Business Modelling – Community CAC

We see the explosion of ‘community’ everywhere around brands. The sudden desire for every brand of every type to create a ‘community’ is both a short-term trend and a long-term shift. Few can create – let alone sustain- a community for their brand(s), and for those who do the question is, what are the benefits for the business model? We look at community from the Customer Acquisition Cost (CAC) perspective in this post.

A lot of the high-growth communities that we see online are around digital products with either an open-source dimension, or products/services that encourage and rewards active participation. The majority of these types of businesses do not, therefore, pay to acquire their community members.

Other companies that are just entering the ‘community’ game are farming their customers from a database of their current customers, which includes a mix of paid and unpaid customers. They generally try to move their customers from passive channels such as an email or social media into more active channels such as Discord or other mediums.

There is (typically) significant a ‘Community Management + Moderation’ cost for any business that attempts to build an active community. This is why even a business were able to acquire members into an active, online community for ‘free’, there is a not insignificant cost to manage, maintain, and moderate it.

When looking at it in the context of the CAC, the Demand Generation Expense (numerator in the CAC equation) is the sum of money invested to acquire members and manage the community on an ongoing basis.

From a business model perspective, we know that the goal is to minimize the CAC in relation to the LTV. This doesn’t mean we necessarily always choose the cheapest option for CAC, as different Cohorts of customers have different behaviours and spending patterns, such as referrals. But a ‘community’ is in no way a cheap way to acquire customers when looking at the aggregated expense in general. What it needs to be benchmarked against is the CAC of other customer acquisition channels and the subsequent revenue patterns associated with customers in the Community channel.

Lessening the need to continuously bring in New Customers to drive margin and profitability is the key to keeping CAC (Customer Acquisition Costs) down, and margins (on a customer basis) up.

Business Model Analytics – Retention
Business Modelling – ARPU, LTV, CAC

Some communities are paid or part of a paid bundle of the product/service as a whole. Users pay a monthly (or pro-rated annual) subscription fee to enter a Discord/Slack/Telegram (or other equivalent) and gain access to a subset of content, connect with other members, participate in voice/video sessions, etc. This fee (let’s say $50 per month) essentially covers the time the Community Managers/Content Creators time as moderators. These communities generally have a contractual (subscription) business model.

Other communities are non-paid and used as a way to create engagement, drive referrals, and develop a tighter feedback loop with customers. The community itself usually sits on Discord/Slack/Telegram and is linked to some kind of social or financial (ie. exclusive access, monthly deals) to keep customers coming back to the channel. The fees for Community Management/Moderation are part of the staffing cost in their core business, so the cost is absorbed as some form of Marketing expense. These communities generally have a non-contractual (ie. retail) business model.

Certain digital products and brands are building their entire franchise off the community and scaling into the thousands/millions of customers off their respective communities. That’s why we need to be able to model Community CAC and look at it from both a contractual and non-contractual dimension.

Modelling Community CAC

Contractual Business (Subscription Model)

Imagine a community with 200 members paying $50 per month ($50 x 200 = $10,000). The ARPU (Annual Revenue Per User) will be defined by how long those members stay on an annual basis.

Say a community can sustain a 200 person membership for a year at a discounted annual rate (=$500). That would be $100,000 (200 x $500) in Annual Revenue ($500 ARPU). The cost to acquire those users (CAC) would have been a mix of either paid advertising or organic content creation. Imagine, hypothetically, that this cost $20,000 upfront in combined time/spend ($20,000 / 200 members = $100 CAC). The team must work to create content each week in order to maintain the membership. The Community Managers + Moderators need to be paid an annual salary of say $50,000 in total.

