The Game with Alex Hormozi - Why LTV's Are Important In Business | Ep 667

Episode Date: March 18, 2024

Watch the YouTube video of this episode HERE"You will know and understand what your cap rate or your hypothetical max is for your business simply by doing the math." Today, Alex (@AlexHormozi) breaks down three primary methods for calculating customer Lifetime Value (LTV) — lifetime earnings, churn rate, and sales velocity — and their impact on strategic business decisions. The discussion emphasizes the importance of LTV in projecting business growth, enhancing customer acquisition strategies, and improving profitability, making it a must-listen for businesses aiming to optimize their growth trajectory.Welcome to The Game w/Alex Hormozi, hosted by entrepreneur, founder, investor, author, public speaker, and content creator Alex Hormozi. On this podcast you’ll hear how to get more customers, make more profit per customer, how to keep them longer, and the many failures and lessons Alex has learned on his path from $100M to $1B in net worth.Timestamps:(0:54) - Three different ways to calculate LTV(1:21) - The significance of LTV in business growth(2:19) - Calculating LTV based on churn(4:23) - Calculating LTV based on sales velocity(6:19) - The impact of LTV on business decisions(10:18) - Strategic business decisions based on LTV(12:23) - Conclusion: The power of LTV in business scalingFollow Alex Hormozi’s Socials:LinkedIn | Instagram | Facebook | YouTube | Twitter | Acquisition(This episode is a re-run. Original airdate was on May 19, 2022)

But all of it gets around to answer the simple question, just how much the customer worth to us? And then from there, we can make better decisions. And so when we're looking at companies, we want to see companies with strong LTBs or the potential to have strong LTVs so that in the future we could spend more in the acquisition and scale. Welcome to the game where we talk about how to sell more stuff to more people in more ways and build businesses worth owning. I'm trying to build a billion dollar thing with Acquisition.com. I always wished Bezos, Musk, and Buffett had documented their journey. So I'm doing it for the rest of us. Please share and enjoy. So I was talking to an entrepreneur who'd apply through Acquisition.com.

to potentially become a portfolio company. And one of the questions that I asked him on the call was, so what's your LTV? Like how much, you know, how much you make per customer over the lifetime? And he honestly was like, I don't know what it is. I know I should know, blah, blah, blah, blah. So I'm making this to that you know one of the most important metrics in entrepreneurship. And I'm giving you three different ways you can calculate it.

So the first one and the easiest one to do this is off of lifetime. The second way to do it is off of churn. And the third way is to do it is off sales velocity. all right and i'll finish with sales velocity because it's the one that i use most frequently but all of these are good ways of getting it and it'll give you approximations and i'll explain how each of them is calculated now as a quick side note the reason that this is so important if you don't know i am atxagosuric.com i own it we portfolio it's about a hundred million dollars year i just make these because i like doing this and i'm a crazy person so if you are a growing business this will

underestimate your lTV but if you have especially recurring and it's you've been doing this for a while and you are growing what you do is let's say that you did one million dollars year one you did two million year two and you did three million year three. All right. Let's just say that for a simple example. And let's say over, over that entire period of time, you sold, let's say, 600 customers. Okay. So what you do here is you add these up, which means you have $6 million in total sales lifetime over 600 total customers lifetime. This is, again, back of napkin math of how to get to how much you make per customer. So it would be $6 million divided by $600, which is probably like, 10 grand. And so that would give you an underestimation because you will have customers

we're still continuing to pay you. It gives you basically from the beginning until now, but it doesn't take the future into account. So it will be under what it is in theory, but this will give you something to work off of. All right? So that's number one. Now, the second way that you can calculate LCV is based on churn. And if you don't know what churn is, it's going to be the percentage of customers that leave at the end of the month that we're here at the beginning of the month. So let's say you have 100 customers at the beginning of the month. And let's say, of those hundred, you've got 95 at the end. Note that the amount of customers you sold between here and here does not matter in this calculation.

All right, just because people get really fucked up with this. All right. So you have 100 customers at the beginning. You have 95 at the end. It means you had five that left. And you do five divided by 100, right? Which means you have 5% turn. All right.

That is your turn. Very simple. Okay. Now, if you're like, well, I had some people cancel beginning. Again, all of these are rough estimates because you can't ever have a beautiful snapshot in a business ever. because time is a component that fudges the world. All right? So once you have churn, this is how you use that churn.

