Chapter 6
Listen Closely, Act Quickly
This chapter is about things you need to understand to build a business. We go a little deep on the order of operations, the power of marketing, and how to think about growing a company. This book, after all, is a combination of principles you employ as a professional to access your objectives and succeed, and it's also about the steps I took embodying other principles in business design.
As we'll see, the core of both being a great professional and building a company are often the same. And it begins with listening closely.
With a two‐person HQ team, Revenue Collective continued to grow in 2019, using email as the primary communication tool. People would email questions and get answers with everyone on the chain.
This was, and still is, a pretty standard format for a community, and many communities employ different versions of this simple idea.
But as membership steadily grew around the world, we pivoted from email to Slack—and saw our growth explode. Nowadays, Slack is a very common community management tool, but back in 2019, it was a relatively new interface.
Where did this idea come from? Well, from our Members, of course. One of our longtime Members, and a good friend of mine, was a huge foodie and had worked with some of the best restaurant minds out there. He also happened to be a forward‐thinking technology enthusiast (his current role combines these two loves). He kept calling me and basically yelled at me to move Revenue Collective conversations to Slack.
In 2019, we finally had critical mass. We took that leap and it paid off.
Listening Is the Key
Today, 30% of our membership engages in Slack every week. In 2021, we had more than a million messages sent across our Slack workspaces. We have hundreds of channels, predominantly built from Member suggestions with Members who step up to moderate and guide conversations.
Some of our most popular Slack channels have taken on a life of their own, spurring regular, virtual meetups of thousands of Members, and even Pavilion University courses.
All of this evolved organically with Member feedback guiding the way. The most interesting part to me is that this was not built with proprietary technology. We built this community with solutions that were already available to us and that we have tweaked and adapted as we have grown.
As we talked about in Chapter 5, so many people overcomplicate their strategy. They think they need to have the perfect solution in place before they launch. But what you really need to do is listen to your customers and meet their needs with the resources you have.
In today's world, especially in B2B software, speed is more important than perfect. People need a solution fast, and are willing to join you as you iterate improvements if the majority of their needs are met.
Slack enabled us to grow and foster conversations with Members across the world, especially during lockdowns and pandemic travel restrictions.
Three years later, we are getting more feedback about how noisy Slack has become, and our Members long for more intimate conversations and closer connections after so many years of remote and virtual meetings.
And that's okay. It's okay to move on from or make adjustments to something that once served you so well—if that's what your customers want.
That's why we are engineering a Pavilion‐created Member portal, taking all of the disparate platforms on which we operate and streamlining the experience into a central Pavilion hub. As our membership grows and as the world changes, the needs of Members change. And we are open to their feedback and adapting with them.
This is to say, your customers should be the ones driving your direction. If you listen to what your customers truly need, you'll be able to act on it quickly and gain their long‐term trust.
The Right Way to Scale
From my own LinkedIn page to Pavilion University lectures to mega industry conferences, I have spoken about the right way to scale many, many times. Yet, I still see businesses today get it wrong.
I start any speaking engagement on this topic with a simple question: What makes a great company?
Is it raising a lot of money? Culture built around a set of shared values? Naps?
I believe that great culture is actually the exhaust of a high‐performing organization. If you're winning and succeeding, then that is the context for having a great culture. And high‐performing organizations are the ones that attract investment dollars.
And while Pavilion is a firmly pro‐nap, values‐based organization, the thing that great companies actually do is profitably and repeatedly regenerate returns on invested capital.
That is what scaling a business really means—profitable repeatability. And you can get there if you take the right steps, listening closely to your customers every step of the way and acting with urgency.
The Market as a Proxy for the Universe
Your customers are the market. And the market represents the universe.
Stick with me here.
Energy flows throughout the universe and for you to be an effective conduit of that energy, you must first learn to be still. This is the mechanism for achieving your wildest dreams. There's a reason that meditation, journaling, and similar practices are exalted by your favorite business leaders. When you are able to tap into the natural flow of the universe, that is when you experience personal growth.
Or if you are less spiritually inclined, think about when you get your best ideas. Is it in the shower? Or on a walk? When you're about to fall asleep? The times where your mind is still and isn't racing through your to‐do list are when you are most receptive to what is happening around you. You can receive information, react to what is presented to you, and choose what to do about it more easily.
