Behind the question of whether a billing system can help your SaaS business grow is the question of what it means for a SaaS business to grow. This guide tackles both — it creates a model you can use to approach SaaS growth and a 360-degree view of how your billing system fits into it. Read More >
One of the main questions that comes up when people are looking to start a subscription box business is, “How much should I charge for my box?”
While this is obviously an important question, it’s not easy to arrive at the answer without first determining four other important metrics that make up the basis of subscription box business financial projections. Determining these metrics gives you a working formula that can help you extrapolate a fair cost for your box based on factors exclusive to your business.
- Cost per Acquisition - How much does it cost you in marketing to acquire a single customer?
- Customer Churn Rate - The rate at which people unsubscribe from your service. This can be calculated on a monthly, quarterly, or annual basis.
- Customer Lifetime Value - The total dollar amount a customer spends, on average, between signup and deactivation.
- Profit Margin (on your entire box) - The profit divided by the selling price.
To make accurate financial projections on your subscription box, start by taking estimated guesses at the values of these important metrics. This will help you arrive at the best cost per box. If you’re already in business and have solid numbers, all the better. This should help you determine if you’re charging too much, or too little, for your subscription box.
Determining your cost per acquisition (CPA) is simple. Factor in your monthly marketing expenses (advertising, PR, social media) and divide by the number of customers you acquire each month. Say you spend $1,200 on marketing each month and, on average, acquire 33 new customers. This means your CPA is $36.36.
Now, to determine your customer lifetime value you need to know your churn rate. Here’s the formula:
Customer Lifetime Value = 1 / by average customer churn rate that month
How do you figure out your churn rate? If you’ve been in business for more than a year, take a look at all the customers who subscribed in January of 2014. What percentage of them are still subscribers today? For the sake of clarity, let’s say 100 people signed up last January, and within 12 months, 35% were still subscribed. That would mean your churn rate is 65%.
So your customer lifetime value (in months) for 2014 is 12 divided by .65, or 18.46 months. That means your average customer in 2014 will remain subscribed for 18.46 months.
Last, determine your profit margin. If it costs $6 to put a box together (including packaging) and you charge $19.99 per month, your profit margin is about 70 percent. But say you get that box cost down to $5 and you charge $24.95 per month. That gives you a better profit margin, around 80 percent.
So if you’re charging $35/month for a subscription with 80% gross margins (once you account for additional costs), you’d estimate a customer lifetime value of:
Having this number handy will help you determine what you can pay to acquire a customer and what your marketing budget should be. As a general rule, you want to keep your cost of acquisition to around 25-35% of your customer lifetime value.
So, how much should you charge for your box?
Let’s take a look at the formula again.
[monthly box cost] x [gross margin] x [customer lifetime (in months)] = [customer lifetime value]
You can tweak calculations by inserting different monthly costs, assuming different margins, and estimating average customer lifetime.
Here’s an example of a box with bad margins (business owner has a hard time negotiating good rates with vendors) and a high churn rate (customers don’t remain subscribed for long):
At this rate, it wouldn’t make sense to spend much on marketing unless the business owner raised the cost of this box, got her churn rate down, or negotiated better deals with vendors! If she raised cost of her box to $35, would her churn rate accelerate? Probably.
Let’s take a look at a box with great margins (business owner gets lots of product for free, total box cost to the business owner is $5.50) and a low churn rate (customers stay subscribed for almost 2 years):
Here, the business owner could afford to drop the cost of the box to retain customers longer. Here’s what that might look like:
Here, the slightly cheaper monthly subscription has a longer customer lifetime, but the margins are lower. Conversely, raising the price a bit might increase the churn rate, but with better margins, you’re still making slightly more money with each acquisition, and that gives you more money to spend on marketing.
So to summarize: how much you charge for your monthly subscription box depends on what your profit margins are on each box and how long your customers are staying subscribed. You also want to factor in how much it costs you to acquire a customer so that your marketing budget isn’t cutting too deeply into your operating expenses and the money you can afford to pay yourself for doing such an amazing job at figuring all this out.
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