Growing your edtech venture: How efficient and effective is your growth engine?
As an edtech entrepreneur and investor, I’ve seen many different ventures in action with many different growth models. Some ventures are high growth and some are slower, steadier growth. Some are limited by the realities of market demand and a shortage of reliable funding streams, while others are limited by the capital they have on hand to invest in growth. But they almost all have one thing in common: the desire to grow more quickly and efficiently. It’s rare to meet an entrepreneur who’s concerned about growing too quickly, but it does happen from time to time.
For entrepreneurs interested in improving their growth engine, it’s important to analyze how efficient and effective your current growth model is. There’s a lot to unpack on this topic, so I’m going to keep this simple and stick to several key concepts: customer acquisition costs and lifetime value, customer payback period, demand generation, and conversion rates. If you’re unfamiliar with some of these terms, I’ll explain them below. Taking a closer look at these concepts will help us evaluate how efficient and effective your growth engine is and where you might focus additional time, attention, and investment to improve it.
1. Customer Acquisition Costs (CAC) and Customer Lifetime Value (CLTV or LTV)
Simply put, customer acquisitions costs (CAC) are the costs associated with convincing a customer to buy a product or service. CAC consists of all marketing and sales costs, such as labor, travel, CRM, and conference expenses. In general, the larger your average contract, the more you can afford to invest on CAC per deal. The smaller your average contract, the less you can invest per deal.
Customer lifetime value (CLTV or LTV) is the total amount of revenue that the venture can expect from a single customer account over the lifetime of that customer relationship. For most B2B edtech companies this is either the monthly price multiplied by the expected number of months you’ll retain the customer or the annual price multiplied by the expected number of years you’ll retain the customer. In a startup, this is typically a projection of expected value because of a lack of renewal cycles. Over time, CLTV becomes an actual number as you build a track record over multiple months or years of renewals.
A key ratio for entrepreneurs and investors alike is CLTV/CAC. As a general rule of thumb, investors are looking for businesses that have a CLTV/CAC ratio of 3:1 or greater. These businesses are generating enough value to not only cover customer acquisition costs, but also to cover other aspects of the business including product development, service, and operations, and still have enough left over for profit. A business that has a lower ratio will struggle to become profitable and will require more capital to reach that point. On the other hand, a business with a much higher ratio (say 5:1 or greater) is operating very efficiently. This is a very positive sign for your growth engine! It might also be a sign that you’re underinvesting in growth and that you could grow more quickly with some additional investment.
It’s easy to see that entrepreneurs who spend more to acquire customers than they earn over the lifetime of that relationship are just burning cash and will fail eventually. If it costs $1,000 to acquire a customer worth $500, then the startup story isn’t going to end well. It’s surprising how many entrepreneurs don’t know their numbers and fall into an unintended death spiral. Know your numbers and don’t fall into this trap!
2. Customer Payback Periods and Recurring Revenues
Another very important measure is customer payback period. This is the length of time it takes to recover your CAC for new customers. David Skok wrote an excellent piece on SaaS metrics about the topic. He argues that an efficient business should recover their CAC in 12 months or less. Think about that for a moment. In a recurring SaaS business, entrepreneurs can invest up to the value of an average first-year contract in customer acquisition costs and still build a viable business. If your average annual contract is $10K, then you can afford to invest up to $10K in CAC per customer. If you multiply that out across a team, there’s an argument to be made that you should be willing to invest up to $1 million in marketing and sales for $1 million in new annual recurring revenue. That’s a really high ceiling for investing in customer acquisition and still be able to operate a viable business. How is that possible? It’s the power of SaaS where revenues recur year after year, customer retention is high (>90% annually), contract expansion is attainable (which can lead to negative churn), and margins are huge once customers are up and running successfully. Successful edtech entrepreneurs understand that customers are expensive to acquire and support in the first year or two of a contract, but in years three and beyond customers are usually successful with little support from the venture. Margins can be as high as 90% by year three in many edtech SaaS companies! That’s a super powerful model and many sustainable businesses have been built with it. Successful entrepreneurs understand that big investments in customer acquisition are necessary to land new customers, but that they’ll be very profitable over time as they renew (and possibly expand) year after year.
3. Demand Generation
A third aspect of your growth engine that is important to get right is demand generation. An effective engine begins with filling the top of the funnel with opportunities, and that starts with doing demand generation well. Edtech companies generate demand in a variety of ways, including offering a freemium product that amasses many free users, developing content marketing programs that attract prospects by providing value-added insights, and sales development that includes email and phone outreach to generate demand with targeted buyers.