In the same regard, you must listen closely to what your customers are saying in order to unlock business growth. Alignment and the conduction of energy is in many ways what a company is intended to do. The very phrase “product‐market fit” alludes to that concept. The market, your customers, fits the product, which is the thing you are building.
How do you get them to fit? Is it a self‐centered and egotistical leap into the great unknown powered only by your creativity and genius? If that were the case, then where did your genius arise from in the first place? What does genius even mean?
Your genius lies in your ability to listen to forces greater than yourself and align yourself with those forces. Genius lies in actively swimming with the current, not against it.
So when the market tells you what it's looking for, listen. Then act quickly to deliver that product.
Building a Customer‐Centric Product
I believe the product is the thing that determines how fast you should grow, whether you should grow, and whether you're in a position to grow.
Your product needs to address the concerns you've heard from your customers. It needs to solve their problems. So many companies and organizations call themselves customer‐first but fail to employ the simplest ideas to ensure they are building the products and services their customers want.
Too many people have read the Steve Jobs's biography and are convinced they know better than their customers. Of course, Apple builds consumer products, not business‐to‐business software. And of course we're not all Steve Jobs. Rather than taking one anomaly and trying to apply it to a completely different market, just step back and listen. Your customers will tell you what they want.
It again comes back to loving your customers. I've worked at places where they did create a product that addressed a large market problem. But the customers weren't their North Star. Their technology was. This caused friction between the company and customers, resulting in slower growth and less predictable revenue. Customers still need to be at the center of what you do in order to reach your fullest potential as a business. A customer‐centric product is a sure‐fire way to generate demand.
Again, the idea here is straightforward. Not easy. But simple.
The essential quality in building a customer‐centric business is empathy. Putting yourself in the shoes of your customer and really trying to understand and appreciate where they are coming from. That's why so many great companies are started by people that experienced that particular problem. Because the founders had empathy.
The quality most related to empathy is the ability to listen.
Practice it. Work on it. Listening comes from the ability to be still. Your movements create noise. Your speech creates noise. Your desire to be noticed and important and to show people how smart you are creates noise.
So how can you walk softly, to bastardize Teddy Roosevelt, so that you can hear the universe when it wants to speak to you. That's the trick. Embrace the stillness. Embrace other people's perspectives. Truly try to understand their feedback so that you can turn it around in your head and really process it.
Generating Demand
This is the stage where most companies get out of order. So many organizations look at their large market and amazing product designed with customer input and start hiring sales reps.
But salespeople don't generate demand.
It seems counterintuitive because I came up through the sales world. But I am a salesperson who believes sales is the least important discipline when scaling. What salespeople are great at is turning demand into revenue. And in order for your sales team to close deals, they need leads.
So who generates demand? Marketing. The least expensive way to bring in customers is to have a great product that people love, that they tell their friends about. A great marketing organization understands how to amplify that message to tell more and more people at large, repeating that message out to a bigger and bigger audience.
Only after word spreads across the market, piquing interest, does a prospect enter a structured buying conversation with your sales team.
The most reliable way to scale and predictably generate revenue is to start with a really, really big market. Then, comes a great, customer‐centric product. Next, you need to be able to tell your market about the product in a structured and effective way. And only then can you turn that demand into revenue.
The Power of Marketing
Marketing is the act of delivering a specific message to a specific group of people, at a specific time, in order to compel them to make a decision. And yet, it's also much bigger than that. It's your brand. It's how people feel about your company or product. What emotions come up for them.
Too many people misunderstand marketing or try to reduce it down to some easily definable essence. “Marketing is lead generation.” No. Not really. It's bigger than that. Or it's longer term than that at least.
Because it's not just about getting new people interested in your product today. It's about making them happy and giving them messages through your brand that make them want to be interested today, tomorrow, and months and years into the future.
Again tying it back to some organic concept of the universe (here he goes again with the universe), marketing is about harnessing the atomic power of your customers' love and appreciation for your product to create a megaphone that broadcasts that love outwards. A clear powerfully broadcast message with a specific intended audience, with a point of view, can reach far and wide and bring people to your door.
