Startup culture is crazy. There is a lot of excitement, meaningful work, and creative licensing involved, but it is insane compared to the normal corporate environment. Many times, this insanity comes from a lack of structure and experience. With a little money from a seed round or series A, the founders think their idea has enough merit to make it big, and they take everything up to 11. Hiring, marketing, sales, culture; all the things that help them deliver a positive report to their new board of overlords. What doesn’t make it into those board meetings? Company efficiency, sustainability, or the satisfaction of anyone who touches the company other than investors. It’s like loading a very expensive round of ammunition for one big shot. Who cares where you aim it?
I have watched this mentality creep into the more rigid and established corporate environments, too. Maybe it is the same investors and board members, but I believe it is more likely to be the new normal in business, especially in technology. Everyone seems to think “move fast and break things” sounds fun and the key to cranking out all the next big things. The reality is, there is not a clean-up crew installed to clean up all those broken things left from the ever-moving tornado of “progress.”
Call me old-fashioned, but I believe that business has one purpose: to make money. To directly trade goods or services at a profit that makes sense to everyone involved. Clear and transparent “good business.” I know that sounds simple, and every contrarian will jump in with the finance voodoo that inflates the bottom line, or the idea of building a business withan exit in mind. I hear you, but therein lies the issue. Business in tech is no longer about doing “good business.” They threw that playbook out as antiquated and obsolete.
Customer Cost and What It Costs
Working in startups of all sizes and even larger corporate tech companies, I have spotted an alarming trend. No one knows what the cost of a customer is. When asked, they seem to think that it is an impossible formula to figure out (spoilers, it isn’t). The fact that customer cost isn’t known kicks off this wild set of symptoms, like wild discount practices, support deficits, and angry customers, and ultimately, churn. Churn of customers, churn of employees, and churn of investors. Do I have your attention yet enough for you to stop breaking things for one minute?
Quick Math on Customer Cost
Every service costs something. Your business costs money to exist, operate, and grow. If it didn’t, there is no budget to balance. It is pure, 100% profit. I doubt that is your business model, but if you found that unicorn, share it with the rest of us, please.
If you want to find your customer cost, I suggest these three simple buckets:
Overhead
These things are non-negotiable costs. Add all the base costs to have your business. Your Accounting team, your office, your hosting, your builders (developers, product teams, etc), and all the hardware and software that keep these functions moving. Your executive team’s salary goes here, too.
Overhead Costs should be equally spread across accounts or units. If your pricing is unit or licence-based, take that into consideration to distribute costs equitably between large and small customers.
Service
These are the costs that it takes to maintain a customer. Support, account managers, billing, customer experience, product marketing, or anything else that is critical to servicing an existing customer.
Service Costs are incurred on a base and usage basis. My favorite example is support tickets. Every customer should have some cost attributed to support. So the base is the total number of support tickets (or support time) for the whole organization for a time period. You can average that amongst all your customers or units and come up with the base (average service cost).
Excess Service Costs should be accounted for when it comes to customers who are the most in need of help. Sticking with the Support Example, if you have an average of 10 tickets per license monthly, but one customer has an average of 15 monthly tickets, they have a 50% higher cost to service.
Acquisition
These are your sales and marketing teams. Every effort you take to acquire new business, from salaries, to ad space, and that conference you sent the team to, to referral programs and content creation aimed at non-customers. If it is designed to attract new business and not a standard part of your offering, it is an acquisition cost.
The Acquisition Cost is deducted from profit (NOT other incurred costs). For example, if you charge $10 for your license and $6 per month is your overhead and service cost, your profit is $4. If it costs $40 to obtain this customer, then it will take 10 months to recover that acquisition cost and make this a profitable customer.
Basic Calculation of Customer Cost – Monthly
(Overhead / Customer Count or Unit) + (Service Cost Incurred / Unit) + (Remaining Acquisition Cost) = Customer Cost
Next Steps
So you calculate your cost, great! What should you do with information, though, as an account manager or leader of an organization? For starters, you shouldidentify who your profitable customers are and which ones are costing you money. In all my years of running renewal conversations with customers, the ones that are running at break-even or even a deficit are the ones who have the deepest discounts and are first to ask for a steeper one. Knowing where a customer stands, as far as profitability, is critical to establish a stance in renewal conversations.
The next thing you should do is evaluate your discounting practices. Discounts are great for sales teams and accumulating new business, but if your discounts push your ROI point past a year, it may be hard to recover. Furthermore, all large discounts should be time-limited. So often, evergreen large discounts lead to lost money and churn. Telling a customer that their early adopter 65% discount has to go is a hard conversation to navigate and will likely lead to churn. This has to do with price anchoring. What they pay for your product is what they think it is worth. Raising prices leads customers to feel they should get more to justify the increased cost, and tends to increase service costs to force you into giving them the increased level of service they paid for.
Last, you should be sure that your pricing is future-facing. Raising prices sucks for everyone, just ask Netflix and the hit they take every time they force a price increase. Keeping pricing where you can comfortably discount 20% in a pinch or afford to increase overhead or service costs in the short-term to hire ahead of growth is more than a luxury; it is security. Pricing should follow estimated costs no less than a year ahead to give you a head start on growth, minimize the amount of increases, and keep you out of the dreaded legacy customer transitions as you grow.
Moving fast is great, but you can also do it intelligently. Operating at a loss for certain customers is always going to be a necessity, and yes, those losses can be made up in different places in the business, but the fact is that all customers should have the opportunity to be profitable. If you want to factor in the benefit of having a logo, throw that into your acquisition cost and keep tracking.
If you can get these numbers, I encourage you to share them with your team. Brandish that customer’s profitability for all to see in support calls, account reviews, and sales meetings. This isn’t to offer that customer substandard service, actually, to the contrary. These teams want your organization to do well, so customers with deficits will get the creative juices flowing on how to turn them into profitable customers. Customer support can identify frequent questions and work to minimize repeat tickets, account managers can look for uplift opportunities to move them to the black, and sales reps can be empowered to stand firm on pricing to demonstrate your value.
When you operate at a loss, no one wins. A time bomb is simply set to the time when losing money is no longer an option. When that bomb goes off, churn happens, and customers are forced to look for alternatives emotionally. Know your cost, make some money, engage in good business.
If you would like help finding your customer costs or simply want to review your current strategies, let us know!