My last article (5 Essential Things to Do When Deciding On Your Business Idea) received some good buzz so I decided I’d dive deeper on some of the individual points in a series of follow up articles.  The first one I wanted to tackle was the all important issue of “Allowable Acquisition Costs” (I’ll refer to these as AAC throughout the article).  It’s probably one of the most important things to understand when you start your company and I’ll detail some ways.  Some are obvious and others not-so-obvious.

As I explained in the last article your AAC is essentially the present value of the lifetime value of your customer.  I’ll use the same example as in the previous article for this article, that of a subscription revenue product being sold at $10/month with a profit margin of 40% and an average subscription length of 8 month.  In this example, the total lifetime value of that customer is $32 ($10 * 0.40 * 8) which you then can adjust for stuff like inflation, cost of capital, etc. that will usually lower your AAC.

The higher your AAC, the better positioned you are relative to your competition.  If your AAC is $32 and your competitor’s AAC is only $20 then when an opportunity comes along to acquire a customer for $24 you can profitably do so while your competitor will have a tougher decision to make.  They can do so but acquiring that customer could actually diminish the value of their business over time.  Not good...

So how do we raise our AAC?  I’ll start with some obvious ways and then move into some not-so-obvious ones:

Obvious Reason #1 - Raise your prices.  Duh huh?  If you raise that subscription price to $12/month your AAC just went up to $38.40 ($12 * 0.40 * 8).  Not bad.  But raising prices can often piss off your customers and allow your competitors to steal market share.  Sometimes it’s appropriate but you always have to be careful about this.

Obvious Reason #2 - Get your customer to buy more or stay subscribed longer.  This one is more subtle but often a more effective way of growing the overall value of your business.  Let’s say you can get your subscriber to stay subscribed for, on average, 10 months.  Your AAC is now $40 ($10 * 0.40 * 10).  This is why retention is so important for subscription businesses.  It is a much less intrusive way of raising AAC than increasing prices.  Non-subscription businesses can also raise their AAC by doing a great job with follow-up marketing to their existing customers.

Obvious Reason #3 - Increase your profit margins.  As your margin increases your AAC grows, often quite dramatically.  This is why cost structure is so important for companies, even ones that are profitable.  If that profit margin goes from 40% to 50% and we hold all others variables constant we increase our AAC to $40, the same as increase the length of subscription.   The only problem with #3 is profit margins are often very challenging to reduce after a certain point.  

What are some not-so-obvious ways to increase your AAC?

Not-so-obvious Reason #4 - Create additional revenue streams that stem from your customer acquisition.  Let’s say that you create an alternative subscription revenue product that’s $25 a month ($15 a month in addition to the existing $10 monthly service).  And you’re able to get 10% of your existing subscribers to upgrade and keep their upgrade for the same length of time as regular subscribers.  Your AAC just went to $36.80 [($32 * 0.90 + $80 * 0.10)].  

Additional revenue streams can come from all sorts of angles.  If you’re an advertising site maybe you add a premium user upgrade.  Or if maybe you offer a tiered subscription model (a la Basecamp) rather than just a standard subscription.  The possibilities here are limitless.

Not-so-obvious Reason #5 - Make your product viral.  Viral products often have a very high AAC.  The reason is that for every customer you bring on board they are going to refer other customers to your business.  To the extent that you have a high viral coefficient (the average number of users a new user refers to your site) you are going to get a big AAC boost.  This can easily double or triple your AAC over time.  

Figure out ways to make it easy for your users to spread the word about your product to service to other people.  And of course, build something worth sharing in the first place! :)

Not-so-obvious Reason #6 - Increase your conversion rate.  OK, I’m cheating here.  Increasing your conversion rate actually doesn’t change your AAC at all.  But what it does do is make your customer acquisition efforts tremendously more effective.  

Let’s say that you were finding that for every $100 you spent on marketing you were acquiring four new customers at that $32 AAC.  That’s great because you are receiving $128 in value for every $100 you spend (this is technically referred to as “printing money”).  Let’s also say that your conversion rate on your marketing spend is 1%.  So you’re reaching 400 people with your offer to get your four new customers.

Now double that conversion rate to 2%.  What just happened?  You just doubled the value you are receiving for your marketing.  So now that same $100 spend is netting you $256 in value.  Wow.  That’s big.  Because that allows you to go out and spend a lot more on acquiring those same four customers if you'd like.  So while your AAC hasn’t gone up your ability to market your product has and since part of the goal of raising your AAC is to give you more marketing firepower I couldn’t help but include this.

So I hope this has been helpful as well.  This is the kind of stuff we’ll be covering in my entrepreneur bootcamp so I hope you can make it.

Photo credit: http://www.flickr.com/photos/evilerin/3331451077/