement seat-belt.

If you imagine scaling this up so lots of dealerships locally are sending pull signals to the distributor, who in turn is aggregating these and sending larger pull signals to the manufacturer, then a very lean system, with minimal inventory in the system is created.

This pull system obviously has cost advantages for everyone in the supply chain as investment in inventory is never made in the hope that the demand exists. If the replacement seat-belts were to be rendered unsafe, then far less assets would need to be written off than with a push system, as there is less waste throughout the system.

Conclusion

In push systems inventory is pushed from manufacturer to consumer, whereas in pull systems inventory is pulled by the consumer of that inventory when they need it. In Lean Manufacturing, pull systems are used to avoid excess inventory and allow us to much more readily cope with changes that need to be made to that inventory.

* Image by markal

How to Communicate your Vision

Denis — Mon, 12 Dec 2011 07:48:05 +0000

Whether you’re a program manager, CEO, project manager, or entrepreneur, you need to communicate the vision of what your trying to achieve. All good leaders know that in order to have people rally to a cause, they must make their followers excited about their cause.

When people are fully behind a vision they are empowered and impassioned to take action to move the organization towards the realisation of that vision. An understanding of the vision helps everyone who is working towards the vision frame their thoughts, enabling them to make the right decisions day-to-day. This is why communicating the vision is so important.

That at least is they theory, but let’s examine the reality. In reality the average employee isn’t career minded and comes into work day in and day out simple to do their job in the hope that management doesn’t interfere with them too much*. Your vision is not of concern to them. They have far more pressing things to worry about, such as paying the mortgage, bills, home repairs, their kids, their pets etc etc.

* This is definitely an over generalisation but the point I’m trying to make is that your plans for communicating your vision should encompass everyone who needs to hear it.

In fact, your strategy is probably somewhere on their priority list just below tidying the garage. To reach these people what can a leader do to ensure that even if employees aren’t rallying behind the vision and biting at the bit to execute it, then are at least aware of and understand the vision? How can you ensure that everyone knows and understands the vision? One answer is to keep the message simple, and repeat it often using all channels available to you.

Keep the Message Simple

Do not try to be clever. Keep your message simple – think of TV adverts advertising cleaning detergents! You could even make it catchy like a TV advert. The simpler and more succinct the message the more likely people will remember it.

Repeat in Often

Repeating a simple message frequently makes people remember it. Remember:

Repeating a message makes it stick
Repeating a message makes it stick
Repeating a message makes it stick
Repeating a message makes it stick
Repeating a message makes it stick

Got it?

Use All Channels Available

Use every channel available to you to reach and engage with your team. This can include verbal communication, email communication, videos of the message hosted on vps etc. Task your direct reports with spreading the vision to their direct reports answering any questions that arise. These directs should then spread the vision to their direct reports. This process should be repeated until everyone in the organization understands the vision.

Conclusion

Everyone within an organization needs to understand the vision in order to enable them to make the right decisions every day. This is why it is important to communicate the vision. Three simple approaches to help you effectively communicate the vision are to keep the message simple, repeat it often, and use all modes of communication available to you.

* Image by Igor Klisov

Customer Journey Programmes in Financial Services

Denis — Wed, 30 Nov 2011 16:41:02 +0000

Today’s post is by Eleanor Bell, manager of Michael Page’s Consultancy, Strategy & Change team who explains how professionals with proven customer journey improvement skills are in high demand and as banks and insurers look to engage customers to increase revenue and market share while also reducing cost.

Across the financial services sector the effects of the global economic crisis are still being felt. In the wake of this crisis retail and investment banks, and to a lesser extent insurance businesses, undertook cost reduction and integration activities aimed at reducing operational budgets to their lowest possible base. Many of these transformation programmes are ongoing.

But when cautious optimism returned to the financial services market as the economy started to expand again, the focus shifted to increasing revenue by improving customer engagement in tandem with the continued effort to reduce costs. Despite the uncertainty in the financial markets are experiencing in 2011, there is increased recognition that any major change programme needs to take into account customer interaction to drive satisfaction, and in turn, revenues.

Customer journey programmes explained

A customer journey programme has two main aims – to better engage with customers to provide a targeted service while using the opportunity to take cost out of the business. The end goal is increased revenues and market share and customer retention as customers spend and engage more as a result of the improved service levels.

The decision is typically taken at board level to undertake this type of transformation activity. On a practical level, a customer journey programme team is created to examine all operational and support departments within an organisation to best ascertain how their service impacts on the customer journey. Widespread change and improvements will be implemented to optimise business processes around e-commerce, mobile banking or paperless statements, for example.