There is an argument to be made that the $20,000 in pure CAC is the acquisition cost, the $100,000 is the revenue, and the $50,000 is variable costs in relation to running the business:

Model 1

  • Revenue = $100,000 ($500 per year * 200 members)
  • CAC = ($20,000) ($100 per member * 200 members)
  • Variable Cost = ($50,000) (salary for Moderation+)
  • Marginal Profit = $30,000

If we were to blend the Community Management/Moderation cost into one calculation, it would look like this:

Model 2

  • Revenue = $100,000 ($500 per year * 200 members)
  • CAC = ($70,000) ($100 per member upfront CAC, and $250 per member in ongoing CAC)
  • Contribution Margin = $30,000 (ie. $150 per member)

The mechanics in Model 2 paint a completely different picture, one where you assume a large CAC cost in order to maximize the probability that the member will stay long-term.

As these models typically work, however, once an established Cohort of loyal customers is big enough to maintain at least a break-even point for the business, the network effects from referrals and word-of-mouth start to take over, which helps lower the CAC as the business grows. This is one way to look at the dynamics when talking about a contractual business model (ie. subscription).

As the CAC cannot continue on in perpetuity (it is an upfront cost within a specified period of time), this diagram above shows the stunning potential LTV in this model (much greater than the 3X LTV/CAC proxy for success).

Instead of building a niche community with an estimated marginal profit of $30,000 per year, we are looking at a business where customers who stay for multiple years generate extraordinary potential LTVs for the business. If a customer stays for 3 months, on the other hand, the business would be losing money on those customers.

Non-Contractual Business (Retail Model)

The framing on a non-contractual business for Community CAC is quite different than for a contractual business. The goal is linked to creating a Cohort of customers who drive long-term returns related to referrals, loyalty, and LTV.

However, when we track a cohort of customers (i.e., a group of customers acquired at the same
time) over time, we do not observe a constant retention rate; rather, we find that the retention rates tend to increase as a function of customer tenure.

Bruce Hardie

In the context of Business Model Analytics and Customer Value, we know that retention and loyalty are typically linked to referrals and word-of-mouth.

Business Modelling – Referral Data

The dynamics of a customer Cohort built via a community will be expected to be vastly different than those of paid channels, and likely quite different than those who are derived from other organic channels. But the bulk of the rewards are unlikely to be captured in the short-term.

The non-contractual business model (ie. retail) deals with purchases that are often times based on factors like seasonality, trends, etc. and are difficult to predict. But if customers who join a community become increasingly:

  • loyal to the brand (higher LTV)
  • likely to spend more per purchase (higher AOV)
  • probable to refer friends or colleagues (lower CAC)

Then the effects of building an engaged and growing community become exponential to the business model, especially if the growth of the community is non-linear. Non-contractual brands don’t typically look for ‘network effects’ in relation to customer acquisition, but communities are inherently designed that way once a critical user threshold is met.

Combined Models

And this where the build-the-franchise type opportunities exist for brand and products that build large and loyal communities. Engaged community members will spend large amounts of money over time, but there is an upfront investment required – in the right content, team, digital infrastructure, events, etc. – in order to build, maintain, and grow a vibrant community.

It seems that during the current trend, many see it as the opposite – as a relatively cheap way to gain customers. Unfortunately, this isn’t true. Expectations for what constitutes a ‘community’ are growing progressively higher everyday; but easy Telegram/Slack/Discord opportunities are dissipating as people want returns on the energy and enthusiasm they put into committing to joining a specific community. Communities must be invested into and designed in some way around the expected dividends in the future in relation to the business model.

Community CAC Proxies

As discussed above, the type of community will depend on a multitude of factors in relation to:

  • whether a business is contractual or non-contractual
  • the size of the company and available resources
  • the types of customers and geographical dispersion (local vs. global)
  • nature of the Customer Relationship

We are seeing early-stage movement in marketing away from traditional social media towards Discord and other related community networks.

Ironically, Discord itself grew to its current size through a strong community strategy of its own, driven by referrals and low CAC to get to scale. The didn’t have a referral program for their users prior to 2020, but they did drive unpaid referrals through their channel partners. Discord has a subscription (contractual) business model whereby the loyalty and value they add to the community typically manifests through long-term loyalty of various types of communities.

