11. Lifetime Gross Profit LTGP | $100M Lost Chapters Audiobook
In this episode of The Game, Alex Hormozi breaks down the key metrics businesses need to understand and calculate their profitability. He explains the fundamentals of Gross Profit and Gross Margin calculations, and demonstrates how businesses can determine their Customer Lifetime Value by analyzing transaction patterns and churn rates.
The episode focuses on the concept of Lifetime Gross Profit (LTGP), which Hormozi describes as the "arms race of business." He outlines different calculation methods for LTGP based on business models and explains why maximizing LTGP through customer retention can be more valuable than reducing customer acquisition costs. Readers will gain practical insights into measuring and improving their business's long-term profitability through these metrics.
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1-Page Summary
Calculating Business Metrics (Gross Profit, Gross Margin)
Understanding business profitability starts with two key metrics: Gross Profit and Gross Margin. Gross Profit is calculated by subtracting direct costs from total revenue, while Gross Margin expresses this profit as a percentage of revenue. These metrics help businesses evaluate the profitability of their products and services before considering broader business expenses, enabling informed decisions about pricing and cost control.
Estimating Customer Lifetime Value Metrics
Two crucial components for understanding Customer Lifetime Value (CLV) are average transactions per customer and churn rate. Businesses track average transactions by analyzing purchase frequency patterns. For companies with recurring revenue models, churn rate measures customer loss over time and is calculated by comparing customer numbers at the start and end of a period. For instance, if a business starts with 100 customers and ends with 95, the churn rate would be 5%.
Calculating Lifetime Gross Profit (LTGP)
LTGP calculations differ based on business model. For physical products, multiply average gross profit per transaction by average customer transactions. For recurring revenue businesses, divide gross profit per customer by churn rate. For example, with a gross profit of $2,400 per customer and 5% churn rate, LTGP would be $48,000.
Importance of LTGP as "Arms Race of Business"
Alex Hormozi describes LTGP as the "arms race of business," emphasizing that companies who can extract more value from each customer gain a competitive advantage. He argues that increasing LTGP is more valuable than reducing Customer Acquisition Costs (CAC), since LTGP can grow indefinitely while CAC can only decrease to zero. Hormozi recommends focusing on strategies that both attract and retain customers to maximize LTGP.
1-Page Summary
Additional Materials
Clarifications
- Direct costs are expenses directly tied to producing a product or service, such as raw materials and labor. They differ from indirect costs, which are overhead expenses like rent, utilities, and administrative salaries. Direct costs vary with production volume, while indirect costs remain relatively fixed. Understanding this distinction helps accurately calculate gross profit.
- Gross Profit is an absolute dollar amount showing how much money remains after subtracting direct costs from revenue. Gross Margin is a relative measure, expressing Gross Profit as a percentage of total revenue. This percentage helps compare profitability across different companies or time periods regardless of size. Gross Margin highlights efficiency, while Gross Profit shows total profit in currency terms.
- Churn rate measures the percentage of customers who stop using a product or service during a specific time period. It is important because high churn indicates customer dissatisfaction or better alternatives, which can harm revenue growth. Tracking churn helps businesses identify retention issues and improve customer loyalty. Lower churn rates typically lead to higher long-term profitability.
- Churn rate is the percentage of customers lost during a specific period. To calculate it, subtract the number of customers at the end of the period from the number at the start. Then, divide that difference by the number of customers at the start. Finally, multiply the result by 100 to get a percentage.
- Customer Lifetime Value (CLV) estimates the total revenue a business expects from a single customer over the entire relationship. It helps businesses understand how much to invest in acquiring and retaining customers. CLV considers purchase value, purchase frequency, and customer lifespan. Accurate CLV calculation guides marketing and customer service strategies to maximize profitability.
- Physical product businesses sell tangible items that customers purchase individually, often with irregular buying patterns. Recurring revenue businesses provide ongoing services or subscriptions, generating consistent income over time. The key difference lies in payment timing: one-time purchases versus continuous payments. This affects how customer value and profitability are calculated.