Recent high-profile customer journey programmes include:

Lloyds Banking Group – The integration of HBOS into Lloyds TSB that commenced in 2009 is projected to save the group £2bn in technology-related costs by the end of 2011. It includes the Galaxy programme, the delivery of a single internet banking platform that is due for completion in autumn 2011. The goal is to move the organisation to a single platform to simplify and streamline the journey that customer undertakes to bank online, while automating process and removing legacy systems to reduce cost.

Many major banks and financial services organisations including Royal Bank ofScotland, AXA, Nationwide and Deutsche Bank have built and continue to expand lean transformation teams to apply process improvement expertise to the customer journey.

The success of a customer journey programme can be measured by:

Reaching targets for improved sales metrics and customer retention
Realising intended cost reduction and savings
Whether the programme is completed on time and in budget
Feedback from customers

Opportunities for candidates

The approach frequently utilised in customer journey improvement is to create a joint programme team comprising of management consultancy specialists and in-house experts to define the strategy and programme deliverables. The implementation and delivery phases are increasingly handled by specialist interims to mitigate the cost factors of engaging a consulting firm for the duration of the programme.

So the areas of opportunity for strategy jobs for professionals with customer journey improvement experience and financial services exposure exist within management consultancies and as well as in-house roles for both permanent and interim employees.

On the whole, employers prefer candidates who have similar sector experience. Within the financial services industry, specific sector experience is typically required as the customer journey in an investment bank to different to that of someone trying to make an insurance claim, for example. Candidates with insurance claims process experience are in very high demand at present. With a demonstrable functional track record, consulting experience may also be considered as it shows the ability to pick up the intricacies of a industry quickly.

Candidates looking to develop their abilities and experience to transition into the ever-growing customer journey improvement arena should focus on developing transferable skills. Those with a sale and marketing background can move across but it is key to get involved in change programmes at a departmental level to gain exposure to the process. Formal project management qualifications and process training, like Six Sigma, are also important and those with a proven track record in these areas can readily apply them to customer journey improvement programmes.

If you’re looking for your next change, strategy or consulting job in customer journey improvement, please get in touch with Eleanor Bell.

T: 020 7269 6247
E: eleanorbell@michaelpage.com

Understanding Customer Lifetime Value (LTV)

Denis — Mon, 07 Nov 2011 10:40:53 +0000

The amount of money an average customer pays you over their complete lifetime with your company is known as the customer lifetime value, or LTV. But why is this figure important?

Whilst some businesses use a viral loop to grow their customer base, the marketing departments of most businesses use advertising to encourage new users to use their products and drive growth.

To have a sustainable business these advertising costs must be paid for out of revenue generated from previous customers. If the finance for advertising comes from exceptional, one-off sources such as financing, then the company is actually in a state of decline even though the top-line customer numbers will be growing. Not good.

Digital advertising boards on the underground. Image by

Before we continue, let’s take a moment to define a few terms:

Marginal Cost: The average cost of acquiring a new customer. This is also known as CPA: Cost Per Acquisition.
Marginal Revenue/LTV: the revenue the customer generates (the revenue the customer generates over their lifetime = LTV).
Marginal Profit: If we subtract the marginal cost from the marginal revenue we get the marginal profit. A positive value means we’re making a profit, and a negative value a loss.

So long as the cost of obtaining a new customer (marginal cost) is less than the money that customer gives us (marginal revenue) then we are making a profit (marginal profit). The greater the marginal profit as a percentage of revenue the faster the company can grow. This is because it will be generating excess profits which it can plough back into more paid for advertising at a faster rate.

Let’s look at a simple example. Suppose we pay $1,000 for some Google Adwords. Now suppose this results in 100 new customers. This results in a marginal cost (cost per acquisition) of $10 per new customer. Now if our LTV is above $10 we are making a profit. How far the LTV is above $10 determines how quickly the company can grow. Obviously, if we’re generating $20 per customer acquisition we can grow significantly faster than if we’re generating $12 per customer acquisition (5 times faster in fact).

One problem with calculating the marginal cost, is that it isn’t just the Google Adwords we’d need to include but also other overheads such as the marketing team, any outbound sales teams etc etc.

Conclusion

How fast a business can grow depends on the interrelationship between cost per acquisition, lifetime value, and marginal profit. The greater the percentage profit made the faster earnings can be ploughed back into advertising to acquire even more customers. If your business model is based on paid for advertising and you don’t understand the values for the costs described above then you are walking in the dark. Even if you are currently loss making these values are useful, as they allow you to determine if your actions (both on the product and marketing side) are moving the numbers in the right direction.

* Image by –Tico–