How to Assess the Health of a Fast-Growing, Money-Losing Business
Customer-Based Corporate Valuation can analyze the paths to profitability for unprofitable businesses
Losing money has never been more fashionable. Many recent IPOs like Allbirds, Rent the Runway, and Warby Parker are growing quickly, but losing money. Customer-based corporate valuation (CBCV) is a tool for triaging unprofitable business models and assessing paths to profitability. It does this bottoms-up by analyzing customer behavior and unit economics.
If a cohort analysis and a DCF had a baby, it would be CBCV. The model’s champion is Daniel McCarthy, an entrepreneur and Assistant Professor of Marketing at Emory’s Goizueta School of Business. Below is a non-technical primer ( here’s a technical one). Even if you never touch financial models, a basic understanding of CBCV offers insights for business analysis.
CBCV starts from first principles: all revenue comes from customers. Using customers as the unit of measurement, it distills revenue into its constituent components, modeling each separately. The goal is predicting customer behavior. In particular, the number of customers acquired and the average revenue per customer. To do this, CBCV answers five questions:
- Customer Count:How many customers are acquired? This is a function of customer acquisition, customer retention, and market size.
- CAC: Customers can be new or returning. Acquiring new customers costs money. If the answer to “do I need to spend this every time I bring in a customer?” is yes, then that expense is part of CAC. For e-commerce and DTC businesses, a big slug of this will be Google and Facebook. Other examples include Toast’s point-of-sale hardware (in addition to sales and marketing expenses) and Warby Parker’s home try-on costs (in addition to media spend). While a rising CAC often spells danger, what’s important is the cost effectiveness of acquisition spend (e.g. ROI).
- Retention: How long do customers stay? A related concept is churn, which measures what percentage of customers stop buying in a given timeframe. High retention (low churn) is good.
- Order Frequency: How often do…