And from there, your sales team kicks into gear to help those people become customers and engage properly with your product.
Too many people make the mistake of under‐investing in marketing, thinking it's just brochures, or it's just one‐pagers, or it's just the website.
It's so much more than that. So take the time to treat it with the care, love, and respect it deserves.
Revenue Is a Team Sport
The essence of all of this is that making money is not just one person or team's department. Making money is the combination of all of the pieces coming together. And in that sense it's a much longer‐term project than we sometimes assume. It's not about driving something someone doesn't need down their throat. It's about building something people love, something that is not apart from them but, in some way, comes from them both directly and indirectly.
All of the pieces fit into place when you have a great product that people love, people want to tell other people about how much they love it, and then you harness and amplify that enthusiasm to tell the world. That's how it works.
Sales is a piece of all of that but not the essence. The essence is the entire movement, in combination and orchestration.
Put another way, salespeople don't generate demand. They turn demand into money. But demand is the essence. In today's world, with the ubiquity of information and with everything on a review site, salespeople can't just tell a customer how the world is. The customer already knows how the world is. Salespeople can help answer questions, can see if there's a fit with that person's needs, and if so convert them into being a customer.
Phases of Growth
Now that you know the right way to scale, how do you decide when it's time to make a move? Again, I say, listen to your customers.
In the early, early days of a business—around five customers—that is the time to focus on product‐market fit. Gather input from your customers and only move forward if you can retain 90% of those customers with 100% revenue retention and have a Net Promoter Score (NPS) greater than 30.
We use NPS at Pavilion, and while there are other metrics you can track and arguments against it, I think it is the easiest way to measure if your product is meeting the needs of your customers. NPS asks customers to rate how likely they are to recommend your product or service on a scale of 1 to 10. People who rate you 1 through 6 are considered detractors, those who rate you 7 or 8 are neutral and not factored into the NPS equation, and only 9s and 10s are considered promoters.
Where some of the debate comes in, is that some founders will lie when they're raising their decks and say that NPS is an average rating of customer satisfaction. It is not an average rating. It is the percent of people who are promoters less the percent of people who are detractors. It is not the average score that you get on a customer satisfaction survey.
So if you are looking at a 30 NPS score, it might mean that 50% of people are promoters and 20% are detractors.
If you hit these metrics in the product‐market fit phase, then that is a signal that you are ready to move to the next stage of business growth—go‐to‐market fit.
I use these metrics and reference them because they are fairly standard assessments of customer health. Remember when we talked about the power of the market? These numbers are reflections of the market because they are reflections of your customers. And these benchmarks are effectively industry standards for signals that would indicate an opportunity to invest and grow.
The essence of them is straightforward—these are numbers that are telling you that people like your product or service. If your customers stick around in large numbers, you have a good thing going. If they leave or are generally dissatisfied, you have a problem. The basics of my philosophy are that if you are seeing increases in people leaving, you should generally consider pausing before adding investments in growth. Because all you'll be doing is growing into customers that will give your product a shot and then decide to leave. And if you do that, you don't have a sustainable business. And that's what we're trying to build.
We've gone through a lot of ups and downs at Pavilion, and the core of our focus and our business has always been Net Promoter Score. We want people to love our product. We want them to have amazing experiences, and we want them to be raving fans of what we do.
Importantly, the other thing to note and to emphasize is that we're not looking generally at a point in time but trying always to understand the trend. One data point at what point in time is somewhat useful. Multiple data points measured consistently are powerful because you can begin to understand which way your customers are moving and spot certain inflection points or trends.
We noticed a dip in Net Promoter Score at Pavilion back at the end of 2020. We'd grown tremendously during COVID and had been pushing big membership growth through a variety of different campaigns. We had become too enamored of growth for its own sake, and our customers started noticing the difference in our tone and in our emphasis. So our NPS began to fall. In a vacuum, the numbers were still pretty good. But it was the trend that was important.
And we made adjustments. So make sure as you evaluate these metrics that you are not just looking at a point in time but specifically looking at the trend line.
Once you see positive indications over time in your retention and your NPS, you are ready to move to more active attempts to scale.
