Fans of The Motley Fool can't help but be aware that it's practically impossible for Wall Street pundits and writers to communicate without some obscure patois slipping into the mix. It's not their fault, of course. The purpose of specialized argot in any arena is to provide folks with shorthand so they don't have to keep repeating long phrases to describe things like "employer-sponsored, tax-advantaged investment accounts whose funds are intended only to be withdrawn in retirement." So much easier just to say "401(k)."
But if you want to play the game, you have to comprehend the conversation, so in this week's Rule Breaker Investing podcast, Motley Fool co-founder David Gardner is bringing in a trio of special Foolish guests to explain six terms that investors might not know as well as they think they do or as well as they'd like to. In this segment, Abi Malin of Stock Advisor and Hidden Gems digs into a key concept that has been dogging a number of well-known recent IPOs and high-tech hopefuls lately: customer acquisition cost.
A full transcript follows the video.
This video was recorded on Feb. 21, 2018.
David Gardner: Now it's time for Abi Malin. Abi, welcome back!
Abi Malin: Thanks for having me!
Gardner: You are going to bring a term, here, in our more advanced portion of the show that does relate to the initial term that you brought. Briefly reviewing, term No. 1 was 529 savings plan. Term No. 2 was customer lifetime value. At No. 3, Sarah bringing upstream, midstream, downstream. Robert just threw down asset location as term No. 4. Abi, what is term No. 5?
Malin: Term No. 5 is "customer acquisition cost." This relates pretty well to my first term, which was customer lifetime value. Customer acquisition cost is the amount that the company spends to attract one new customer.
Gardner: Now LTV is an acronym that people often use for your first term. Have you seen CAC out there? Do people say "the cack"?
Malin: I don't see it as commonly, but I know in my own notes I abbreviate it that way. I don't know if it's an industry standard.
Gardner: So, customer acquisition cost is, again, often in there for subscription businesses like The Motley Fool. That's something that we use here at The Motley Fool. We ask how much does it cost us to find a new Fool, whether we're advertising on the internet, or baking in all the costs of any given business. Now, we used Starbucks earlier as an example. Do you want to use Starbucks as an example of this one, or do you have another company or insight in mind?
Malin: I think one that's interesting -- a lot of new IPOs have sort of centered around these subscription businesses. So one that jumps to mind is Blue Apron. And I think at the time they filed their IPO, management estimated that customer acquisition cost was about $94 per customer. And we've seen that stock really struggle since they went public, and analysts have said that they think that number is more around, like, $400.
Gardner: I have to admit. I'm aware of Blue Apron. I haven't followed it that much. I have heard some, I think, appropriately bearish commentary, maybe from you, but certainly some Motley Fool analysts about that. It's not a stock that we've picked in Motley Fool Rule Breakers or Stock Advisor. But the company may have undershot its own estimate of the acquisition cost of its customers by 4 times?
Malin: It's a little bit more complicated than that. The general formula for calculating customer acquisition cost is sales and marketing expense attributed to new customers divided by net new customer count. So, it really depends what they consider a new customer vs. actives vs. inactive. It can vary based on what you consider a new customer vs. just retaining or reenticing customers to order another box.
Gardner: Now, I have to believe that for digital businesses, it's going to be a little bit easier to make this calculation. I think at The Motley Fool, we have a pretty clear sense of what it would be for any given quarter or, more importantly -- who cares about our company -- how about Netflix, a great stock for a lot of us. Netflix, it seems, does a pretty good job talking about its acquisition costs and measuring that. Is it fair to say that digital businesses probably have it easier?
Malin: I definitely think digital businesses have it easier. I would think internally most companies have this unlocked, but it's a matter of when you're an analyst and you're reading transcripts, or 10-Ks or 10-Qs or whatever it is, sometimes you have to make a little bit of assumptions.
Gardner: Awesome. Abi, are you ready to use "customer acquisition cost" in a sentence?
Malin: Yeah, I can do that.
Gardner: Go for it. Now, is this going to be one that you've written down ahead of time, or are off the cuff just killing it with another long, but educational sentence?
Malin: To be honest, all of my sentences included my examples of companies, so this is off the cuff, but I can wing it.
Gardner: Awesome. Go for it.
Malin: I guess connecting my two ideas, oftentimes when we think about subscription companies, we like to look at ratios, so, customer lifetime value to customer acquisition cost. So LTV divided by CAC, typically that's a ratio that we like to look at, especially as it trends over time. Our goal is that that ideal ratio should be about 3-to-1, so lifetime value of a customer should be three times the size of the acquisition cost. If it's less than that, it means the company is spending too much and if it's more than that, it means they're spending too little.
Gardner: Period. Full stop. Again, good uses of semicolons. But much more seriously, Abi, that's really helpful, so that ratio, 3-to-1, is kind of what you're shooting for as a business.
Malin: The golden ratio.
Gardner: Golden ratio. Abi Malin, thank you very much!