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Growth at what cost – de-mystifying the CAC riddle

Rajat Agarwal
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At Matrix Partners India, we have been an early investor in several consumer internet businesses across Marketplaces, consumer brands, ed-tech, Media, social, gaming, etc. One common issue that we see most early stage consumer internet companies facing today is the ballooning cost to acquire a customer (CAC) as evidenced by the chart below.

In such a scenario, especially when the "grow at all costs" days are firmly behind us, founders and growth teams are often grappling with three core questions:

  1. Why is the CAC ballooning so much?
  2. What’s the right CAC for my business?
  3. What can I do about it, especially as an early stage company?

While I'm no expert on this topic, i'm going to attempt to give our point of view based on some of our learnings across companies.

Why is the CAC ballooning so much?

We would all like to believe that CAC is going up because of too much competition and too much money being invested by investors in similar companies. While that is likely true, there are three underlying issues that are at the heart of the problem:

  1. Products and services are not differentiated enough in the eyes of the customer (e.g., the mattress industry fiasco in US)
  2. Total addressable market is much smaller than what the company / investors might have thought initially (1-1 live classes arguably)
  3. Digital only channels for customer acquisition are getting exhausted much sooner than what we would like to believe

What’s the right CAC for my business?

There are several articles that talk about ideal lifetime value to CAC ratio (LTV / CAC) to aim for. However, most early stage companies don't have enough data to measure true LTV. Hence in the early days, CAC payback period or number of orders needed for CAC payback is a better metric. Businesses with large average order value and low repeat characteristics must recover the CAC in the first transaction itself (e.g., mattress companies, some ed-tech courses). Businesses that are dependent on repeat purchases should ideally recover the CAC in 6-12 months (e.g., daily essentials, beauty and personal care)

if you have enough vintage data of customers, you should also measure LTV. Note that LTV should be measured at CM1 level (CM1 defined as GMV minus discounts, commissions, GST, cost of goods sold, inward and outward logistics cost, packaging cost, payment gateway charges and other direct costs). LTV / CAC of 3x is good but great companies get to 5x or more. Also, whenever you are doing LTV or payback analysis, it's important to do this by channel and not mix the customers acquired organically. Repeat purchase rate of organic customers tends to be higher as they are much more loyal and an aggregate analysis does not give you a real picture of efficiency of a channel.

Sometimes, especially for consumer brands, the same customer is also buying on Marketplaces and your website or app making LTV estimation hard. in an ideal world both Marketplaces and own channels should independently make sense (i.e. every marketplace order is profitable and website only repeats are good enough to recover CAC within 6-12 months). if thats not the case, an aggregate measure like overall contribution margin and its trend over time can also be used. From what i’ve seen, best brands can become contribution margin positive when they get to around iNR 1 cr/m of net revenue (with some variability based on AOV).

Lastly, you should think about whether your business has winner take all or most characteristics or if there are real first mover advantages. There could be an argument that businesses with such characteristics can spend a lot initially to acquire as many customers as possible. Such decisions should be very carefully thought through as customer loyalty is very hard to achieve in india.

What can i do about it?

There are five potential levers that early stage companies can explore to manage this issue:

1.Product iterations:

This is perhaps the most important but hardest thing to do. it needs to start from exploring the possibility that your product may not be good enough (low NPS or repeat purchases are clear signs). Sometimes the product works well, but it is targeting a niche market. Companies need to ask themselves:

  • is the product solving a real pain point and offering a 10x better experience vs alternatives (e.g., some of the online ed-tech classes now that offline market is open)?
  • How easy is it to adopt (e.g., is the price too high for someone to trust a new company)?
  • How easy is it to copy the product (e.g., for CPG companies with outsourced manufacturing)
  • How large is the customer segment where the product-market-fit is clear?

Rapid product iterations till you find a 10x experience product or having a product development engine that churns out new products and gives you a head start of 6-12 months is often the answer to some of these challenges.

2.Have a differentiated go-to-market strategy:

Founders should think about devising an acquisition strategy that is in harmony with the target customer persona and product proposition. For example, if your TG is deal seekers or those looking for highest value for money, potentially acquire them through Marketplaces (e.g., Boat). if your TG is a more discerning customer and advocacy is a key lever to build trust, influencers and authentic content led marketing is likely the best approach (e.g., MyGlA Matrix Moment).