This is the phase where you will bring on someone to manage marketing, craft your messaging, and start generating demand. You should then hire your first sales reps to close on that demand and customer success managers to retain your current customers, keep them happy, and potentially upsell or expand their contracts.
As you grow to 20 customers, you should still be able to retain 90% of customers and 100% of revenue with a NPS score greater than 30. The next metric you'll want to measure is a payback period of less than 12 months or less than one sales cycle. We'll go through how to measure this below, but go‐to‐market fit is a crucial step in determining whether the cost of acquiring a customer is worth it.
Only then can you move onto the final phase, which I call scalable growth. My advice here is to hire based on capacity relative to demand generation, and always be sure you are maintaining the baseline metrics from the previous stages.
The Importance of Unit Economics
Unit economics tell the core story of your business and whether it is designed in a way that ultimately works. They distill all of the churn, all of the big macro trends into an evaluation of dollars per customer.
So what does the phrase “unit economics” mean anyhow? Here's what it means at its core. It means understanding the basic sales and marketing motion and understanding the relationship between how much money a typical customer pays you, how much you paid to acquire them, and how quickly.
How much are you spending to get this customer? How much do they pay us back and over what time period? That's what unit economics will tell you. A simple premise, but so rich in terms of operating a business successfully.
Now, you might be thinking, I'm a salesperson who doesn't do spreadsheets. Sales is about relationships, and the most important thing is to form a relationship with your customers, right?
But if you want to be in an executive role, you need to realize that you can't just focus on one aspect of the business. You also need to know spreadsheets because they, too, tell a story of the business. It's another way to listen closely, but with the data to back up your actions.
What Goes into Unit Economics: Customer Acquisition Cost
We can get into the math of it but again as I mentioned earlier, the basics of the math are that you take all of the costs associated with acquiring a customer and add them up. Those costs include the salaries of all your salespeople and their benefits, the salaries of most of the people that work on marketing for you, even the salaries of some of your support folks that spend most of their time working with existing customers but occasionally hop on a call with a prospect to tell them what it's really like being a customer.
You also add in all the money you're spending on marketing programs—things like the plane trip you took to Indianapolis to meet with a big potential customer, the steak dinner you wined and dined them with, the big conference you sponsored where you hosted a booth and scanned a bunch of name tags, and, of course, any money you're spending advertising on places like LinkedIn, Google, Instagram, TikTok, and anywhere else.
This is what we call Customer Acquisition Cost, or CAC. Don't be a child and make some funny joke about the acronym (unless that joke is so absurdly funny South Park–style that despite all the people it rightfully offends for its childish infantilism, it still elicits a chuckle).
When you are thinking about CAC, the point is that you don't want to be too optimistic. You want to be conservative. You want to add in all the possible things you're doing to get people interested in your product. All the people you're hiring. All the money you're spending.
Importantly, this is only money you are spending to “acquire” the customer, not to serve them. This isn't the R&D you're doing to build a new product, and it's not the staff you're paying to make sure once your customers are sold, they're happy. But this is everything else.
Your temptation when building your analysis will be to take some things out. Maybe you just hired a salesperson and you don't feel it's fair to include them in the calculation. They just started after all, and they're still in their ramp period. My advice is to avoid that temptation and to try and include every possible cost you can to be as realistic as possible.
We're not trying to spin when we think about how much it takes to get someone to try our wonderful beautiful product. We're trying to understand the actual tangible cost.
To the point of values espoused in this weighty tome we call a book (not really that weighty, I'm sure this is solidly in the quite light category, maybe should've been an essay‐length book), doing things the right way takes time. Kind Folks Finish First isn't about shortcuts, and it isn't about schemes. These aren't schemes. All the things we're talking about (again with the parentheticals but obviously nobody is talking, you're reading and I'm writing) take a certain amount of time. The values in this book, the beliefs I'm articulating, are not about grabbing everything you can as quickly as you can, and they're not about lying to yourself. They're about trusting that if you work earnestly and painstakingly in service of other people (in this case your customers) that you'll succeed.
So put everything you can think of into your Customer Acquisition Cost. That's the first key element.
What Goes into Unit Economics: Gross Margin
The next thing we're going to do once we have CAC is to understand our Gross Margin. The essential way of thinking about Gross Margin is the marginal cost of delivering one more unit of the product.
