12. Payback Period PPD | $100M Lost Chapters Audiobook
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What is the payback period and why is it important?
Payback period equals PBD. How fast do you make your money back? If you think of what a business is, it's a box where you get a much higher return than the stock market on far less money. What makes business valuable is they are able to get 5x, 10x, 20x returns in a matter of weeks or months compared to 10% returns over years. Payback period equals the time it takes to break even on what you spent to get a new customer. Example, you make $50 per month in gross profit from a customer. You pay $100 to acquire that customer. You get your first payment day one, so you get $50 to your original $100 back. Then you get your second payment on day 31 to get the remaining $50 to your $100 back. Therefore, your payback period is 31 days.
I'll be using a hypothetical business, a lemonade stand, throughout this section to illustrate the concepts and frameworks and to make acquisition models fun and accessible. Most importantly, I'm doing this to illustrate that these models work with all businesses, including yours, whatever that might be. So let's start a lemonade stand. All right, here we are. We've got a fledgling lemonade business. We've got aspirations to become the citrus kings of a lemonade empire. But do we have the skills to do it yet? Let's say we start with a recurring lemonade model. And let's say for simplicity's sake, whether we charge $10 per month per customer. And let's say our average customer stays five months for a total of $50 of lifetime revenue.
Note, add or remove zeros as desired. This could be a $10,000 per month and $50,000 of lifetime value, depending on the product, business, or prices you aspire to. The concepts remain the same. Now let's say we run 80% gross profit margins. In this hypothetical business, we might pay $2 per month to fulfill these $10 per month lemonade shipments for us, which would be delivery costs, lemonade powder, filtered water, et cetera. So 10 bucks minus two bucks equals $8 in gross profit. That's an 80% gross margin. That means of the $50 we make, 40 of that is gross profit, aka it goes back towards paying our other costs, like paying off the quarter neighbor to use their lawn, keeping track of our accounting, and making a profit for us, the owners.
In this example, as the average customer buys lemonade for five months, our LTGP is $250. Knowing only how much we make, LDGP, it would be impossible for us to know if our lemonade stand is likely to be a rocket ship or a dud. We also need to consider CAC and then payback period to help us fully figure out our growth potential. How much is the CAC for a customer that pays us $10 a month? That's the next piece of information we need. This includes all the costs that go into acquiring a customer. Advertising dollars, payroll to a media buyer, creative team, software that that team uses to make advertising, sales commissions and salaries, etc. If you like pictures, I did my best to illustrate this above.
The back of napkin math way I used to figure this out is by looking back at any time period in the past, so last 3, 6, 9, or 12 months. The Equation Take all marketing and sales team compensation, advertising and software, and then divide it by CAC.
How does a lemonade stand illustrate customer acquisition?
That equals the total number of customers required over that period. So, the example would be, if we spent $400,000 in total cost to acquire all customers for 12 months, divided by $40 CAC equals 10,000 customers required in the business for 12 months. So how quickly does that lemonade stand payback the CAC and start making money, aka payback period? Payback period is important because it will increase the speed of cycles in which you can multiply your cash. Doubling our money in one month versus three months may not seem like that big of a difference, but it is. We're talking about a 4x difference in growth potential. We could double our money in month one, 2x, then double our money in month two, 4x, and then finally quadruple amount in month three, 8x, for a total of 8x our original sum.
The three-month example would only double in that same three-month period.
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