- For physical product businesses, LTGP is based on the total profit from all purchases a customer makes over time. For recurring revenue models, LTGP accounts for ongoing profit until the customer leaves, using churn rate to estimate customer lifespan. This difference reflects how revenue is generated: one-time purchases versus continuous payments. The churn rate helps predict how long recurring customers stay, impacting total profit calculation.
- Dividing gross profit by churn rate estimates the total profit expected from a customer over their entire relationship with the business. The churn rate represents the fraction of customers lost each period, so its reciprocal approximates the average customer lifespan. Multiplying gross profit per period by this lifespan gives the lifetime gross profit. This method assumes consistent profit and churn rates over time.
- The term "arms race of business" refers to the ongoing competition where companies continuously improve their ability to generate more value from each customer. It implies that businesses must constantly innovate and optimize customer value to stay ahead. This competition is relentless, as gains by one company push others to improve as well. The concept highlights the importance of maximizing long-term customer profitability over just minimizing costs.
- Customer Acquisition Cost (CAC) is the expense a business incurs to gain a new customer, including marketing and sales costs. Lifetime Gross Profit (LTGP) measures the total profit a business expects to earn from a customer over their entire relationship. While CAC is a one-time cost, LTGP accumulates over time as the customer continues to make purchases. A sustainable business model requires LTGP to exceed CAC, ensuring profitability.
- LTGP can grow indefinitely because it depends on how much value a business extracts from each customer over time, which can increase with better retention, upselling, or price increases. CAC, or Customer Acquisition Cost, has a natural lower limit at zero since you cannot spend less than nothing to acquire a customer. While you can optimize and reduce CAC, it cannot become negative or infinitely small. Therefore, focusing on increasing LTGP offers more long-term growth potential than solely minimizing CAC.
Counterarguments
- While Gross Profit and Gross Margin are important, they do not account for operating expenses, taxes, interest, and other costs that affect net profitability.
- Focusing solely on Gross Profit and Gross Margin might lead to underestimating the importance of operational efficiency and cost management in other areas of the business.
- The calculation of CLV based on average transactions and churn rate might oversimplify the metric, ignoring other factors such as customer acquisition cost, the potential for upselling, and changes in customer spending over time.
- Churn rate as a standalone metric does not account for the reasons behind customer attrition, which are crucial for developing effective retention strategies.
- The LTGP formula provided for recurring revenue businesses assumes a constant churn rate and gross profit, which may not be realistic as these can fluctuate over time.
- Hormozi's view on the superiority of increasing LTGP over reducing CAC might not apply to all business models or stages of business growth. For some businesses, especially startups, reducing CAC might be more critical in the early stages to ensure sustainability.
- The assertion that LTGP can grow indefinitely is overly optimistic, as market saturation, increased competition, and changes in consumer behavior can limit growth.
- The recommendation to focus on strategies that both attract and retain customers, while sound, may not acknowledge the need for a balanced approach that also considers product development, market expansion, and operational efficiencies.
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Calculating Business Metrics (Gross Profit, Gross Margin)
Understanding business metrics is essential for any entrepreneur or business manager. Two crucial metrics in this domain are Gross Profit and Gross Margin, as they provide insights into the profitability and financial health of a business.
Revenue Minus Direct Costs Equals Gross Profit
When calculating Gross Profit, the basic formula subtracts the direct costs of producing goods or services from the total revenue earned.
Gross Profit vs. Net Profit: Revenue After Expenses
It's important to differentiate between Gross Profit and Net Profit. Gross Profit is the money remaining after deducting the costs directly related to the production and delivery of products and services (like materials and labor), while Net Profit is what remains after all expenses, including operating expenses, interest, taxes, and other overhead costs, have been subtracted from total revenue.
Gross Margin Is Gross Profit as a Percentage of Total Revenue
Gross Margin, on the other hand, is a metric that expresses Gross Profit as a percentage of the total revenue. This percentage is important because it shows how much the company earns taking into consideration the costs required to generate its goods and services.
Gross Margin & Profit: Insi ...
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Calculating Business Metrics (Gross Profit, Gross Margin)
Additional Materials
Counterarguments
- While Gross Profit and Gross Margin are important, they do not account for the full complexity of a business's financial health, such as cash flow issues, debt levels, or asset management.