In the old days, it was pretty easy to calculate. If you made widgets, you'd calculate the cost of making the widget and producing it, including the cost of the materials, and you'd subtract that from your revenue, and that would be your gross margin.
Software and services are a bit more theoretical. Because, again, it's about “How much does it cost you to deliver the product itself?” If you're being extremely sunny, you'll just take out your web hosting costs under the assumption that “Hey this is software, the beauty of it is that one more unit of the product is just the money I'm paying Amazon Web Services to power the website and the app, and it's infinitesimal.”
Maybe. But probably not.
Because if you need any humans to support the delivery of the product, you need to include them in the calculation. These days we call those people Customer Success. It's a function that makes sense and has existed for ages but was really formally popularized by Nick Mehta and Anthony Kennada when they built the software company Gainsight.
And these days almost everyone realizes that to make people actually use something, it takes humans teaching them and coaching them through the best practices, checking on them regularly to see how things are going, and ensuring that the customers are mapping and aligning their specific business goals with the actual uses of the product you've built.
All of that is part of the marginal cost of delivering the service, and all of it should be put into Gross Margin. As I mentioned above, if some portion of the time of your Customer Success Team is allocated to talking to prospects with the Sales Team then put that percentage into CAC, but all of the salaries and investments you make in Customer Success should go in either CAC or Gross Margin.
At Pavilion, our Gross Margin has another wrinkle because from the very beginning we've paid our Chapter Heads, the community managers that helped us build the global network. The very first folks like Tom Glason in London and Rich Gardner in Boston made as much as 90% of the total dues at one point. These days we've thankfully renegotiated those deals, and our community managers make a flat monthly retainer based on total number of Members in their chapter.
So when we calculate Gross Margin we put in 25% of the marketing team's time and money (the other 75% goes into CAC), 100% of the Member Success Team (that's what we call Customer Success), and we even allocate some of my salary as the CEO both to CAC and Gross Margin. We also add in the software we use to support our Members (like Slack or Airtable or any one of the myriad services we use), and, of course, we take out the Chapter Head payments. These days those payments come out to anywhere between $150,000 to $200,000.
Add it all up and that's effectively our Cost of Goods Sold. Subtract that from our monthly membership dues, and the result is our Gross Margin. Even though some might call us a services business, our Gross Margin is still pretty good hovering around the 70% range. Great software businesses have 80% gross margins, and that's why they're so fantastic. Ours is still pretty good (cue the Larry David impression).
What Goes into Unit Economics: Churn
Not every business is a subscription business, but every business wants their customers to stick around and buy more stuff or to come back quickly once they buy the first thing.
Churn is most common when looking at subscription businesses but it's a concept that can be applied anywhere. And it's not rocket science. It's simply the percent of your customers and the money they spend that walks out the door in any given time period.
For subscription businesses, it's the lagging indicator that NPS might first alert you to. And it's fundamental. Since it's really describing whether people like the thing you've built or not.
I've been in some hilarious investor meetings where the venture capital investor speaks of churn as sort of an abstract variable. “If you just fix churn by 10%, you'll easily hit the number,” which is very funny if you think about it since what you're saying is “If you just make people like your thing 10% more, you'll hit the number.” Well, the entire business, the whole point of everything, is to make people like your thing; so yeah, thank you for the input, we are working on it!
For most businesses that sell to consumers like Netflix, a great number is 2% monthly churn which means 2% of your customers walk out the door every month.
If you can't solve churn then, of course, you have to add more customers to make up the difference.
And this is also why market size is so important because you need enough people that love what you do and that find it regularly valuable that they don't leave and they do stick around.
When we analyze churn, we want to look at it by groups of customers or cohorts. For companies that sell to other companies (B2B), you might have a lever you can pull that makes things a lot better, which is expansion revenue.
This means that you might sell a customer a set of goods or services in January, but over the course of the year they tend to buy more stuff from you. Maybe they add more users. Maybe they increase their usage.
But if, on average, your customers as a group tend to spend more collectively at the end of the time period, you are doing really well. We call that number Net Revenue Retention and it means what percent of the total sale do you tend to keep after a typical time period, say a year.
