Customer economics and cash 9 of 13 in this group
SOP 223
Read the revenue ceiling off sales velocity
What this page is for. Use it when you want a fast read on how big a business can get as it runs now, and on whether it is growing or shrinking toward that size. It gives quick sums for sizing up a business: lifetime revenue from price and churn, the average stay, a churn estimate for a business under a year old, lifetime gross profit, and the ceiling you get by multiplying sales a month by lifetime revenue. It then works backward from a revenue goal to the salespeople to hire, reads what a customer is really worth off flat revenue, and sets out the view of value per customer as an arms race.
SOP-223-Read-the-revenue-ceiling-off-sales-velocity.md
1. Quick sums, and what they leave out
What follows is some of the back-of-napkin math for sizing up a business quickly. The sums are rough. They are not exact, and they do not factor in cohorts. Reading churn one sign-up group at a time is SOP 158 — Diagnose churn by cohort.
Lifetime revenue. For any kind of subscription business, divide the price by the churn. Two cases, each a let's say:
| Price | Churn | Lifetime revenue |
|---|---|---|
| $100 a month | 10 percent | $1,000, the hypothetical case |
| $5,000 a month | 5 percent | $100,000 per customer |
The same division, carried on through gross margin, sits in section 9 of SOP 74 — Price continuity against upfront cash.
The average stay. One more sum: one divided by churn gives the number of months the average customer stays. One over 5 percent is 20. Knowing only the churn and the price tag, you can tell that a customer stays 20 months on average and brings in $100,000 on average.
2. Estimate churn before you have a year of data
Asked how to estimate churn when a business has not yet been open a year, the answer is: exactly this way. It is an extrapolation, taken from where you are now and carried forward. Count last month's customers and how many of them are still with you this month: you had 100, 95 of them remain, so churn is 5 percent. Price divided by that churn then gives lifetime revenue.
Customers you add do not change it. A case: you started last month with 100 and this month you have 110, but 20 of the first 100 have gone. The churn is 20 of the 100, or 20 percent: the number added makes no difference. The rule, with its worked definition, sits in section 4 of SOP 55, the page that computes lifetime gross profit.
3. Lifetime gross profit
Multiply lifetime revenue by gross margin. On the $1,000 from the $100 membership, with a gross margin of, say, 85 percent, lifetime gross profit is $850. This figure is also called LTV. Working out gross margin in the first place, and the steps behind lifetime gross profit, belong to SOP 55.
4. The ceiling: sales velocity times lifetime revenue
Sales velocity is how many units you sell each month; it is a rate. Multiply it by lifetime revenue and you get the hypothetical revenue max: the level the business will not grow past.
A case, with figures picked as an example: 30 units a month of a thing priced at $10,000, a figure taken to make it this simple. If that thing is all the business sells, with nothing else at all, then $10,000 is the lifetime revenue expected from each customer, and 30 of them a month means the business keeps going but tops out at $300,000 a month.
In a business with recurring revenue, knowing this sum is worth a great deal.
5. Growing or shrinking
Set the ceiling beside current revenue and you know which way the business is going. Two cases, both doing $1 million a month (the second to keep it simple):
| Measure | Selling 20 a month | Selling 1,000 a month |
|---|---|---|
| Current revenue | $1 million a month | $1 million a month |
| Sales velocity | 20 a month | 1,000 a month |
| Price | $5,000 | $100 a month |
| Churn | 20 percent a month | 5 percent a month |
| Lifetime revenue | $25,000 ($5,000 ÷ 20 percent) | $2,000 ($100 ÷ 5 percent: 20 months at $100) |
| Ceiling | 20 × $25,000 = $500,000 a month | 1,000 × $2,000 = $2 million a month |
| Direction | Shrinking: by half if nothing changes, and it settles there | Growing: it should get to $2 million a month |
These metrics alone tell you, and the same read works on a publicly traded company: look at its sales velocity and its lifetime revenue and you can see whether it will keep going up or go down, even while it takes in a million dollars a month.
