Not all customers are equal - here's what founders need to understand
Which is the more valuable startup - the one with 50 paying customers or 500 customers who pay zero dollars?
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Whilst we’ve seen thousands of startups onboard customers in a million ways, how deeply are founders thinking about the business model that they have, how much effort is required to acquire customers, and the value they get in return for the effort spent?
As important as it is for startups to create value for customers, it’s also important for startups to consider the value that customers in turn add to the business.
After reading this article, you should have a better understanding about:
The concept of economic utility, why it is useful to you as a founder, and how it may influence how investors evaluate your startup.
The three kinds of customer archetypes - recurring sales, transactional sales, and transactional-no sales. We define these categories in more detail below.
How to value your customer acquisition efforts.
What is economic utility?
Economic utility is defined as the ability of a product or service to satisfy a customer’s needs and/or wants. For more information on this concept, read Investopedia’s definition.
Now that you understand the basic idea behind economic utility, it’s also important to think about how this utility can be influenced by the different customer archetypes.
The three kinds of customer archetypes
Recurring sales: This customer likes your product and is happy to place recurring orders. Typically, this would be a startup with a subscription-based model.
Transactional sales: This customer likes your product and makes a purchase a la carte. They may decide to come back again, or they may decide to try a substitute product or service offered by another startup. Typically, this would be an e-commerce store.
Transactional no-sales: This customer is happy to perform a non-monetary transaction, like signing up to your platform. Social networks are a good example of businesses with this customer archetype.
Customer archetype meets economic utility
It’s helpful to think about the economic utility a customer derives for each of the archetypes listed above.
In recurring sales, a customer that experiences high utility will be happy to sign up for a subscription. Your cost of customer acquisition for a given customer goes to zero once they sign up for a subscription, and there on, you are deriving full economic value from the customer, as long as they in turn keep deriving economic utility from your service.
In transactional sales, your customer’s economic utility is fleeting. They may come to you for certain choices, but find replacement for other choices. You are therefore constantly spending to attract this customer, especially if you are in a crowded market. So while you do get economic value from this customer, you also have to keep expanding time and effort to make repeat sales.
In transactional no-sales, economic utility is only realised when you have a flywheel effect. Take a social network for example. Even if you succeed in getting 100 people to sign up, no one derives any utility as there is no real network effect. What if you have 1,000 people - ok, maybe some utility depending on the nature of your platform. 10,000 people? Ok, if you were a hyper-localised social network, then you may be approaching a tipping point where your customers are starting to derive utility from the network.
In all of the examples above, the key question is: how much effort do you have to put in for each marginal customer in order for your business to derive value from each customer?
Let’s put things into perspective
We take two hypothetical startups. For the ease of illustration, we are going to be very liberal with our assumptions. Let’s assume that the cost of acquiring a customer for both startups is the same: RM10. We will also ignore costs of inventory, operations, etc.
Startup A: A toy subscription service that charges RM9.99 a month.
Startup B: A network app that lets you find and connect with people who play chess - the app is completely free, but will start selling ads further down the road.
If Startup A were to acquire 50 customers, this would only cost them RM500. Assuming all 50 decide to subscribe, in the second month, the startup is already collecting RM499.50 a month from the first 50 customers and can now move on to signing up its next 50.
Startup B: How useful is a social network app with only 50 customers? Let’s say you’re a pretty good chess player, you might get bored after playing a couple of people if they are not as good as you. The startup will have to keep spending to increase its customer base to maybe 500 customers before enough people can find competitive players to play with. They have now spent RM5,000 on customer acquisition in search of economic utility, which is still far from guaranteed.
Why this should matter to founders
Founders need to be aware of how they value their customers. Two startups can claim to have 1,000 customers each, but the value of these customers are far from equal.
When evaluating a startup, investors want to understand how the startup captures its value from customers and vice versa with its business model. This helps to paint a clearer picture of the startup’s growth potential and trajectory, as well as the founder’s belief in how their idea can change the world. An early stage startup with just 50 paying customers can easily be far more valuable in the long run than a similar stage startup offering a free service to 1,000 customers.
Tell us what you think
Do you agree that not all customers are equal? Tell us why or why not!