Typical User Acquisition Strategies

• Organic / word-of-mouth: high value, low volume, low cost - but if your service is good enough, you can encourage referrals and save on marketing dollars - and potentially pass that on to users in the form of lower fees, creating a virtuous cycle.
• Press and publicity: if there's something truly innovative about your service, or it provides a highly unique and compelling end-value to user, bloggers and traditional media may write about it. Generally, however, if you don't want to leave press coverage purely to luck, you're going to have to spend at least some money on press releases and other forms of public relations.
• Advertising: the traditional "push" form of advertising, with the massive advantage in online environments that you can target users in very, very precise ways thanks to search engine marketing. I have a site that I promote where I only advertise it to folks searching on google for "alternate side parking" within the New York City area. That's not a lot of people - but they're very, very high value leads and it's worth advertising to them because the conversion rate is so high.

The Customer Lifetime Value ("CLV") of your service will dictate which of these acquisition strategies make sense, and how much you'll want to spend on any given strategy. Obviously, you don't want to pursue any acquisition strategy where the cost of acquisition exceeds your estimated CLV. In reality, you'll start with the lowest-cost options and then keep pursuing progressively higher-cost strategies so that you're able to generate enough total traffic to cover fixed costs and make the business compelling. If you're not able to generate that level of traffic without the marginal cost of acquiring a user (e.g. the per-user-cost of the most expensive strategy you're using) still being a fraction of your estimated CLV, you need to re-examine your business strategy and figure out if there's a way to improve monetization or retention, so that CLV rises.

Why limit acquisition costs to a fraction (and I mean 1/4 or 1/3, not 4/5) of estimated CLV? Because CLV is almost always a "best-case" estimate, and acquisition cost is a known, up-front cost. Especially if you're capital-constrained (and at this point, who isn't?), you're going to feel a lot of pain paying up-front acquisition costs and then maybe waiting months to see the cash generated by monetization of those users come back in the door.

This is an important enough point that I'm going to provide a very simplistic example. Let's say you have a "freemium" site that's acquiring users via Google Adwords, at a cost of $10 per lead. (That's on the low side, btw. I'm estimating a 1% conversion rate to a paying user, and 10 cents per click-through from Google.) It generates $5 a month from paying users after a first month of free service, with an average user life of 7 months for an approximate CLV of $30.

Sounds great, right? However, there's a few other important details:

• Adwords must be paid every month, creating an average account payable of 0.5 months on acquisition costs
• User fees are collected at the start of the month, starting with the second month
• The credit card company takes 30 days to pay the collected user fees to the vendor

If you sketch this out on a napkin, you'll see that for the $10 spent on a user, you don't get paid back that original $10 investment for 3.5 months, or 9 weeks. (You get 2 weeks of float from Google, and it takes four months before $10 from the user is back in your bank account.)

If you're trying to acquire 10,000 users per month, that means you'll need to "front" at least $35,000 in acquisition costs during the initial growth period, until your realized profits start to catch up. If your CLV is lower than expected, you may have to use even more than that as it will take longer to pay back the initial investment.

Mitigating Growth Capital Requirements

There are ways to manage this capital issue. In particular, anything you can do to accelerate the receipt of payments, even at the cost of total returns, may be worthwhile. This is why so many services with monthly subscription plans offer large discounts to users willing to pay a full-year up-front, even if the site offers a pro-rata refund should the user choose to cancel before a full year is over. Getting the cash in hand earlier means a reduction in the capital needed to grow the business.

And yes, this also means it's possible to grow a service business right into bankruptcy. One memorable instance was Amp'd mobile, a "virtual" mobile phone service that existed from 2005 to 2006. In addition to acquisition costs, they also had to pay service fees each month to the physical mobile phone network they were reselling to end users. Unfortunately, their users often took 60-90 days to pay for the services. Between the up-front marketing costs for acquisition, and the obligation to pay monthly fees to their vendors, Amp'd managed to run out of money because every user it added meant more cash used. I have no doubt that their estimated CLV war in excess of their acquisition costs; but they weren't adequately providing for the offset in cash flows between acquisition and monetization.

Acquisition for Advertising-based Businesses

If your business has a monetization strategy based on selling advertising space, then you need to be even more aware of the relationship between CLV and acquisition costs, because in essence you're running an arbitrage between the cost of advertising for users, and the amount you can make by showing them advertisements when they visit your site.

For example, if you have to buy 100 ad impressions to acquire one user, then you need to show that user 100 ads before your CLV starts to exceed acquisition cost, assuming the effective ad rates are equivalent (and if you are a small-site, that's a best-case scenario, since a lot of your page views will run with low-paying ads.) And that's ignoring the inherent friction of the ad sales side, including commissions paid that can run as high as 40% of the rate card price. I've seen too many business plans and financial models where if you calculate the effective CPM (eCPM, essentially revenue divided by page views) you get a figure as high as $10. Given that many major, top-100 sites may have eCPMs below $2 despite a dedicated in-house sales force (and that $2 is before any internal overhead, including sales commissions and costs), if you're going to project an eCPM that's several times above market, you'd better have a very good justification for it.

Have a Plan

Much like value proposition and monetization, the key to achieving successful performance in the acquisition component of the business is simply to have a plan. It might be right or wrong, but you should have a plan, with an estimated cost per successful acquisition, and you should know how it compares with your estimated CLV. If acquisition costs prove to be lower than expected, great. If they don't, you should be willing to iterate on both your acquisition and monetization plan until the business works for you - and you should have reserved appropriate time and resources to do so. Having a plan means you can raise a red flag and know things are not working right in the first few weeks, rather than two months later when you're expecting that your cash flow should be improving. That can be the difference between a healthy business improvement and a failed effort.