Great businesses keep upwards of 125% of their original spend. Companies like Snowflake Computing have 140% NRR or more at time.
It's tough to get there but if you do, you have something magical.
But the bottom line is pretty straightforward. Churn is the measurement of whether people actually stick around. If people stick around, you've got something. If they leave, something is broken.
More than anything else, churn is the number in your financial statements that tells you whether the thing you've built is working or not.
The Four Core Pieces of Unit Economics
So the four core pieces of unit economics are how much you have to pay to acquire a customer (CAC), how much they pay you in return (this is Revenue; I didn't do a section on this since hopefully it's obvious; it's that you know the money your customers pay you for the thing), Gross Margin, and churn with the number of customers you acquire being the final key variable and telling you your average sale price as well.
Think of it this way:
Businesses are money machines. They are designed to take in some amount of money to produce something, run it through the machine, and then spit out more money at the bottom, almost like the game Plinko on the Price Is Right.
The way they do this is they use money that's left over from servicing their customers or they use investor capital.
As a business is growing, you might be making tons of investments that pay returns over a long period of time. You might be hiring lots of engineers to write code, you might be doing a ton of R&D on potential new products, you might be building new retail locations that have amazing experiences inside them (like my wife's store The Seven in the West Village, which if you haven't visited you absolutely must, it's amazing).
But all that money is not the core unit economics. Those are investments.
So when you're trying to understand if a business is any good, what you need to understand is that if you strip away all the investments and all the money you might be taking out of the business, if you just look at the core mechanics, is it a good business?
You spend money to acquire customers, they pay you your fees, you then spend money to service those customers, and what's left over from all of that can either be taken out of the business (look at the nice new motorcycle you just bought yourself) or reinvested back into the business to keep it growing and to build new stuff.
But at the core, if you're spending too much to acquire a customer and they're not paying you back enough, or it's costing too much or they leave too soon, then you might have a bad business.
And, again, because repetition is important, this is very much related to the core values that we're talking about. This is about generosity and playing for the long term. Because at the core, the way to build a great product is to make it not about you. It's about your customers. It's about listening to them. It's about tinkering on the margins to make them happier. It's not about your brilliance. Building a great product and correspondingly a great company is about service. Being in service to your customers.
One Last Metric: Lifetime Value
If you know your CAC (again, resist the urge to make a silly joke), your Gross Margin, and your churn, you can calculate your unit economics, and you can start to understand if you've got a good business or not.
One of the most important ratios you might calculate is Lifetime Value. Lifetime Value is simple—it's the average Gross Margin per customer divided by churn. What it means is this: What's the total value of the money your customers contribute to your business over the lifetime of their relationship with you.
You compare Lifetime Value to your Customer Acquisition Cost to understand what I reference above—how much do you spend to acquire a customer, and is it worth it depending on how much they pay you back in total over the life of their relationship?
David Skok, famous investor and entrepreneur and founding partner at Matrix Partners, says the ideal ratio is 3:1. That means that on average your customers pay you 3 times more than it costs to acquire them. I prefer 5:1 mostly because even if I'm being conservative I still think I tend to be too rosy in my assumptions and want to try and bake in as much cushion as possible.
Again, this is important stuff. Why? Because it's fundamental. It's “Do people like my thing enough to stick around and pay me more and make up for how hard it is to convince them to try it out in the first place?”
Put another way, they have to stick around. They have to come back. And they have to think it's worth enough to run the business.
Sometimes folks ask me, “What if my lifetime value is low because the most I can charge for my product doesn't cover the cost of acquiring the customer?” And my response is unfortunately a bit smart assy. Because if that's your situation, then you don't have a good product, and you're in the wrong market.
The fundamental group that gets to decide how much your product is worth is your customer, which is another way of saying the market, which is another way of saying it's not about you and your time and how hard anything is for you. This isn't about you. It's about them. Period.
The Final Ratio (for Now and in This Book, There Are Obviously Lots of Ratios): Payback Period
Lifetime Value is important, but the most important metric in my opinion when it comes to this stuff is Payback Period. Payback Period just means: “How long till I recoup my costs so I can put the money back into the business?”
Again, think of boiling these ideas down to their essence. If you spend a ton of money to get someone to try your product and they pay you only a little bit of money, even if they stick around, it's going to take you a long‐ass time to funnel the proceeds back into the business to get more customers.