Discord didn’t pay its partners for getting new signups on their servers. However, the partners could make money by accepting donations and getting tips through Patreon. So, more people on your server means more chances to make money—even though the money wasn’t coming from Discord directly. This gave Discord partners a lot of incentive to do referral programs of their own. Partners used the Discord invite link to track referrals and gave rewards to people that got others to join their servers

Extole

Generally speaking, most overwhelmingly-successful community strategies to date have been in contractual businesses, or those with a pseudo-cult following around a brand that has the majority of its presence online. But that doesn’t mean non-contractual firms are not beginning to experiment with – and refine – community strategies.

A bevy of retail (non-contractual) brands have jumped on to Discord itself, but the fragmentation means that it takes some time for them to build their own communities and figure out the strategy between reaching customers who are ‘native’ to Discord (typically GenZ) and actively recruit current customers to the platform. Only 22% of its hundreds of millions of MAUs (Monthly Active Users) use it specifically for gaming purposes (for which it was originally designed), and no ads are allowed.

Launching a campaign on Discord is no easy task. The difficulty is that Discord is not designed to be a social network the way TikTok and Instagram are. The platform might boast more than 150 million monthly active users, but they are dispersed across thousands of smaller servers and are therefore difficult for brands to reach.

Modern Retail

Whether a brand wants to use Discord, Slack, or other similar types of ‘community networks,’ the nature of the engagement is having a discussion in real-time, which is much different from the nature of social media where advertising is allowed (in various forms) and the goal is virality of content (one-to-many).

Cashmere Agency, the marketing agency that ran the Discord campaign for Jack in the Box, has said that Discord’s main benefit is its ability to help brands form “relationships around common interests and having discussions in real time.”

New types of ‘community networks’ are launching, which are designed specifically for retail brands and their efforts to build community. Geneva is one such platform they are on, which bills itself as more of a ‘group chat’ application.

Some startups, like Thousand Fell, Mejuri and August, for example, are turning to a new chat tool called Geneva to foster so-called brand community. Geneva just launched out of beta this year, and has a number of ties to the DTC world.

Modern Retail

But there is no set strategy for retail brands to use as a proxy at this point. Experimentation will continue, and that is why it is important to have some kind of model to benchmark off of.

Brands aren’t finding massive audiences there: Rare Beauty, Selena Gomez’s cosmetics line, has 94 members on its Geneva page, compared to 3.2 million followers on Instagram and 821,000 on TikTok. Still, the brand is “doubling down” on Geneva, said Ashley Murphy, Rare Beauty senior director of consumer marketing.

Business of Fashion

Structuring Community CAC

The mechanics of CAC for the whole business need to be understood upfront. As mentioned above, starting-up a community is not a cheap or easy endeavor. It requires investments in time, energy, and resources. The dividends very rarely come right away.

Therefore, the benefits from a business model perspective need to be understood. The projected benefits of building out a community can not be marginal, they need to be potentially major and transformative.

Some questions to think about when structuring Community CAC:

  • Will it change the revenue profile of current customers? (ie. will more engaged customers spend more frequently)
  • Can it be used as a channel to help acquire new customers at a lower cost once it is established? (ie. once critical mass is reached, do the network effects take over)
  • Can the costs be offset through certain marketing strategies? (ie. this would be an interesting way to execute a referral strategy)
  • What are the potential LTV implications in a Community Cohort long-term? (ie. will more customers become repeat customers, and will repeat customers stay even longer)

These questions can help structure a cost-benefits analysis in relation to Community CAC.

Overall, the explosion of communities around the world is far from a fad. Whether businesses and brands can harness this ‘trend’, on the other hand, will be determined in many ways by how well the mechanics of Community CAC work in relation to their business models.

Related:

Business Model Analytics – Customer Value

Business Model Analytics – Retention

Business Model Analytics – Behavioural

Business Model Analytics – Channel

New Tech – Community Networks