Analyze your business Ep 341

In a recent episode, Alex from Mozie on acquisition.com, whose portfolio companies generate $85 million annually, shared valuable insights on business analysis. He discussed a critical framework for evaluating businesses, focusing on key metrics like new sales, current revenue, price, churn, lifetime value, and gross profit. By examining a hypothetical business case, Alex demonstrated how understanding these variables could reveal a company's growth potential and constraints. He emphasized the importance of knowing your business's hypothetical maximum revenue and the importance of reducing churn to increase enterprise value. Alex's approach is rooted in the theory of constraints, aiming to identify and remove the biggest barriers to growth, advocating for strategic focus rather than scattered efforts.

• Alex introduces a framework for analyzing businesses.
• The framework can be used to analyze one's own business or potential investment opportunities.
• Alex emphasizes the importance of entrepreneurs being able to perform quick, back-of-napkin calculations without solely relying on systems or finance reports.
• The framework involves five key variables, with a sixth as a bonus.

If you are good at something, you need tools. Welcome to the game, where we talk about how to get more customers, how to make more per customer, and how to keep them longer, and the many failures and lessons we have learned along the way.

This quote sets the stage for the conversation, highlighting the focus on business growth and the value of having the right tools and knowledge.

And I want to give you one of the most useful frameworks that I use to analyze a business, that you can use today to analyze your own business.

Alex is offering a practical tool for business analysis that he personally uses, emphasizing its immediate applicability for listeners.

And it requires five variables, and I'm going to show you what they are, and then I'm going to show you how I got the two hardest numbers that most people don't know how to get within their business.

The quote introduces the anticipation of learning about the five crucial variables for business analysis and hints at the challenge of obtaining two specific numbers.

• Number of new sales per month: A metric most businesses are aware of.
• Current revenue: A commonly known figure in most businesses.
• Price: Typically a known variable.
• Churn: A metric many businesses struggle to calculate.
• Lifetime value: Another challenging metric for businesses to determine.
• Gross profit: Introduced as a bonus sixth variable.

So I can even give you the 6th number, which will be a bonus one, all right, number one is going to be number of new sales per month.

Alex lists the first variable, indicating it's a number most businesses track.

The next number is going to be churn. Most people do not know this number. The next number is going to be lifetime value. Most people do not know this number.

This quote highlights two of the five key variables, churn and lifetime value, that businesses often have difficulty calculating.

• Alex uses a hypothetical example to demonstrate how to apply the framework.
• He discusses a business with 100 new sales per month, using this as a starting point for analysis.
• The conversation aims to extrapolate business potential, identify weak points, and assess the size of opportunity.

So I'm going to show you how in a simple conversation, we can figure out all of these things and extrapolate where a business is going to cap out where the weak points are and how we can see the size of the opportunity.

This quote explains the purpose of the conversation and the framework: to understand a business's potential and weaknesses and to evaluate opportunities for growth.

• The company is currently making $400,000 in revenue.
• They have 380 clients.
• The current price for their service is $1,000 per month.

They were doing four hundred k in revenue. Their current price was $1,000 per month.

The quote indicates the company's current financial performance and pricing model, which is essential for understanding its business scale and client valuation.

• The company did not initially know their churn rate or the lifetime value of a customer.
• By calculating, it was determined that 13 people cancel per week, which is approximately 50 per month.
• This led to a churn rate of 13%.
• Using the churn rate, the lifetime value (LTV) per customer was calculated to be approximately $7,700.

Churn. They didn't know. Lifetime value. They didn't know. It's 13% churn. So now I know that $7,700 is going to be the LTV per customer.

The quotes highlight the company's lack of knowledge regarding key business metrics and the subsequent discovery of a 13% churn rate and an LTV of $7,700 per customer. These metrics are crucial for assessing customer retention and long-term revenue potential.

• The hypothetical maximum (asymptote) for the company's revenue is around $9 million a year.
• The current growth is rapid due to high sales velocity.
• Growth will eventually slow down due to churn affecting a larger percentage of new business.

Which means that this business is going to cap out at month, all right? Which is about $9 million a year. So with this kind of sales velocity, they're going to keep growing pretty quickly, and then it's going to become an asymptote.

These quotes explain the concept of an asymptote in business growth, where a company's revenue approaches a maximum limit but never fully reaches it. The hypothetical maximum revenue and the impact of churn on growth are discussed.

• The company operates with over 90% gross margins.
• The cost to fulfill a customer is less than $100 for a $1,000 per month service.
• High gross margins are due to the low cost of fulfilling a customer's needs.

We know the churn now, which is 13%. We know the lifetime value of each customer now, which is 7700. And they were running over 90% gross margins. So for them, for that $1,000 a month customer, it cost them less than $100 to fulfill on.

The quotes provide insight into the company's profitability, revealing high gross margins and a low cost of customer fulfillment. These financial metrics are key indicators of the company's efficiency and potential profitability.

• Alex explains that the lifetime gross profit per customer is $7,000.
• A business remains profitable as long as the cost of acquiring a customer is less than this amount.
• Profitability is a key metric for assessing the viability of a business model.