The very best businesses have short payback periods, which is a way of saying your customers pay you a lot and your cost of servicing them is low (high Gross Margin) so that you can quickly take the profits from acquiring them and servicing them and reinvest those profits back into the business to get even more customers or to build new products or to pay yourself a nice fat dividend.
We calculate a cash‐based payback period at Pavilion (vs. calculating reported revenue, which is not always the same as cash) and historically have been paid back on our investments in under one time period. On an annual basis, that means we get paid back under 12 months which is fantastic.
Just like a bad Lifetime Value (LTV) to CAC ratio, if it takes a long time to get paid back on your acquisition efforts, something is broken in your business. In any given time period, the Payback Period might move around. For example, we did a bunch of in‐person conferences in 2022 that cost a lot of money but didn't pay us back in the form of new Members very quickly. So in the short term, our Payback Period suffered. But generally speaking, our Payback Period has been around 10 months at scale.
Investors will tell you that 18, maybe even 24 months, is an acceptable Payback Period. But think about what that means. That means that when you spend a dollar, you don't see the full benefits of that dollar for over a year and a half. Maron. That's a heckuva long time. So much in the world can change in a year and a half. And more importantly, if you want to keep growing, you're going to need another source of cash than revenue. You're going to need investment.
So I get that lots of people out there think that 18 months is fine, but I think when people really love your thing and when you've designed a simple beautiful machine that's built around the needs and wants of your customers, they'll tell you more emphatically and sooner than in a year and a half. That's just me though. You do you.
Here are my four tips for evaluating unit economics:
- Match your evaluation period to your sales cycle
If your sales cycle is 18 months, you'll want to compare how much you spent over 18 months and how much you got back over 18 months. Of course, we'd love to get the money back more quickly, but it's only fair to evaluate the whole thing based on your average sales cycle. Another good reason to push for quick sales cycles.
- Fully load all sales and marketing costs, including headcount
As I wrote above, you'll be tempted to take a bunch of money you spend that feels iffy and keep it out to make the numbers look better. But put everything in there, even the new people that don't know what they're doing. You want your CAC and Gross Margin calculations to be as thorough and comprehensive as possible.
- Add in any marketing spend and variable acquisition costs
In my opinion, you should add in any marketing spend and variable acquisition cost. That includes paid acquisition, the conference that you went to, the client dinner, even the plane tickets that were needed to take the customers to dinner. You should include as many of the costs as you can to get a more accurate picture. If you start removing costs from the equation, that's when you start getting into funny stuff territory.
- No funny stuff
To me, funny stuff would include things like only looking at the customer acquisition cost (CAC) for fully ramped account executives, when you have several unramped AEs on your payroll. That is still a cost you need to factor in.
You can debate what goes into CAC and what goes into gross margin. Should you include hosting cost in gross margin? Should you include the CEO salary in gross margin? I certainly know CFOs and CEOs who are in the fundraising process who would exclude those costs to try to lower the CAC.
I think you should factor it all into CAC. That is money you're spending, and you want to look at it honestly. Believe me, the longer you lie to yourself the harder it will be to unwind that lie later. It is only when you are honest about the truths uncovered by unit economics that you can go about fixing them.
Rules of Thumb
Once you have all of your numbers loaded in, divide relevant time period bookings by CAC to understand your payback period.
If the payback period is less than 9 months, that is an incredible business. Invest in that business, or find investors if that is your business, immediately. Nine to 12 months is still good, but things start to get dicier in the 12–16 month range. Up to 24 months, the business is not looking good, and anything over 24 months means something is fundamentally broken in the business.
Common Mistakes to Avoid
There are three mistakes I see most often when it comes to unit economics:
- Assuming your customer acquisition cost will get better over time
- Assuming your early habit of underpaying is sustainable long term
- Assuming no one will notice the funny stuff
There could be an argument for a U‐shaped curve where CAC gets better with true market penetration, when everyone knows your product. But, generally speaking, your CAC is going to get worse as your company grows. That's because you're reaching out to people who are further and further afield from the people who were originally interested in buying your product. You need to expand your reach and spend more time educating and nurturing. That costs money.