There are a number of ways to measure demand generation efficiency and effectiveness (perhaps a topic for a more in-depth blog post), but a simple way to measure this in a B2B context is tracking the number of new meetings with pre-qualified buyers. A pre-qualified buyer is someone in the right role (i.e., the preferred person you’d want to talk to at a school or district), in the right organization profile (i.e., a traditional school, charter school, or school district you could successfully serve), and who’s interested in speaking with you about your product or service.
It’s difficult to provide a standard daily or weekly goal for the number of new meetings with pre-qualified buyers because edtech companies vary tremendously in terms of deal size and the numbers of potential buyers. Nonetheless, we should provide a general estimate for startups as a guideline. So, as a general rule of thumb, I like to see each salesperson have 1–2 new meetings per day on average with pre-qualified buyers to fill pipelines and keep them full. These are marketing qualified leads (MQLs), which we discuss in more depth in the next section.
4. Pipeline Conversion Rates
Edtech ventures use many different sales processes to work prospects through their pipelines, but at its most basic level, we can boil a sales process down to three simple milestones: Marketing Qualified Lead (MQL), Sales Qualified Lead (SQL), and Closed Won/Lost.
There are various definitions of an MQL. In a B2B environment, I define an MQL as a discovery meeting (~30 minutes) with the right person in the right profile organization. Completing the discovery meeting allows a sales leader to identify potential fit between the prospect and the company and yields an MQL regardless of whether or not that meeting becomes a sales opportunity.
An SQL is an MQL where we have BANT, which stands for Budget, Authority, Need, and Timeline. It’s the job of each salesperson to uncover information about each of these four areas to determine whether or not there’s an SQL. SQLs are real opportunities in a sales pipeline and are the basis of effective sales forecasting. It can take one or more meetings to determine BANT, but salespeople need to determine BANT in order to deem a prospect an SQL. Since they’re sales qualified, these are the opportunities that sales organizations want to focus on and spend time working to close.
Conversion rates from MQL to SQL to Closed Won vary among B2B edtech companies, but across the dozens of edtech companies I’ve worked with and/or invested in, there are conversion rate ranges that indicate the efficiency or lack thereof for the sales organization. Let’s take a look at some simple ratios we find across B2B edtech companies. From MQL to SQL, conversion rates range from 2:1 on the super-efficient end of the spectrum to 4:1 for teams that are learning how to prospect and qualify well. For conversion rates from SQL to closed won, the numbers are very similar. 2:1 for highly effective teams and 4:1 for teams that are doing okay, but need improvement in closing qualified opportunities. In other words, typical B2B teams in edtech close between 25% (converting 1 in 4 SQLs) and 50% (converting 1 in 2 SQLs) of their SQL or qualified sales pipeline. Aggregating up to the MQL to Closed Won ratio, we see close rates as high as 4:1 for MQL/Closed Won and as low as 16:1 for MQL/Closed Won. In other words, companies typically convert between 6% (1 in 16 MQLs) and 25% (1 in 4 MQLs) to new customers. To be clear, these ranges do not apply to all B2B edtech companies, but they cover the vast majority of businesses in my experience.
So, if we track sales pipeline from MQL to Closed Won we can draw some inferences about what types of investments we can make to grow a venture. If we have an average annual contract of $10K, then we want a customer payback rate of 12 months or less, which means we can invest up to $10K in acquiring the customer. If we assume our closing rate is 4:1 for SQLs to Closed Won, which is okay, but not great then we can extrapolate that we could invest up to $2,500 per SQL. Now, I’m not recommending that you immediately invest that much per SQL, but that is the investment ceiling in the model. So, if you can invest that much per SQL, why wouldn’t you do as much as you can at a lower rate of $1,000 or even $1,500 per SQL? Applying this logic is a powerful way to unlock how much to invest in sales and marketing efforts and to measure Return on Investment (ROI) of your various marketing and sales initiatives.
Conclusion
There are many different models by which edtech startups grow, but by applying some simple analysis we can draw some important inferences about the efficiency and effectiveness of their growth engines and where teams can can focus on improvement. In addition, customer acquisition is difficult and expensive in edtech, but recurring revenue business models like SaaS make it possible to invest substantially in sales and marketing and grow a thriving, viable business at the same time. We often see entrepreneurs have great growth ambitions, but who unknowingly starve their growth engines due to lack of knowledge on the level of investment needed to successfully grow. We hope this information helps entrepreneurs realize they often have additional room to invest in growth and to set reasonable expectations for what they should get for those investments.
Do you think about growth in similar or different ways? Did you run your numbers and now have an investment plan? We’d love to hear from you.