In one owner's practice, this is the math that actually takes up the time, and probably as near as anything comes to that owner's daily work.
6. Why the stay averages out
To show where 20 months comes from, walk 100 starting customers through 5 percent monthly churn. The next month there are 95; the figures offered after that are 94 point something, then 91 point something. The count keeps falling and the fall slows, so that with 5 percent monthly churn you get 20 months on average from a customer. A hundred dollars times 20 is $2,000.
7. Two numbers, and working backward from a goal
Sales velocity and lifetime revenue are the two numbers that tell you where a business stops growing: you sell this number of customers, and each is worth this much; multiply them and you have the size of the business. There are only two things to do to grow a business: sell more customers, or make them worth more. That frame is carried on SOP 225 — Pick your war and check lifetime value is the constraint. To grow, look at the two numbers and ask which one you think you can raise more easily: more customers at the same value, higher value with the same customers, or both. You can move all of these around to derive the other pieces.
From a goal to customers a month. A case, under a let's say: $2,000 per customer (the same figure as the lifetime revenue of the 1,000-a-month case, called LTV here), $1 million a month now, and a goal of $2 million a month. Divide the goal by the value per customer: $2 million over $2,000 is 1,000 customers a month. Then ask whether that is probable, and whether it is realistic. An upsell goes through the same test, along with the question of whether you have the capacity.
From customers to salespeople. In one practice, once a business has a model, this is how it starts to be spelled out. The figures for one salesperson are given on average, under a let's say, and hypothetically, to keep the math clean:
| Step | Figure |
|---|---|
| Calls scheduled | 8 |
| Of those, how many show | 6 |
| Deals closed a day | 2 |
| Days worked a week | 5 |
| Deals a week for each salesperson | 10 |
| Customers needed a week | 250, with 1,000 a month made clean and easy |
| Salespeople needed | 25 |
| Salespeople on hand | 10 |
| To hire | 15 more, to reach $2 million a month |
This is how that practice projects and works out what is going on. Planning headcount ahead the way you plan the finances is section 3 of SOP 179 — Plan the workforce and map responsibility.
8. Value per customer as an arms race
The view here is that lifetime value is the arms race in business, provided you lack a superior strategy, such as brand, that lets you acquire customers for less. Of the two wars named, making customers worth more is the one this subject belongs to.
9. Read what a customer is really worth off flat revenue
In one example, an owner spent a consulting day with a competing business. Its cost to acquire a customer was the same as the owner's own business's, it sold the same number of customers each month, and its revenue was stuck.
The move drawn from it: if you know a business's revenue and how many units it sells, and it is flat, meaning it has not grown at all, divide the revenue by the units sold a month. What you get is what a customer is actually worth. The competing business's owner did not know the figure; the division gave it, because the business had not grown and its sales were steady. The back-of-napkin, easiest version: is the business stable? How many units a month? Divide the revenue by that number.
This, it is claimed, happens all the time, to other owners as well. An owner might point to a couple of tiers, customers who have been there a while, and some grandfathered prices, and think a customer is worth more than the division shows. The reasons given for the lower figure: payment issues, accounts-receivable issues, payment plans that do not actually work, customers churning out the back, a bunch of false starts, and not really counting. The divided figure is the real number.
10. What a multiple in value does to profit
The two businesses competed for the same attention and sold the same number of customers each month, and one made several times the revenue of the other. The gap in net profit was far wider than the gap in lifetime revenue, and the point is not making one or two times the money. This page gives no figure for the gap between those two businesses. A comparison of two businesses selling about the same number of units a month is section 10 of SOP 55.
11. The coffee chain
Now to bigger businesses. Why does a local coffee shop not have 20 or 50 locations? The answer offered is lifetime value. A big coffee chain has got so good at bringing customers back, and at getting them hooked on the whole process, that over a customer's life it makes far more than the local shop does. Asked whether that would not raise what the chain pays to win a customer, the answer frames the case as the same upfront price, with customers coming back far longer. Some of you are trying to sell high-priced offers; the chain sells drinks. This page gives no figure for the chain's lifetime value.
