February 23, 2008

Multichannel Forensics: Online/E-Commerce Startup Example For Venture Capitalists And Founders

My work is increasingly focused on internet startups, focusing on the challenge of forecasting long-term sales based on almost no customer purchase/usage history.

I try to keep things simple. Here's a business that has been in existence for less than a half year. By recency, here is the probability of a customer buying in any given month.

Recency Custs. Buyers Resp.
1 1,239 88 7.1%
2 812 47 5.8%
3 522 26 5.0%
4 279 12 4.3%

Given the limited amount of information available here, let's take a wild guess at incremental response rates for twelve months of recency.

Recency Custs. Buyers Resp.
1 1,239 88 7.1%
2 812 47 5.8%
3 522 26 5.0%
4 279 12 4.3%
5

3.7%
6

3.2%
7

2.8%
8

2.5%
9

2.3%
10

2.2%
11

2.1%
12

2.0%

Obviously, your guess is as good as mine. We have no idea what will really happen. But it is important to make a guess.

Given that guess, we can estimate a twelve month repurchase rate (using an extension of the life table as described in the Database Marketing book:
  • 1 - ((1 - 0.071) * (1 - 0.058) * (1 - 0.050) * (1 - 0.043) * (1 - 0.037) * (1 - 0.032) * (1 - 0.028) * (1 - 0.025) * (1 - 0.023) * (1 - 0.022) * (1 - 0.021) * (1 - 0.020) = 35.5%.
An annual repurchase rate of 35.5% (and the actual rate will be lower, because we average all twelve month buyers, not just following a cohort through a twelve month period) puts this startup in "Acquisition Mode".

Now you might say, "duh, they're a startup, of course they are in Acquisition Mode". And you'd be right. But we're talking about the dynamics this business will need to deal with when it becomes mature, not what it needs to do for the next few years.

The dynamics suggest that if this business survives, its number one focus will always be to aggressively acquire new customers.

Fortunately, there's time to see how the business really evolves. And as the business evolves, these estimates are re-calibrated.

VCs like this information because it gives them tangible data about the long-term trajectory of the startup. If this startup can acquire an ever-increasing number of customers in a cost-effective manner, the startup has potential. Venture Capitalists get an early glimpse into the direction the startup is headed in.