The Mathematics of Business, Explained | Ep 990
In this episode of The Game, Alex Hormozi breaks down the fundamental mathematics that drive business success. He explains the relationship between pricing and close rates, sharing specific benchmarks that help identify whether a business is underpriced or experiencing sales process issues. He also discusses the optimal ratios between customer lifetime value and acquisition costs across different business types.
The episode covers practical strategies for improving business performance, including customer retention targets, lead response timing, and content creation volume. Hormozi outlines his "rule of 100" for achieving rapid growth, provides guidance on sales team utilization, and shares approaches for structuring payment terms to optimize cash flow. Throughout the discussion, he emphasizes the importance of maintaining healthy profit margins while scaling operations.
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1-Page Summary
Pricing and Sales Strategies
Alex Hormozi presents a detailed framework for understanding the relationship between pricing and close rates in business. He explains that close rates above 80% typically indicate a business is underpriced by 3-4x, while rates between 60-80% suggest 2-3x undervaluation. The sweet spot, according to Hormozi, is a 35-40% close rate, which indicates appropriate pricing. He advises that rates below 30% usually point to issues with the sales process or customer targeting rather than pricing.
For service industries, Hormozi recommends focusing on improving services and raising prices rather than increasing customer volume, emphasizing the importance of maintaining at least 80% gross margins.
Financial Metrics and Ratios For Business Performance
Hormozi outlines crucial LTV (Lifetime Value) to CAC (Customer Acquisition Cost) ratios for different business types. He suggests a 3:1 ratio for businesses without human interaction, 6:1 for those with some human element, and 9:1 or higher for businesses with multiple human touchpoints. Drawing from his experience, Hormozi shares that achieving high ratios (like his 100:1 during his gym's first year) can drive substantial growth.
Customer Acquisition and Retention Strategies
Speed is crucial in lead response, with Hormozi noting that contacting leads within 60 seconds can quadruple sales. He emphasizes the power of content creation, sharing that his business produces around 450 pieces of content weekly, leading to significantly better outcomes than competitors.
For retention, Hormozi sets an 80% annual benchmark for B2B businesses, explaining that high retention rates dramatically increase customer lifetime value and enable more effective scaling.
Operational and Financial Best Practices
Hormozi introduces the "rule of 100," recommending 100 daily actions for 100 days in a specific growth area to achieve rapid results. For sales teams, he advises maintaining around 70-75% utilization to optimize close rates and team morale.
Regarding payment structures, Hormozi recommends aligning payment terms with customers' cash flow cycles and offering incentives for prepayment. He suggests using strategies like setup fees, defined programs, and third-party financing to improve cash flow and reduce risk.
1-Page Summary
Additional Materials
Counterarguments
- Close rates can be influenced by factors other than pricing, such as market saturation, product quality, and brand reputation.
- A 35-40% close rate might not be ideal for all businesses, as some may thrive with higher or lower rates depending on their industry, competition, and business model.
- Low close rates could also be a result of external economic factors, not just sales process inefficiencies or poor customer targeting.
- Increasing customer volume can be a viable strategy for some service industries, especially if they can scale without compromising quality.
- A one-size-fits-all approach to gross margins may not be applicable to all service businesses, as some may have different cost structures or competitive strategies.
- The recommended LTV to CAC ratios might not be attainable for all businesses, especially startups or those in highly competitive markets.
- High LTV to CAC ratios are beneficial but may not be sustainable long-term as competition increases or market dynamics change.
- The effectiveness of contacting leads within 60 seconds might vary depending on the industry and the nature of the product or service.
- Producing a large volume of content may not yield better outcomes for all businesses, especially if the content is not of high quality or relevant to the target audience.
- An 80% annual customer retention rate might not be realistic for industries with naturally high churn rates or for businesses facing intense competition.
- The "rule of 100" may not be practical or effective for all types of growth areas or for businesses with limited resources.
- A 70-75% utilization rate for sales teams may not be optimal for all organizations, as some may require higher or lower rates to meet their specific goals.
- Aligning payment terms with customer cash flow cycles may not always be feasible, especially if it leads to inconsistent cash flow for the business.
- Incentives for prepayment could potentially alienate customers who are unable or unwilling to pay upfront.
- Setup fees and defined programs may not be attractive to customers who prefer more flexibility or a pay-as-you-go model.
- Third-party financing can introduce additional complexity and potential dependency on external entities, which could increase risk in some scenarios.
Actionables
- You can assess your pricing strategy by surveying customers post-purchase to gauge their perception of value versus cost. After a customer makes a purchase, send a short survey asking them to rate the value they received compared to the price they paid. If most customers indicate they feel like they got a great deal or more than their money's worth, it might be a sign that you could increase prices without hurting sales.
- Improve your service business's profitability by conducting a 'service audit' where you evaluate each service for quality and cost-effectiveness. Create a checklist that includes factors such as time taken, resources used, customer satisfaction, and profit margin for each service you offer. Use this to identify which services could be enhanced or priced higher, and which are not contributing enough to the bottom line and might need to be discontinued or restructured.