If your lifetime value is a large multiple of your competitors', it is not a fair fight.
12. Miss less, over a career
Master this math so that you can make really good judgment calls on which products and offers to make, the ones that are actually worth it and move the needle. Ask whether you have had an offer you expected to earn a great deal bring in very little instead. Probably plenty of you have. Over a career you want that to happen fewer times. You will miss some. If you can miss less, consistently and over time, you make more good calls, and each builds on the last. That is how the chain wins with ease.
13. What this page does not decide for you
- The churn walk's counts after 95. Not established on this page.
- How long a business takes to reach its ceiling. This page gives no figure for the time it takes.
- How cohorts change these sums. The sums leave them out; SOP 158 reads churn by cohort.
- Whether the salesperson figures fit your team. They are given hypothetically, to keep the math clean.
14. The checklist
| Step | What to do |
|---|---|
| 1 | For a subscription, divide price by monthly churn to get lifetime revenue; treat it as rough, with no cohorts |
| 2 | Divide one by churn for the average stay in months |
| 3 | Under a year old: churn is the share of last month's customers gone this month; new customers do not count |
| 4 | Multiply lifetime revenue by gross margin for lifetime gross profit |
| 5 | Multiply sales velocity (units a month) by lifetime revenue for the hypothetical ceiling |
| 6 | Set the ceiling beside current revenue: in these cases, a ceiling below it means shrinking toward it, and one above it means growing toward it |
| 7 | Ask which you can raise more easily: customers a month, value per customer, or both |
| 8 | Work back: the revenue goal over value per customer gives customers a month; ask whether that is probable and realistic, and whether you have the capacity |
| 9 | Turn customers a week into deals for each salesperson, salespeople needed, and hires, as one practice does |
| 10 | If revenue is flat, divide it by units sold a month to see what a customer is really worth |
15. What this page does not cover
Why value per customer matters, and whether it is your constraint, is SOP 225. Reaching a margin goal is SOP 226's, and the targets that hold it are on SOP 227 — Hold the margin line with targets, not industry averages. Price tiers belong to SOP 224 — Set fractal price tiers and read price off the close rate. Selling to richer customers is SOP 229 — Sell to richer customers and rewrite what you measure. Doubling new customers, purchases or price in turn, and what each does to profit, is section 1 of SOP 82, the page on the pricing rules.
Brand as a way to win cheaper leads is SOP 216 — Make content for the customers you want and build a brand, section 13.
Terms defined on this page
- Average stay
- How many months the typical customer stays: one divided by monthly churn. Churn of 5 percent means 20 months.
- Churn
- The share of customers at the start of a period who are gone by the next; customers who join during the period don't count. For a business under a year old, a quick version compares last month's customers with this month's.
- Lifetime gross profit
- All the gross profit one customer brings across their whole time with you: lifetime revenue times gross margin, so $1,000 at 85 percent gives $850. Also met as lifetime value; the gross-profit name is preferred because it names margin, not revenue.
- Lifetime revenue
- For a subscription, price divided by monthly churn: $100 a month at 10 percent churn gives $1,000. A rough figure that leaves cohorts out.
- LTV (lifetime gross profit)
- Lifetime gross profit; see that entry.
- LTV (lifetime revenue)
- In the revenue-ceiling sums, lifetime revenue; see that entry.
- Revenue ceiling
- Sales velocity times lifetime revenue: the hypothetical level beyond which the business will not grow as things stand. Below current revenue, you are shrinking toward it; above, you are growing toward it.
- Sales velocity
- How many units you sell each period. Multiplied by lifetime revenue, it gives the revenue ceiling; it tends to run high at a low monthly price, since referrals rise and the decision is easy.