There’s a traditional way to think about this which you can generate straight from your finance system of CAC = What you spend on sales and marketing and LTV = ACV x5 (or x3 depending on who you ask). As long as we’re just talking my personal opinion, this version makes no sense in a platform business. Ultimately, the goal of the LTV/CAC metric is to look at “how many dollars do you spend to make a dollar” and then — because pipeline businesses think of the world in accounts — it averages that across accounts. But, most platform businesses don’t monetize on the account, they monetize on a platform transaction.
I’d sum it up as there are two main issues:
1) You need both sides of the network to see value.
So for a platform I would reframe the intent of LTV/CAC to be “ROI of participant acquisition”.
Your acquisition cost and returned value need to have both sides of the network included. Taking an Airbnb example for simplicity – If you only look at the cost of acquiring guests, you’re going to miss a major dynamic in your business because the value to the platform at some point will not be gated by bringing new guests on it will be gated by bringing new hosts on.
2) CAC is not linear formula in a platform
Another way traditional LTV/CAC fails in platform vs. pipeline is the assumption that it’s fixed and linear. The 3:1 ratio for pipeline businesses assumes a very linear and single-variable growth pattern, that is to say “for every dollar I spend on acquisition I get 3 dollars in return” and you could scale that from spending $100k to $10M and expect roughly a corresponding linear return in your value side.
On platforms, the acquisition cost of a single participant should go down based on the number of existing participants.
I’ve framed this as there are 3 phases to a platform market (eg a market being a city for Airbnb).
- Ramp up
- Network Effects
In the Ramp Up phase, you’re sprinting to get to a tipping point where your network effects start to take hold. Related to LTV/CAC – I’d define that tipping point as where growth and acquisition start to diverge from a linear relationship. I’d argue stressing about the LTV side in this phase is a fool’s errand, the single goal is fund growth to get to the tipping point.
In the Network Effects phase, you’d have a healthy network going and your objective is to focus on cross-side attraction and utilization. Your CAC should be really low at this point because you should be relying on your existing network and platform to pull new participants in. Your incremental investment should go into driving utilization of the participants, and incentives to maintaining a balance in the network (if side A grows faster than side B, you need to subsidize side B to preserve a balance).
In the Saturation phase, you’ve got all the participants already on the network. Now you need to focus on synthesizing the side that’s reached saturation. Another Airbnb example, this happens when basically everyone who could be interested in being a host, is a host – if airbnb wants to continue to have more hosts after that they need to create them, which we have seen them doing by building and renting their own apartment buildings in SF and NYC.