Duc Luu is an Edtech and Proptech Entrepreneur, Angel Investor, and Keynote Speaker who founded and sold an Edtech startup which then went public on Nasdaq in 2017. In his spare time, he indulges in travel, basketball, poker, chess, and fashion, not necessarily in that order.
Let’s talk about the infamous LTV/CAC ratio, its application in Proptech and beyond.
What is LTV?
LTV is Lifetime Value, either customer lifetime value (CLV) or product lifetime value (PLV), depending on whether you’re building a product centric or customer centric business. Since most of proptech is and should be customer centric, let’s stick with understanding customer CLV.
Assume a college graduate who’s just gotten her first job in the city. She’s now looking to move out of her parents’ house and into her own apartment. In fact, over the next 5-10 years she will rent rather than buy because she 1) doesn’t have the income or down payment necessary to buy or 2) isn’t ready to commit to home ownership.
When she does choose to buy, likely after several years of working as a company manager or director with greater disposable income, she will choose a first home within her budget, leveraged or unleveraged, often saved for the downpayment or been gifted/lent the amount from her parents. Often she will be planning or have gotten married so dual incomes may factor into affordability and mortgage needs.
Half a decade or more later, she, now in her 30s or 40s likely with a child or two, likely has two roads to travel with some level of expected probability. One road leads her new family to upgrade their existing home to a larger home (3 bedrooms or more) in a nicer neighborhood (better schools, safer area). The other road leads her to buy a new home(s) to lease to tenants for passive rental income. The former will probably upgrade once or twice in their lifetimes. The latter will invest in anywhere between 2-5 new homes depending on their real estate as investment allocation. A third option exists for the risk-takers which is to buy and flip houses for a short-term profit, flipping 1-10 units a year for another source of active income.
The aforementioned streams of decisions to rent, buy, sell, lease all present customer value to the property broker and in aggregate define the customer lifetime value given some expectancy probability and number of units churned (number of rentals in her lifetime, number or upgrades, number of buy to lease, number of flips). When we’re able to calculate the entirety of this CLV stream, we can then do the following very important things:
- Define/build/offer the right products/services to capture her CLV, given her customer segmentation.
- Allocate more appropriate marketing costs to acquire her as a customer (loss-leading acquisition for the first rental to pick her up as a lifetime customer).
- Allocate more appropriate re-marketing/nurturing costs to retain her as a customer.
- Provide greater insights to our sales teams on her specific property or property adjacent needs.
- Focus on the more profitable customer segments with more robust CLV.
What is LTV/CAC?
Items 1-3 above deal directly with Customer Acquisition Cost or CAC. CAC is defined by all variable and fixed costs associated with acquiring or retaining a customer. As many of you may already know, the VC world loves the LTV/CAC metric because it defines a winning customer value proposition(CVP) and defines where in the business expansion cycle you should be. In general LTV/CAC below 3, you’ve got an unhealthy business you need to fix before spending on expansion. Between 3-5, it is time to expand aggressively to capture market share, above 5 and you’re most likely under-marketing and losing valuable time and money to your competitors.
Oftentimes we’ll look at LTV/CAC alongside a more traditional metric like gross profit margin to make sure we have enough profit per transaction and are efficient relative to our industry. SAAS gross profit margins hit 80+%, while traditional product sales have gross profit margins between 30-50%. Anything below that 30% and you’ll likely be net margin unprofitable and un-investable.
Scale or Die?
Businesses then must make a choice. VCs prefer businesses that scale or die, forgoing short term profitability for oligopoly or monopoly position, i.e. market share dominance. Private equity and corporate ventures generally seek to reach profitability quickly through operational or financial engineering, willing to be more patient with the larger check sizes and longer/slower growth curves.
What’s your company’s CVP, CLV? Email me if your LTV/CAC is over 3. We’ve got some serious money to make!
Ping me at duc.luu@chicagobooth.edu if you have thoughts on this article or questions/ideas for future articles and I’ll give you my two cents for whatever digital or fiat cents are worth nowadays!