Business is noisy.

Each day you can receive hundreds of different pieces of information.

One of the fine arts of entrepreneurship is deciphering the difference between noise and signal effectively.

Take marketing, for example.

We either look at it like a foreign object that we’re too scared to touch, or we’re like moths to bright light and can’t stay away from it.

I am fortunately or unfortunately depending on how you look at it continually staring at that bright light. Looking at social media analytics, google analytics, tinkering with the website and so on.

We can market on many different channels and use even more different tactics on those channels.

I’m guilty of spending more time thinking about what a particular channel or tactic could do for my business than actually trying it.

And on occasion when I’ve decided to take action rather than theorise, for whatever reason I’ve found it hard to stay away from all those pesky analytics numbers.

Marketing is necessary for virtually any business to succeed and monitoring analytics to judge and improve marketing efforts is sensible.

The problem is a lot of that information is just noise. Many of the different ‘tactics’ that I’ve picked up from podcasts or blogs are also noise.

They’re inputs or outputs that make no material difference to the businesses I’ve owned and don’t contribute any value to the decisions I need to make.

Customer complaints are another one I’ve found that’s more noise than signal.

Many times I’ve invested a lot of time and energy into resolving a customer complaint and trying to find the underlying issue that caused it, when more often than not, it was purely circumstantial rather than evidence of a business issue that needs addressing.

Sometimes staff had made an error. Sometimes the customer had just had a bad day, and we bore the brunt of it. Sometimes an email has been misinterpreted or missed.

While each complaint needed to be respected and addressed, they weren’t indicators of a larger business issue that impacted our long-time revenue or profits. For lack of a better word, they were just noise.

The signal is the meaningful information that we’re trying to detect. The noise is the random, unwanted variation or fluctuation that interferes with the signal.

The signal is what we can use to make sound business decisions, and the noise is all the stuff that can throw those decisions and our attention off course.

There are three signals that I always count on to give me a proper understanding of any business situation.

These are called CAC, LTV, and CHURN.

THE BIG THREE

CAC or Customer Acquisition Cost, measures how much it costs your business to acquire a new customer. The ‘cost’ is the marketing and sales spend for each new customer.

For example, at a hair salon I used to own during the first three months of last year, we spent $869.40, $1909.14 & $1312, on Marketing, and during that period, we acquired 244 new customers. So our CAC was $16.76 per new customer 4090.54/244.

* CPA = CAC

LTV or Lifetime Value is a customer’s value to your business over the lifetime of that person’s custom.

A lot of our salon clients became long-term customers and visited many times after their first appointment. Each time they visit the salon, the lifetime value of that customer increases.

Some customers visited the salon 50+ times and spent over $10,000. Others visited just once for a $20 buzz cut.

LTV is an estimation of the average lifetime value of all the customers, net of costs.

CHURN is the percentage of customers who ‘left’ your business over a specific period.

Generally, I calculate customer churn monthly. However, annually suits some businesses better.

At Arrowtown Hair, we calculate our customer churn rate using yearly averages.

We do this because salon customer visits are infrequent. Our average client visits the salon once every 8.5 weeks, so a monthly churn rate doesn’t work.

We use Timely (booking software), which calculates our customer retention rate. As you can see, our annual retention rate last year was 85%.

So for every 100 clients, we were serving at the beginning of the year, 85 were still customers at the end of the year. We’re losing ~15% of our customer base per year, or roughly speaking 1.25% per month.

APPLYING THE BIG THREE

These aren’t the only useful signals we have at our disposal, but they tell us a lot about what’s happening in our business and help us make better decisions.

Going back to the customer complaints example. If the number of complaints remained relatively stable but all of a sudden our churn started increasing. That’s a strong signal that there are larger issues within the business that need to be addressed and the complaints aren’t just circumstantial.

If we try out a new marketing tactic and realise the cost to acquire each customer using that tactic, it is higher than a customer’s lifetime value. We know that’s not a feasible tactic, and we either need to re-iterate that tactic or move on and try something else.