- Focusing too heavily on Gross Margin might lead to neglecting other important financial metrics like EBITDA, Net Profit Margin, or Return on Investment, which provide a more comprehensive view of a company's financial performance.
- Gross Margin can vary significantly by industry, so high or low margins should not be interpreted without considering industry benchmarks.
- The Gross Margin does not account for the potential impact of fixed costs, which can be substantial and can affect the overall profitability of a business.
- Decisions based solely on Gross Margin might overlook qualitative factors such as brand reputation, customer satisfaction, or employee morale, which can also significantly impact long-term profitability and business success.
- In some cases, a low Gross Margin might be acceptable or even strategic, for example, if a company is pursuing a market penetration strate ...
Actionables
- You can create a simple spreadsheet to track your personal income and expenses, mirroring a business's gross profit calculation. Start by listing all sources of income as your total revenue and then subtract the direct costs associated with generating that income, such as materials for a freelance project or gas for rideshare driving. This will give you a clear picture of your "gross profit" from various activities, helping you understand which endeavors are most financially rewarding.
- Develop a habit of calculating the gross margin for your side projects or freelance work. After determining the gross profit, divide it by the total revenue and multiply by 100 to find the gross margin percentage. This practice will help you evaluate the efficiency of your income-generating activities, showing you where you can adjust pricing or reduce costs to increase profitability.
- Use a personal financ ...
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Estimating Customer Lifetime Value Metrics (Average Transactions, Churn)
Understanding Customer Lifetime Value (CLV) is a key metric for businesses, as it helps predict the total value a customer brings over the course of their relationship with a company. Two critical components in estimating CLV are average number of transactions per customer and churn rate—both of which give insights into customer behaviors and business health.
Estimate Transactions per Customer
Businesses estimate the number of transactions each customer will complete to predict revenue and plan for future growth. Average transactions can be determined by looking at purchase frequency over a customer's lifetime.
Recurring Revenue: Understanding Customer Churn
Churn rate plays a critical role for companies with a recurring revenue model. It's the measure of customers that stop using the business' products or services over a certain time frame. Minimizing churn is vital to maintaining a solid customer base and ensuring revenue longevity.
Calculating Churn Using Customer Numbers
Calculating churn rate gives businesses an overview of how well they retain customers, which is just as crucial as acquiring new ones.
Churn Rate Is Vital for Revenue Businesses to Understand Customer Retention and Revenue Longevity
To calculate churn, you use the formula:
( \text{Churn rate} = \left( \frac{\text{Number of customers at starting period} - \text{Number ...
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Estimating Customer Lifetime Value Metrics (Average Transactions, Churn)
Additional Materials
Clarifications
- Customer Lifetime Value (CLV) estimates the total revenue a business expects from a single customer over the entire duration of their relationship. It helps companies decide how much to invest in acquiring and retaining customers. CLV guides marketing strategies by identifying the most valuable customer segments. Higher CLV means more sustainable and profitable business growth.
- A "transaction" in CLV refers to any completed purchase or exchange where a customer buys a product or service from the business. It includes one-time purchases, subscription payments, or any revenue-generating interaction. The value and frequency of these transactions help estimate the total revenue a customer will generate. Transactions are the building blocks for calculating average purchase behavior over time.
- Churn rate measures how many customers stop using a product or service over time. It indicates customer loss, which can reduce a company's revenue and growth. High churn means customers leave quickly, signaling potential problems with satisfaction or value. Lowering churn helps businesses keep steady income and build long-term relationships.
- Recurring revenue models generate consistent income through ongoing customer payments, such as subscriptions or memberships. Other business models often rely on one-time sales or irregular purchases. Recurring models focus heavily on customer retention and minimizing churn to sustain revenue. This contrasts with transactional models, where acquiring new customers is more critical than retention.
- New customer sign-ups do not affect churn rate because churn measures the loss of existing customers, not the gain of new ones. Including new sign-ups would distort the retention picture by mixing growth with loss. Churn focuses solely on how many original customers leave during a period. This helps businesses understand retention independently from acquisition efforts.
- Purchase frequency is measured by counting how often a customer makes a purchase within a specific time period, such as monthly or yearly. This data is collected from sales records or transaction histories. To estimate average transactions, businesses calculate the average number of purchases per customer over their entire relationship with the company. This helps predict future buying behavior and revenue potential.