So you take your price, your average monthly price. So let's say you've got 100 people and you're making whatever $100,000 a month. All right. So you've got 100K per month divided by 100 people, which means you're making $1,000 per month per client, right? So that's our average price. And we divide that, which is this thing, right? You divide that by your turn.

all right so a thousand divided by five percent would be 20x 1k which equals 20k so that is your lTV and so if i had this business and let's say they were stable at a hundred thousand dollars a month i would know that they're probably only selling five new clients a month pretty interesting now if they're selling more than that then i know that they are actually growing and they haven't realized or tapped out what their with their new revenue threshold is going to be kind of interesting this is why it's important to know this stuff as an entrepreneur because you might be like why isn't it growing faster? But if you're in the situation, you've got 5% churn, you're doing $1,000 a month, you've got 100 customers and you're selling 20 a month, then your hypothetical

max is going to be 400KK. So you don't need to change anything. You just got to wait and you're going to hit 400K a month. All right? That's why LTV is so important to understand how to calculate it. All right. So you can do it off lifetime, which I showed you first. The second way you can do this off churn. And the third way is off sales loss. And this is the one that I do most commonly. And the reason for that is because, I mean, it'll give you an approximation. And this is important, especially if you have like a low price, very high volume, like recurring membership. Lifetime one is helpful. That one is also useful for that, but it's more of a hypothetical. And sometimes it overestimates it. So you're going to want to average out your turn because let's say you get 5% turn one month,

but you had 20 the month before and 13 the month that, you know, before that. So you want to average your turn. I'd be like, all right, well, we average 12%. Right. And then you use that as the turn number that you use the calculation to calculate for the business. And you want to do it the most recently, because if you all of a sudden start selling more, but then your turn goes up, those are the new metrics to your business. You can't use your turn from a year ago when you were only selling one-off people. And now you have a sales machine, but you're not doing as well in fulfillment because you don't have enough personalized attention, right? That's why this is so important. Now, sales velocity, this is the third way to calculate this. And then I'll leave you with a phone story. So sales

velocity number three is you say, how many people are you selling per month? You just ask them. And you can say, like, last three months, what are you averaging? Let's say they say, 10 people per month is what we're averaging in new sales. All right? This is important, new sales. Now, I'll say, what are you doing in revenue? The reason the sales velocity one, or the conditions under which this one works, is if the revenue has remained relatively the same. So for the last three or four months, let's say they've been at $100,000-ish a month, right?

Now that they're at a point of stagnation, or close enough stagnation, that we can use it for a calculation. So let's say $100K a month is what they were averaging in their business, and they're selling 10 deals a month, you know, where this is going. Then I can tell them that the rough estimate for their LTV is going to be $10K. And that gives you a good idea because if they're just maintaining it this, then it means they're losing some, they're gaining new ones and they're staying at that level, which means they've already hit that point of equilibrium. And so all of the thing with LTV is the relationship between sales velocity and how much are clients worth, right? And so the turn calculation showed a little bit more depth around pricing and turn to get the LTV right number, but all of it gets around to answer the simple question, just how much the customer worth to us? And then from there, we can make better decisions. And so when we're looking at companies, we want to see companies with strong LTVs or the potential to have strong LTVs so that in the future we could spend more in the acquisition and scale the business, right? And a lot of times this is one of the weakest

points in companies, especially in that $3 to $10 million range, is that they don't actually make enough per customer. The margin starts getting squeezed, which compresses their ability to scale. And so if you can speak in these terms, you will impress people. And more importantly, you will impress yourself because you'll have more tools in your entrepreneurial toolbox. Mosy Nation, real quick, if you are a business owner that has a big old business and wants to get to a much bigger business going to $50, $100 million plus. We would love to talk to you. And if you like that, we would like to hear more about it, go to acquisition.com. You can apply anywhere on the page and talk to one of our team and see if we can help you get there. I'm going to go a little

deeper on this concept of using LTV to project. And I just want you guys to know, like, I'm not an Excel whiz. Like, I had to learn this stuff because like I just haven't naturally been that good at it. So I had to learn the back of napkin way of doing business. And I'll be real with you. Just about every major business system I make, I just make it on back of napping because even the most precise calculations can still be done off of rough data sets. And so you got to just understand like where your gut is and just kind of like the directional math around the stuff. All right.

So let's say we have, I'm going to give you two scenarios. So I'll give you scenario A, scenario B. This is important because it will help you make decisions for your business about what to do to grow. So let's see we've got a business that's selling 10 people a month and they're doing $100,000 per month. And their price point is $5,000 a month is the price of what they're selling. for these 10 people, right? And let's say their churn is 20%.

All right. And let's say we have the same ones. So we have new sales and say it's 10. Let's say price points 5K month. And let's say that they're doing 500K per month and their turn is 20%. All right. Now, let's see the difference between these two scenarios. All right.