At a gym I own I noticed when we invest in the space with new equipment, new classes on the timetable or improve the layout our churn drops and the LTV of each member increases.

When we had to make a few negative changes to space due to Covid, our churn almost doubled in the area of 3 months, and the LTV of our members dropped.

The real magic to using these signals effectively is understanding how they work together, what aspects of your business they relate to and how to use them to make decisions.

WORKING THEM TOGETHER

See if you know how much it costs to acquire a customer, how much that customer will be worth to your business, and how long they will remain customers.

You can make business decisions to ‘pull on these levers’.

Decrease CAC = Profits will increase
Decrease Churn = Profits will increase.
Increase LTV = Profits will increase

I’ll use some examples here to illustrate this point.

Let’s say you’re spending $1,000 per month on marketing, which generates you one new customer per month. In this case your CAC = $1,000.

If the lifetime value of that customer is $10,000, then your business has made a 10x return on marketing spend.

However, if that customer’s lifetime value dropped to $1,000, your business is only breaking even on marketing spend. For every dollar spent on marketing, you’re only getting that dollar back. Not a great use of resources.

Your Churn rate compliments your CAC and LTV. If your churn rate increases, your business is losing more customers per month, which will decrease your customer lifetime value and, in effect, reduce the number of marketing dollars you can afford to spend to acquire each new customer.

REAL-LIFE BUSINESS CASE

Here’s how I use this for my gym World Fitness.

When I set up my Google pay per click advertising campaign, to make sure my drive was sufficient, i.e. we make a positive return on marketing spend, I needed to know what I could afford to pay for each new gym member.

First, I needed to know how much a gym member is worth. If I know how much each member is worth, I know how much I can acquire them.

So I need to calculate LTV (Customer Lifetime Value). Here are the calculations I need to make.

ARPU – Average Revenue Per User

As above, I need to know the ARPU and Churn rate to calculate LTV.

Our numbers are all over the show due to COVID, so I had to ‘smooth’ the data for this calculation to make sense still. I used the period Jan 2020 until August 2020 but removed the months of April and May from my calculations.

With a glance at Xero, I can see total revenue for those six months were ~$140,000. From our CRM software, I can see that we had an average of 345 paying members during that period.

Here’s the calculation – (140,000/345) = ~($405) per member or ~$67 per member per month. So on average, a gym member is worth $67 per month.

From Xero, I can also see that each member cost $47 per month to serve.

CHURN RATE

Next, I needed to calculate the churn rate for the same period. I know our churn rate will be abnormally high due to COVID, but these are the conditions we are trading in, so I think it would be foolish for me to remove the effects of COVID on this calculation.

We had 170 Members leave the gym during those seven months (I’ve excluded April as members couldn’t cancel during that month due to us being closed), which equated to ~24 per month.

Using our average membership base of 345 members during that period, we can calculate our churn rate 24/345 = ~7%. Unsurprisingly this is a 50% increase over the same period last year.

LTV

Now I had enough information to calculate our LTV. Using the formula from the chart above and accounting for costs. Each member had a monthly value of $20, and the churn rate was 7% 20/.07 = $285 per member.

I first calculated these numbers in August 2020. I’ll update this article in August 2021 and see where these numbers sit.

CAC

So, going back to my Google Ads campaign.

If I wanted to do better than break-even when acquiring a new member, I’d need to spend less than $285 per member.

As a rule of thumb, I like to generate a 5x return on marketing spend. Given that expectation, I could afford to pay $57 to acquire each new member.

In Summary:

LTV = $285
Churn Rate = 7%
Max CAC = $57

The last time I ran a Google CPC campaign, we spent $228 to acquire a new member, which is well above what we can afford to pay now. COVID has increased our churn rate by 50%, which significantly lowers what we can afford to acquire a new member.

If you can understand these three metrics then you know the fundamentals of any business model.

Turn down the noise, turn up the signal and make better decisions.