"All right, so now you get roughly, let's say $7,000. Okay, so the lifetime gross profit per customer is $7,000, which means as long as we're spending less than $7,000 to acquire a customer, we are going to be a profitable business, right?"

The quote clarifies that the benchmark for profitability in customer acquisition is spending less than the lifetime gross profit per customer, which in this case is $7,000.

• There are two primary ways to grow a business: acquiring more customers or increasing the value of each customer.
• Alex highlights the importance of these fundamental growth strategies.

"So if we want to grow this business, we either have to increase this one or we have to increase this one. That's it. You can only grow a business by getting more customers or making them worth more, period."

This quote succinctly summarizes the two core strategies for business growth, emphasizing the necessity of either increasing customer numbers or their individual value.

• Alex discusses the impact of reducing churn rate from 13% to 3%.
• Reducing churn significantly increases the lifetime value (LTV) of a customer, which can transform the financial outlook of a business.
• Churn reduction is presented as a potentially easier and more effective strategy than increasing customer acquisition by tenfold.

"So if we change this to just 3% churn, all right, the new LTV becomes $33,000 per customer."

The quote explains the dramatic effect of churn reduction on customer lifetime value, illustrating the potential for increased profitability.

• Retention rates are crucial for the enterprise value of a company.
• Private equity firms typically look for a yearly retention rate of at least 80%.
• A 13% monthly churn rate results in keeping less than 20% of customers by year's end, which is considered undesirable for enterprise value.

"And FYI, for a company to have enterprise value, most private equity firms want to see 80% yearly retention, all right? Meaning you keep 80% of your clients per year."

The quote indicates the industry standard for customer retention that private equity firms seek when assessing a company's enterprise value.

• High churn rates can severely diminish the perceived value of an enterprise.
• Alex suggests that with a 13% monthly churn, a business is unlikely to be considered valuable by investors.

"Now, if anyone wants to venture a guess at what 13% monthly churn looks like, you're probably keeping less than 20% of your customers by the end of the year. And so for them, they don't think that's an enterprise that's very valuable."

This quote emphasizes the negative impact a high churn rate has on customer retention and, consequently, on the enterprise value as perceived by potential investors.

• Businesses are evaluated based on growth, stickiness, and profit.
• Growth refers to the rate at which a company is expanding.
• Stickiness indicates the likelihood of the business to retain its position in the market.
• Profit denotes the financial gain after accounting for all expenses.

"There's three main variables that they're going to be looking at. Any kind of potential buyer, which is what's the growth, right? Number one. Number two is how likely stickiness, which is like, how likely is the business going to be here? And then what's the profit?"

This quote outlines the three main factors that potential buyers or evaluators consider when assessing the value of a business: growth, stickiness, and profit. These factors determine the business's potential for sustainability and profitability.

• The objective is to transform businesses with medium growth, low stickiness, and low profit into ones with high growth, high stickiness, and high profitability.
• This involves identifying and addressing weak points in the business model.

"So you could pretty much multiply these things together, which is, if I have a super fast growth company, all of the revenue is super sticky and we're very profitable, then this is going to be a very valuable business. If I have a business that is mediumly growing, right, it is not sticky and I have low profit, then this is going to be a low value business."

Alex explains the process of multiplying the three key variables to determine a business's value. A business with high scores in growth, stickiness, and profit is deemed very valuable, while one with lower scores is considered less valuable.

• Business owners need to know their hypothetical maximum capability to identify caps and weaknesses.
• Knowing basic business metrics like new customers, sales, current clients, revenue, and prices is essential.
• Understanding customer churn allows for calculation of potential growth and identification of constraints.

"So right now, if you're a business owner and you don't know what your hypothetical max is with your current model and your current numbers, you are fooling yourself. You don't know where you're going to cap out, which means you don't know where your weak points are, all right?"

Alex emphasizes the importance for business owners to understand their maximum potential and weaknesses within their current business model. Without this knowledge, they cannot effectively identify or address the limitations that prevent growth.

• Businesses are organic entities that naturally want to grow but face constraints.
• The theory of constraints suggests that a business will grow up to its nearest constraint.
• The goal is to identify and remove the biggest constraint to facilitate growth.
• Focusing on the fewest actions that yield the most returns is considered a smart strategy.

"Because I'm a big believer in theory of constraints, which is a business will grow up to its nearest constraint. And so all I try and do is simply remove the constraints of the business to allow it to grow, right?"

Alex discusses his belief in the theory of constraints, which posits that businesses will expand until they encounter a bottleneck. His strategy involves identifying and removing these bottlenecks to enable further growth.

• Alex Ramosi reports from acquisition.com with a portfolio revenue of $85 million a year.
• He emphasizes that he has nothing to sell and encourages his audience to continue being awesome.
• Alex invites new viewers to subscribe to the channel if they enjoyed the content.

"And so, anywho, my friends, this is Alex Ramosi reporting in from acquisition.com. We're doing $85 million a year in our portfolio revenue, and I have absolutely nothing to sell you, Mosey Nation. Keep being awesome."

In his closing statement, Alex provides a brief report on his company's success and reassures his audience that his intention is not to sell anything but to share valuable insights. He signs off with an encouraging message and an invitation to engage with his channel.