- A high churn rate means a business is losing customers quickly, which can reduc ...
Counterarguments
- While CLV is a valuable metric, it can be difficult to calculate accurately because it relies on predictions of future behavior, which are inherently uncertain.
- Estimating average transactions per customer may not account for the variability in customer spending habits, which can lead to overgeneralizations and inaccurate forecasting.
- The focus on churn rate might lead businesses to prioritize retention over the acquisition of potentially more valuable customers, which could limit growth opportunities.
- The churn rate formula provided does not account for the time value of money, which could be significant for long-term customer relationships.
- The churn rate calculation does not differentiate between customers of different values, potentially obscuring the financial impact of losing high-value customers versus low-value ones.
- The assertion that new customer sign-ups do not affect churn rate calculation could be misleading, as the growth rate of new customers can be an important factor in overall business health and customer base stability ...
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Calculating Lifetime Gross Profit (Ltgp)
Calculating Lifetime Gross Profit (Ltgp) is essential for businesses to understand the long-term value of a customer relationship. It represents the amount of gross profit a customer accumulates over their relationship with a business, which is the total money made from the customer minus the cost associated with delivering the product or service.
Calculating Ltgp For Physical Products: Multiply Average Gross Profit per Transaction By Average Customer Transactions
Lifetime Customer Gross Profit Estimate
For physical products, the LTGP can be calculated by multiplying the average gross profit per transaction by the average number of transactions a customer makes. For example, if a widget is sold for $100, but costs $20 to manufacture and ship, the gross profit on a single transaction is $80. If a customer typically makes four transactions, the LTgp would be $80 times 4, or $320.
Recurring Revenue: Divide Gross Profit per Customer By Churn Rate to Calculate Ltgp
Formula Considers Ongoing Customer Value Adjusted For Departure Likelihood
In a recurring revenue m ...
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Calculating Lifetime Gross Profit (Ltgp)
Additional Materials
Clarifications
- Gross profit is the money a business makes from sales after subtracting only the direct costs of producing the goods or services sold. It does not include other expenses like marketing, administration, taxes, or interest. Net profit is what remains after all these additional expenses are deducted from gross profit. Revenue is the total income from sales before any costs or expenses are subtracted.
- Churn rate measures how many customers stop using a service during a specific time frame. It is crucial because it directly affects the total revenue a business can expect from its customers over time. A high churn rate means customers leave quickly, reducing lifetime value. Understanding churn helps businesses improve retention and forecast future earnings accurately.
- Dividing gross profit by churn rate estimates the average total profit from a customer over their entire relationship. The churn rate represents the fraction of customers lost each period, so its reciprocal approximates the average customer lifespan in periods. Multiplying profit per period by average lifespan gives total lifetime profit. This method assumes consistent profit and churn rates over time.
- Physical product sales involve one-time purchases where customers buy items individually. Recurring revenue models generate continuous income through subscriptions or ongoing services. The key difference is that recurring models rely on customer retention over time, while physical sales depend on repeat purchases. This affects how lifetime value and profit are calculated.
- Average gross profit per transaction is the typical profit earned from one sale after subtracting the direct costs of producing or delivering the product. To calculate it, subtract the cost of goods sold (COGS) from the sale price for each transaction, then find the average of these values over multiple transactions. This metric helps businesses understand how much profit each ...
Counterarguments
- The calculation of Ltgp for physical products assumes that the average gross profit per transaction and the number of transactions remain constant over time, which may not account for changes in customer behavior, market conditions, or costs.
- The method for calculating Ltgp in recurring revenue models does not consider the potential for customers to upgrade or downgrade their service levels, which can affect the gross profit per customer.
- Using churn rate to calculate Ltgp in recurring revenue models assumes that the churn rate is constant over time, which may not reflect real-world dynamics where churn can fluctuate due to various factors.
- Both methods assume that the cost to acquire a customer (CAC) is not significant enough to be included in the calculation, which could underestimate the true cost of maintaining the customer relationship.
- The text does not address the potential for negative gross profit in some transactions or customer relationships, which can occur if the costs exceed the revenue generated.
