Thread by @dunkhippo33

Ending the week with a tweet storm!

Today I want to talk about margins in a business. I don't think it's addressed enough, and I'm going to walk through a concrete example that reflects some of my conversations w/ founders this week

Read on >>

1) First, what are margins? There are so many different accounting terms: gross profit, net profit, etc.

To keep things simple - in this case, I'm talking about gross profit. I.e. If you sell a pair of shoes for $100. And it cost you $50 to buy in wholesale, your margin is 50%.

2) In other words, it's what you get after paying for the cost of goods but before paying for the overhead of your team and marketing expenditures.

Ok onwards >>

3) Example 1: A friend of mine was looking at a subscription box company to invest in and asked me what I thought about the business.

Here's how I'd think about it as either an investor or the biz owner.

How much can you sell the box for to consumers? $20/mo? $30/mo?

4) You want to charge as much as you can without causing ppl to churn. Based on what they were offering in the box, I felt that I might pay $30/mo as a consumer.

Now how much would the cost of goods cost? Maybe they can buy the items at wholesale. Or get some for free even.

5) But at scale, I felt that it would be hard to get all the items for free. So maybe the COGs is $15/box/mo.

This means that the business gets $15/box/mo - which it has to use to cover all overhead (office / salaries / etc) + marketing.

6) Some ppl might say that 50% margins are good. But it's not the margins that matter -- it's the actual amount that you get that matters.

In this case - it's the $15/box/mo.

7) The critical piece many ppl underestimate is how much time & money cust acq requires.

For this particular demographic, at SCALE, I think in ad channels, it would cost $70-$120 to successfully acquire a user. This is based on seeing a lot of cos go after this audience.

8) If say it costs $100, then your payback period would be $100/$15 = 7 months payback.

For a pre-seed startup w out funding, this is TOO LONG. But even they had money, the concern is that it will be hard to make money.

9) After the 7 mo payback, you still have to retain the customer to pay off some overhead of your team and then eventually actually MAKE MONEY! And a lot of "nice to have" consumer subscription companies aren't able to retain the ave customer for 1+ yr.

10) You could argue that they could use non-ad channels to find cheaper channels. Maybe SEO - though for their category it's incredibly crowded to rise above the noise. Maybe partnerships -- ala bloggers and influencers, but again for this category hard to rise above the noise.

11) The pt of this story is NOT to dissuade you from starting or investing in subscription box companies. But you have to think through the unit economics.

How much are YOU going to make on a transaction? And will mktg and overhead start to fit into that gross profit?

12) And will you retain the customer long enough to get past your payback period and actually make money? Or will they churn because it's a nice-to-have product?

13) The wildcard is that sometimes the initial business unit economics can be bad, but if you can muddle through it to get enough volume going, then maybe you can layer on additional business models to increase the lifetime value and make money.

14) If you don't have a good sense of what your CAC could be at scale, do some quick research. I haven't checked recently, but the Google Ads API gives you a sense of CPC for various keywords. Do you some landing page tests.

15) Even if you don't use ads, I still think this tends is a good proxy for the cost of other channels. The higher the CAC, the more competitive the space. It also means it will be a dogfight for partnerships & mindshare in SEO -- it's not any LESS competitive in non-ad channels.

16) These are not perfect tests but good proxies to how hard or easy the customer acquisition will be and will give you a sense of your payback period. And if it's long, then you will need a lot of capital to bridge yourself for that long.

17) And maybe you start the business but maybe you don't. But whatever you decide, you should have a good sense of how "tight" the numbers will end up being.

Just some Friday thoughts to end the week.