The most important metrics in the internet business

In the internet economy – be it a web2.0 Or the App industry, one of the most important metrics determining a firm’s value is: “Customer Lifetime Value” (CLV).  CLV is the value generated by a customer while using the app (or website) that is in turn captured by the website or the app.  Another metric of importance is the customer acquisition cost  (CAC).  CAC is the cost of acquiring a customer through  either advertisements, referals or through regular sales cycle.

One of the ways to calculate the CLV is as follows:(A more detailed definition and formula for the same is given here.)

Customer Lifetime Value (CLV) = average  sale  value x number of repeat transactions x average retention time.

For example, Lets say that a Netflix customer uses the service for 5 years (average retention time) and pays 8$ per month (average sale value) and 12 times a year ( i.e. number of repeat transactions).The customer lifetime value for Netflix is 5 X 12 X 8 = 480$.

If Netflix spends 80$ to acquire one customer on average, the net realizable value from a customer is:

CLV – AC  ie. 480$ – 80$ = 400$ per customer per year

Obviously the more the number of customers the higher is the firm’s revenue. The net realizable revenue for netflix with 40 million customers is 16billion$ over 5 years. For services that are dependent on advertisements e.g. news sites or google, the average sale value is dependent on the average number of times a customer clicks on an advertisement (CPC ads) OR the number of times an advertisement can be displayed to the customer (Display/banner advertisements).

Most internet firms or apps try to increase their customer lifetime value by increasing either:

a)the number of repeat transactions:  This is achieved by increasing a customer’s time spent using the app (or the website) by making the site’s value proposition very compelling. In addition high repeat transactions are achieved by making customers engage in  actions such as clicking ads or browsing or purchasing digital goods.

b) the retention:  This is achieved by making it very difficult to leave the application or the platform AND by making the user return to the platform  over and over again.

Overall, if an internet business increases the number of repeat transactions and increases the retention of customers while simultaneously increasing the number of  customers, their business  will get very valuable quickly – like Whatsapp…

Lessons from “The Shark Tank”

ABC network is telecasting a series called the Shark Tank, where entrepreneurs pitch their businesses to a panel of 5 Venture Capitalists (VC). The Venture Capitalists (VC) then choose to buy a stake in the entrepreneur’s firm. After acquiring the stake, the VCs  help to take the entrepreneur’s business to the next level by increasing sales, marketing reach, production capacity, etc.. Also, during the course of the show one Venture Capitalist will show you how his(or her) prior investments have performed. Several entrepreneurs get rejected (and nastily too) by the venture capitalists and fail to raise capital.

During the pitch, most entrepreneurs showcase new consumer products e.g. better winter wear,  packaging for wine, wipes for greasy hands, kids toys, etc. Very few of these products are software or hardware related which are valued very differently, and may not interest the audience of nationally broadcasted TV series.

While funding success is a great criterion to measure  the entreprenuer’s capability, there are also definitely several lessons learnt  from failed pitches. These learnings  could be applied  to any creative profession: be it scientific research, fine arts or even computer programming.  A few learnings that impressed upon me are as follows:

1) Build products which people buy in order to use.

2)Demonstrate 100% commitment to make the venture a success. You should be so convinced about your idea that you should be willing to do whatever it takes to make your idea  successful.

3) Plain Innovation ( in the form of patents) sometimes do have a value, even when there are no sales. [ you could either license or sell your patent.]

4) If you want a large valuation for your company – you should already have big sales or  should demonstrate a large market potential for your product.

5)Though prior money raised by your firm is not a criterion for additional funding, prior money from investors does help increase the value of your firm.

6) Know your idea very well, know your market very very  well and know how your customers think and act  with your product very very very well in that order.

7) Don’t go begging for funds with a half baked idea and a half baked product – you will never get funded irrespective of how much you are in debt. Be humble , patient and listen… these guys have done it over and over…

8) Once VC’s invest money, the value the entrepreneur derives from an investment is much larger and is significantly disproportionate to a monetary investment. For e.g. if a company is making a revenue of 1,00,000$ before VC investment then the company could see its revenue grow to 2 million$ after VC investment. The VC investment is a classic “Inflection point” for the entrepreneur.

9) Age and experience are never binding factors for innovation, entrepreneurship and funding. E.g. a 18 year old high school student raised 100,000$ and a 60 year old man raised more than 1 million$.

10)However, the older the firm the lower the investment raised (and the possibility for raising money)

11) The investment is mostly in the talent of the entrepreneur(s) and is rarely ONLY based on the technology.

Uber – the transformative power of software applications and data analytics.

Last week there was a lot of noise about “Uber” – (ref #Ubergate – on twitter)- because an executive spoke something at a private dinner. Also, Taxi drivers formed large roadblocks in San Francisco downtown to protest Uber and other ride sharing services. Two completely unrelated events – highlighted by national and international media, bring Uber right at the center of media attention. Success – a 4 billion $ revenue in 4 years – has its problems and media scrutiny is one of them.

My friend Sangeet Paul (of Platform thinking), has beautifully described the feedback loop which Uber’s business model thrives (ref. simple diagram). Uber has executed on each phase described in the feedback loop with precision. They are super-star executors with a very humble and forward thinking CEO – who publicly apologizes for his exec’s “private dinner” gaffe…..

Uber has got multiple sides of their platform (the  driver’s side, the passenger’s side and payment gateway side) working well and at scale. It is easy to onboard a driver and it is easy to get a customer a car within a few minutes of requesting one. Their backend analytics which allows for dynamic pricing and matches cars to consumers works well. Their payment system integration operates superbly over mobile networks and lets customers travel without credit cards. These in themselves are engineering feats worth credit.

Overall, Uber is a classic product that solves a large societal problem – one pertaining to human transportation. It also gives many people (drivers on Uber(X)) a chance to add  to their income, without imposing time or location restrictions. At least for now, Uber allows markets to decide a fair price – and effectively gives consumers a choice against  taxi driver (or autorickshaw) lobbies, such as the ones in India.

In an economist’s language, Uber as a platform has made several constituents in their network better off (or increased social welfare) i.e.

a) the drivers, because now ordinary people can earn an additional income. b) the consumers (riders), because they have an accessible, reliable and affordable transportation service. c)  the car dealers because they see increased sales of a particular “black car.”d) the taxi industry – because they bring quality and price competition (UberX).

In general, societal welfare increases too – because Uber has enabled net demand in the economy by creating thousands of paid jobs where people earn money.  For me, Uber portrays a shining example of the transformative uses of the mobile internet technology on society.

As a frequent Uber(X) user – I love the service. On many occasions when I have traveled either alone or with my family, I have used it. Even  last week, my colleague and me were stuck at the mist covered Golden Gate bridge at 7:30 am. Uber – at the click of a button on my iPhone- helped us get back to the warmth of our hotel, within 2 minutes of waiting.

Imagine that you get off a train at San Francisco(or any other big city) during peak hours (6pm – 9pm), when it is very cold outside, after a long day of work, and, you find NO taxi waiting. The taxi service number you call  tells you that someone would  pick you up in 25 minutes, but you are not sure where to wait in the cold. Then you will know why Uber Rocks!!!