- The text does not consider the time value of money, which could make future profits less valuable than current profit ...
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Importance of Ltgp as "Arms Race of Business"
Alex Hormozi emphasizes the critical role of Lifetime Gross Profit (Ltgp) in maintaining a competitive edge within the business landscape.
Ltgp: Gross Profit From a Customer's Lifetime, Key For Understanding Acquisition Value
Hormozi refers to Ltgp as the "arms race of business," stressing that understanding and maximizing Ltgp is crucial for businesses keen on acquiring new customers and comprehending the value of each customer.
Maximizing Ltgp Gives Businesses an Edge In Acquiring New Customers
Ltgp represents the total gross profit that a business can expect to earn from a customer throughout their relationship. The company that can extract the most value from each customer ultimately gains the advantage, as it can afford to invest more in acquiring additional customers.
Boosting Ltgp Is More Impactful Than Cutting Cac Since Ltgp Can Grow Infinitely, While Cac Only Falls To Zero
Hormozi argues that businesses should prioritize increasing Ltgp over simply reducing Customer Acquisition Costs (CAC). Since Ltgp has the potential to expand indefinitely, unlike CAC which can only be reduce ...
Here’s what you’ll find in our full summary
Importance of Ltgp as "Arms Race of Business"
Additional Materials
Clarifications
- Lifetime Gross Profit (Ltgp) is the total profit a business earns from a customer after subtracting the direct costs of goods or services sold, over the entire duration of their relationship. It is calculated by multiplying the average gross profit per purchase by the number of purchases a customer makes during their lifetime. This metric helps businesses understand the long-term value of each customer beyond just initial sales. Tracking Ltgp allows companies to make informed decisions about how much to invest in acquiring and retaining customers.
- Customer Acquisition Cost (CAC) is the total expense a business incurs to attract and convert a new customer. It includes marketing, advertising, sales, and any other costs related to gaining that customer. Lowering CAC means spending less to get each customer, improving profitability. However, CAC cannot go below zero, limiting how much it can be reduced.
- Ltgp is called the "arms race of business" because companies compete to maximize the total profit earned from each customer over time. Like an arms race, businesses continuously improve their strategies to outdo competitors in extracting value. This ongoing competition drives innovation in customer retention and value extraction. The company that wins this race can invest more in growth and dominate the market.
- Ltgp (Lifetime Gross Profit) measures the total profit from a customer over time, while CAC (Customer Acquisition Cost) is the expense to gain that customer. A business must balance spending on CAC with the expected Ltgp to ensure profitability. If Ltgp exceeds CAC significantly, the business can afford to invest more in acquiring customers. Focusing on increasing Ltgp allows for higher sustainable spending on CAC, fueling growth.
- Businesses can increase Ltgp by upselling and cross-selling additional products or services to existing customers. They can improve customer retention through loyalty programs, excellent customer service, and personalized experiences. Enhancing product quality and regularly introducing new offerings also encourages repeat purchases. Finally, businesses can increase prices strategically without losing customers to boost overall profit per customer.
- Gross profit measures the money a company makes from sales after subtracting the direct costs of producing goods or services, showing core profitability. Unlike revenue, it reflects the actual earnings available to cover other expenses and generate profit. It is more actionable than net profit for understanding customer value because it isolates the profit directly tied to sales. This focus helps busines ...
Counterarguments
- While Ltgp is important, focusing solely on gross profit may overlook the significance of net profit and cash flow, which are also vital for the sustainability of a business.
- The concept of an "arms race" implies aggressive competition, which may not be the most sustainable or ethical approach for all businesses, especially those prioritizing social responsibility and long-term relationships over short-term gains.
- Maximizing Ltgp could lead to aggressive upselling or cross-selling that might not always align with customer needs or satisfaction, potentially harming the brand in the long run.
- The assertion that Ltgp can grow indefinitely may not account for market saturation, changes in consumer behavior, or economic downturns that can limit growth potential.
- Reducing CAC is not just about bringing the cost to zero; it's also about improving the efficiency and effectiveness of marketing efforts, which can have a significant impact on profitability.
- Customer retention strategies are important, b ...
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