Another differentiated approach can be to build a relevant "on-ramp" product which gives you access to your TG. A few examples where we have seen this work:

  • OneCard (Matrix India portfolio company): Credit card company that acquires all its users through a free credit scoring app, OneScore. This has enabled OneCard to have one of the lowest CACs in the credit card industry in india
  • Dealshare (Matrix India portfolio company): Online grocery app that acquired customers initially through Whatsapp groups of people seeking deals on daily grocery items such as staples, etc.
  • Gymshark, Vuori and other community first D2C brands where a strong, authentic community of target customers acts as the top-of-the-funnel
  • AirBlack (vocational learning) has done a remarkable job of using community as a channel to drive sales resulting in CAC that is reducing with time – something that’s unheard of in Edtech in general

Key to make this work is that the cost of acquiring users for the "on-ramp" product needs to be minimal and it should have the potential to scale fast as only a small percentage of users will convert to your paid / main offering.

At the same time, not all "on-ramp" products have worked as well as anticipated, especially when decision makers are not the same as users of the on-ramp product or when there is just too much competitive intensity (e.g., doubt solving in Edtech). The equation of cost per download of the on-ramp product X retention rate X conversion rate for actual purchase is not easy to make work and quality of end product, brand affinity, etc also play a role.

3.identify, test and scale new channels for marketing and distribution:

Most channels, specially the digital ones, tend to max out at certain scale. Additionally, most digital channels become extremely expensive in times like iPL, Diwali, Big Billion Day, etc. Hence, the best companies look to expand their channels constantly. For example, one of our social-media companies runs their marketing spend optimisation almost like a trading desk where they constantly monitor CAC, conversion rate and retention for scores of channels and dynamically allocate marketing spend based on how things are trending.

Some examples of channels that we don’t see companies leveraging well in their early days:

  • YouTube - The data couldn't be clearer that YouTube is one of the most effective channels and every company should start investing in creating authentic content for YouTube very early on as it takes time to build your reach. As an example, Country Delight in our portfolio has done a phenomenal job of driving traffic and building a brand via YouTube through brand campaigns. Alternatively, many companies including Zupee in our portfolio have leveraged micro influencers on YouTube very effectively to drive downloads.
  • SEO and ASO – This is another one that takes time to build but is extremely helpful down the road when paid channels start tapping out. For example, our portfolio companies Dukaan and Testbook have done a fantastic job on this and both started doing this very early.
  • Affiliates – e.g., GPay and PhonePe coupons have done remarkably well for some D2C brands. important to watch for LTV from the overall affiliate channels and be careful with incentives as maximum frauds and bad customer acquisition happens through affiliates in general
  • Smart referrals - most companies end up doing paid referrals but perhaps some lessons are to be learnt from Rent the Runway where they encourage their customers to share their experience of using the products resulting in an eye-popping 94%+ organic customer acquisition

4.Re-think offline

The reality of the indian market is that for most categories, 80-90% of customer shopping still happens offline. Hence at some scale, most companies including Byjus, MamaEarth, Plum, Wakefit, Cars 24 and numerous others have decided to go off-line. For non-fashion D2C brands, its cheaper to get to first INR 50-100 cr of scale through digital channels. But post that some experiments with offline might be warranted, especially if you are a low AOV product. Also these days B2B commerce companies such as Saveo or Bijnis or Udaan might be an easy place to start distribution. Fashion and other products where you may need your own stores (EBOs) is harder and perhaps better suited to experiment at a larger scale, if at all. Offline might scale slower and a different playbook for demand generation might be needed, but it's a necessary evil in the long run in my view in most cases.

5.invest in Enablers early

  • People: invest in a cross functional growth team early (as soon as you have product-market-fit). The growth team should have one person each from product, engineering, design, analytics and marketing under a growth head. important to not outsource creative and design teams as having control and ability to do rapid iterations matters
  • Tools: invest in good CRM tool and a good marketing automation products such as MoEngage as early as possible to help analyse, segment, engage and retain customers. Additionally, think about investing in tools like GoKwik to improve conversion rates through checkout optimisation
  • Processes: Setup a culture of rapid experimentation and A/B test everything from design of website to marketing communication to product features to pricing to fulfilment SLAs, etc - all focused on optimizing conversion and retention

Additionally, there are several things that one can do to retain a customer as retaining a customer is almost always cheaper than getting a new customer. Founders and management teams should think harder about building out a strong referral program, gamification engine, loyalty programs, etc to retain customers and increase life time value.

Lastly, there are lots of interesting insights on the topic of growth in books such as Hacking Growth by Sean Ellis and Traction by Gabriel Weinberg – will recommend all founders and growth teams to read them in case not done so already. We’ve also covered some aspects of this in our Matrix Moments episodes as well (Growth hacking, GTM and Gamification).

Figuring out the CAC puzzle is perhaps the most important question that all market participants - whether founders, investors or growth teams - are grappling with. We would love to hear your thoughts on how companies can break through this barrier and build long term, sustainable businesses.

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Rajat Agarwal
Rajat Agarwal