When you underpay your early hires, it might seem like you have this amazing ratio between lifetime value (LTV) and CAC. But, if you want to attract and retain the kind of talent who will make you profitable, you'll need to pay market rate. Underpaying your employees is not sustainable, and being a bad place to work is the kind of reputation that will get back to your customers. Then you will become an organization that's bad to do business with.
And as I mentioned earlier, funny stuff like manipulating the numbers is a costly error. The earliest investors in your business might be easier to fool as they are just as enthusiastic about your product as you are, but in later fundraising stages people will do real due diligence. Funny stuff will not fly.
Now, I'm not telling you all of this because I am an all‐knowing sales being. I'm telling you this because I have learned these lessons the hard way. I hadn't listened to my customers. I hadn't acted in their best interests. I got fired.
These are lessons I am sharing with you from personal experience, and I know I would have benefited from somebody helping me understand how to actually evaluate a business.
The Wrong Way to Scale
When I was working at Axial between 2010 and 2015 (the place where I tried to get the CEO fired), we didn't have product‐market fit, but we had raised a lot of money.
So, I hired more and more people—sales development reps, account executives, customer success managers. The executive team felt so much pressure to be a company that we weren't, and we were told by investors that we needed to grow our annual recurring revenue (ARR).
We started running promotions. New customers signed on, paying for 10 months and getting 2 months free. The problem with that is ARR dashboards are annualized. That per month payment was multiplied across 12 months, making it seem like more money was coming in each year than there actually was.
When our next round of funding came up, I put together the term sheet outlining our financials and celebrated with the team.
Thinking the deal was in the bag, I left on my honeymoon with Camille and expected to return to news of more investments. Instead, the deal fell through.
I received a call no one wants to get, especially on their honeymoon. I screwed up.
I had to leave my honeymoon early to come back home and clean up the mess. It was one of the most humiliating and terrible moments of my life, albeit a formative and powerful one.
Trying not to make the same mistakes at Livestream, where I landed after Axial, I wanted to understand our customers better. When upselling current customers wasn't working, I found that the same people were coming back a few times a year when they needed our service and then canceling their subscription.
Thinking I had found our mistake, I hired a demand‐generation manager to bring in more leads. Remember, a great marketing organization understands how to amplify a message. And the best messaging comes from your customers and how they talk about your product.
Again I jumped too far ahead. We didn't have a compelling message or a base of content addressing the pain points we heard from our customers. The demand‐gen person had no message to amplify.
We pitched the board, but didn't grow as we promised we would. Another lesson in scaling the wrong way.
Then at The Muse, I lowered the target, trying not to mess this up again. But too high of a target wasn't the issue at Axial and Livestream. It was a misunderstanding of the order of operations.
By the time I went full time with Revenue Collective, I got it. I started with a large market, and built something that people were asking me for. We grew organically by word of mouth, then I brought on a great marketer to harness that customer sentiment and to form messaging that would accelerate existing demand. And by the end of 2020, we hired enrollment managers to handle that inbound demand and turn them into paying Members. An outbound sales motion didn't exist at Pavilion until 2021, five years after we'd started.
The right way to scale is to follow the correct order of operations, deeply understand your unit economics, and underpin everything you do with a love and appreciation for your customers. This is what will enable you to act quickly and delight your customers.
I finally got scaling right, but there was something looming on the horizon that would test our values and force us to back up all of our principles with action. The onset of the COVID‐19 pandemic forever changed our lives and the nature of Revenue Collective.
Chapter 6 Tactics
Core SaaS Metric Definitions
CAC = Customer Acquisition Cost
The cost related to acquiring a new customer calculated by totaling all of the money you spend in the acquisition, including sales and marketing head count and other costs.
LTV = Lifetime Value
A prediction of the net profit attributed to an ongoing relationship between customer and product calculated by multiplying the average purchase value by the average number of purchases.
LTV: CAC Ratio
How much money you'll make per customer over how much it cost to acquire them.
Payback Period
The time to recover your CAC on average per customer.
Churn
The number of or monetary value of customers lost per time period.
NPS = Net Promoter Score
Measures customer experience of your brand by calculating the percent of customers who are promoters less the percent of customers who are detractors.