So if we have 10 clients per month and they're selling it 5K, right? And we know churn is 20%. then what do we have to figure out? We have to figure out the lifetime value, right? And so if we take the 5K per month and we divided by the 20% turn, we're going to have a 25K LTV, right? Right. Right. This makes sense. Now, if we're selling 10 new people a month, right, then it means that this business is going to continue to grow and it'll slow down at 250,000 per month. This is a back of napkin way that you can do projections, right? So think about it. If we have 10 new clients, and they're signing of a $5,000, we're adding $50,000 a month, but we're also losing 20%.

And so as we, the first month, we'll make 50. The next month we'll do 50 plus 40, right? And the next month we'll do 50 plus 40 plus 30. Right. And so it continues towards this asymptote, which means it approaches a number, but it doesn't actually hit it. So 250,000 is the asymptote. Right.

At that point, we'd have to change something to business. We'd have to change the price. We'd have to change the turn or you'd have to change the number of new sales that are happening in order to grow this business. All right. Now, if I'm talking to somebody here or you are that person there, then I know that this thing is growing, which is great. Right, even if we change nothing, the business can continue to grow.

Awesome. Now, here's the flip side. Let's say we have that same scenario, 10, 5, except the only difference here is it's at 500,000 a month, right? Well, if we know that this thing is going to cap out, right, at 250K, so it's going to drop dramatically in the beginning, and then it's going to even out at 250K. So if I'm talking to this business,

then I know that they're at 500 today, and this guy's at 100K today. But they're both going towards 250,000 because that is the reality of the business. business. So if you're selling 10 a month at 5K with 20% churn, your business does 250,000. That is what I want you to take away with this, is that you will know and understand what your cap rate or your hypothetical max is for your business simply by doing the math, right? And so you'll know if you have the capacity to grow, you're on a shrinking curve, or which common is you're in scenario C, right, which is you're at

$250,000 a month, you're selling 10 people per month, at $5K per month, and your turn is 20%. And you're stagnant like this, which means that one of these things must change. We either have to sell more people, we've got to change the price, we've got to add some zeros to the price, or we have to fix the churn. Now, here's where it's kind of interesting. If we can fix the churn of this business, let's say we just get it from 20% to 10% churn. Doesn't seem like it's a big difference, does it?

It's a hell of a difference. And so if you're thinking about the levers that you're going to pull in your business, you could say, all right, if I wanted to get to, let's say, a million. a month, which is probably common for somebody who's at this stage, right? They want to get to a million a month. That's their next objective. Well, let's talk about the ways they can get there. All right. Scenario number one, to get to a million a month, we'd start selling 40 people a month, right? And change nothing else. We start selling 40 people a month equals one million per month. All right? Because we just four-xed this number. The second way we can get to a million dollars a month

is we could four-x this price. We start selling 20K per month, right? With the same number of sales. and that will get us to a million a month, assuming churn stays the same. The third scenario is that we would reduce churn to 5% and change nothing else. Which of these seems easiest? Well, forrexing price might be difficult, right? That might be, you know, represents a serious risk to the likelihood, you know, the value exchange might not be there, right? And so you probably not choose this guy.

This one probably wouldn't be the first bet, right? So then you're pretty much left with I'm going to either forx the number, of sales, which means that you're going to spend more money on ads or I got to do more reachouts or I got to do more posts or get more affiliates or get more word of mouth, whatever, right? Or I got to work on my back end and reduce churn. Here's the interesting tidbit. It's easier to fix churn, and then all of a sudden, you're at 4 million a month. This is why business is fun. And so that is how, like, that's how we approach business problems and acquisition.com. It's like, okay, what are the biggest levers that we can use to transform this business using the biggest rocks that

we have available to us. I think it's important to think through these business problems strategically. So you can think, which of these levers can I pull that as the highest likelihood? And here's the problem if you do this in a different direction. Let's say you four X the sales, you get to 40 a month, right? You're going to build infrastructure. You're going to know those other stuff. But the problem is you might have built infrastructure too quickly and the people that you hire suck. And then you can't get the churn down, right? And then you also can't fix things properly. And so you basically feel like you have to keep selling to keep, just keep the business afloat, even though you know that you have this 20% turn, which is killing your business.

right? And so in order to make this thing a sellable business or have a business of value or enterprise value is we have to fix the product. We have to fix the client experience so that people actually want to continue to pay for this thing. And so this is how you can think strategic is if you fix the back end first, then guess what happens? Your LTV quadrupled. Now you can go and spend whatever you want in the acquisition and still be profitable. Whereas in this scenario, you probably have to compress your margins because usually when you increase acquisition margins to get compressed, but you already compressed them, right? Like you didn't expand them to begin with.

So let's say you were at a 30% margin and you four-ex your sales. Now you're at a 10% margin. That sucks, right? And so what we want to do is we want to expand the margin, expand the lifetime gross profit per customer by extending the LTV through turn and creating a better experience, better product, better product market match. And then at that point, then you can open up the opportunity to scale like crazy.