You are already growing your number of customers as fast as you can. So, how could you create more value for your company?
The answer: sell more to your existing customers!
Recurring purchase businesses are prone to growing ARPU (Average Revenue Per User) or transactions. Why? Because we want to test your product or service. We start by buying a book on Amazon, then we buy shoes or furnitures!
This article will explain how to value your customers with an upsell strategy in 3 steps.
Table of Contents
STEP 1: Calculate your initial ARPU growth
This is quite straightforward. If your average customer were spending $100 last year versus $120 this year, your initial ARPU growth is 20%.
Translate your discrete growth rate in a continuous growth rate:
Your 20% of discrete Initial ARPU growth corresponds to ln(1+20%)=18.2% of continuous Initial ARPU growth rate.
Then, you will decrease yearly the continuous growth rate to saturate the growth of the ARPU towards 0%. To achieve this, you multiply your continuous initial growth by a fixed coefficient q<1 every year. For example, a coefficient 0.9 would translate by a decrease of 10% yearly.
STEP 2: Estimate your maximum ARPU
As the continuous growth rates follow a geometric series, we are now able to calculate the maximum ARPU:
Here, you could use the ARPU of competitors to estimate your asymptote and deduct from the previous equation your coefficient q:
If you have no competitor, you could graph your past ARPU growths to estimate q with a OLS method (Non-linear least squares should be applied here):
The linear regression sets q=74%. So, if ARPU(0)=100:
STEP 3: Discount your cash flows
The stronger your discrete initial growth, the faster you will approach your maximum ARPU:
Now, that you have the evolution of your ARPU, you can multiply it by your percentage of contribution margin and discount it with a WACC (Weighted Average Cost of Capital) and a churn. And you get your CLV (Customer Lifetime Value) with an upsell strategy:
As we set a 20% contribution margin and an annual discount factor of 20% for the WACC and churn, the customer valuations increase towards the maximum ARPU.
Now, you are able to tell how much Customer Acquisition Costs (CAC) you can spend on a customer with the potential to double its purchases on the long term.
The valuation of your customers already acquired increase proportionally to your CLV. But the net present value of your future customers increase proportionally to your CLV net of CAC. With a 50 CAC, we would get the following increases on valuation:
- If you know how to measure your upsell strategy, you can increase your growth. Why? Because you will accept to spend higher CAC on your go-to-market strategy and you will still create value.
- Understanding your upsell strategy will help you to maximize the valuation of your company.