- Enhance your sales process by implementing a 'speed-to-lead' challenge where you aim to contact new leads as quickly as possible and track the results. Set a goal to reduce your response time to new inquiries, aiming for that 60-second window when feasible. Monitor the impact on your close rates and adjust your process accordingly, such as by setting up automated alerts for new leads or rearranging staff schedules to ensure someone is always available to respond promptly.
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Pricing and Sales Strategies
Hormozi outlines a comprehensive approach to pricing strategies, showing how close rates are inversely related to pricing in a business context. He emphasizes the importance of understanding these dynamics to optimize profitability.
Close Rates Inversely Related To Pricing
Hormozi discusses various hypothetical scenarios that highlight the importance of close rates and their correlation to business valuation.
80%+ Close Rate Indicates Business Underpriced by 3-4x
If a business has a closing rate of 80% or higher, Hormozi shows that this indicates the business is likely underpriced by three to four times its current rates.
Close Rate 60-80% Suggests 2-3x Undervaluation
For businesses with a close rate between 60 to 80%, it is suggested that they might be undervalued by two to three times.
Close Rate 50-60%, Business Likely Underpriced 1.5-2x
A close rate of 50 to 60% means the business might be underpriced by approximately 1.5 to two times.
Close Rate 40-50%: Business Likely Underpriced By 1.25-1.5x
Hormozi indicates that a close rate between 40 and 50% suggests the business may be underpriced by 1.25 to 1.5 times.
Close Rate of 35-40% Indicates Appropriate Pricing
A close rate of 35 to 40% is seen as a good pricing indicator, arguably where pricing should be set, assuming proper selling mechanisms are in place.
Close Rate Below 30% Indicates Sales Process or Avatar Issues Before Lowering Prices
Hormozi advises that if the close rate falls below 30%, it is likely due to issues with the sales process or targeting the wrong customer profile (avatar). These areas should be addressed before considering price reductions.
Balance Pricing, Close Rate, and Other Factors
Hormozi delves into the balance between pricing, close rates, and other key business factors, discussing the complex interplay between pricing decisions and business growth.
Lowering Prices Increases Demand but Reduces Profit Margins
He notes that lowering prices could increase demand but would also reduce profit margins.
Businesses With Limitless Scale Must Bala ...
Here’s what you’ll find in our full summary
Pricing and Sales Strategies
Additional Materials
Clarifications
- Close rate is the percentage of potential customers who complete a purchase after engaging with a sales process. It is calculated by dividing the number of sales made by the number of leads or prospects contacted, then multiplying by 100. For example, if 100 people are approached and 40 buy, the close rate is 40%. This metric helps businesses evaluate the effectiveness of their sales efforts.
- "Underpriced" or "undervalued" means the business is charging less than what the market or its true worth justifies. This implies the business could increase prices without losing many customers, thus earning more profit. It also suggests the business’s overall value or sale price is lower than its potential. Recognizing underpricing helps owners adjust prices to better reflect value and improve profitability.
- Close rates are inversely related to pricing because higher prices typically reduce the number of customers willing or able to buy. As prices increase, fewer prospects convert, lowering the close rate. Conversely, lower prices attract more buyers, increasing the close rate but often reducing profit per sale. This trade-off requires balancing price and volume to maximize overall profitability.
- In sales, an "avatar" refers to a detailed profile of the ideal customer a business aims to target. It includes demographics, behaviors, needs, and pain points. Defining an accurate avatar helps tailor marketing and sales efforts effectively. Misidentifying the avatar can lead to poor sales performance despite good pricing.
- Gross margin is the percentage of revenue remaining after subtracting the cost of goods sold (COGS), showing how much money is left to cover other expenses. Maintaining an 80% gross margin means the business keeps 80 cents from each dollar of sales after direct costs. This high margin provides a buffer to pay for rent, marketing, salaries, and other overheads while still making a profit. It also allows flexibility to invest in growth and absorb unexpected costs.
- Scalable businesses can grow rapidly without a proportional increase in costs, often through automation or digital products. Unscalable businesses require more resources, time, or labor as they grow, limiting their expansion. For example, software companies are typically scalable, while service-based businesses like consulting are often unscalable. This distinction affects pricing and growth strategies.
- Service-based businesses are typically unscalable because they rely heavily on human labor, which limits how much work can be done as the business grows. Each additional customer often requires proportional time and effort from employees or owners. This contrasts with product or software businesses, where one product can be sold repeatedly without extra work per sale. The 80% figure reflects the large number of small businesses focused ...
Counterarguments
- The relationship between close rates and pricing may not be as direct or universally applicable as suggested; other factors such as market conditions, brand reputation, and product quality can also significantly influence close rates.
- High close rates might indicate effective sales tactics or a strong product-market fit, rather than solely being a sign of underpricing.
- The suggested multipliers for underpricing (e.g., 3-4x for 80%+ close rates) may not be accurate for all industries or business models and could lead to overpricing if applied without market research.
- A close rate of 35-40% being indicative of appropriate pricing is a generalization and may not apply to all businesses, especially those in niche markets or with unique value propositions.
- The assertion that businesses with a close rate below 30% have issues with their sales process or customer targeting may overlook external factors such as economic downturns or increased competition.
- Lowering prices can be a strategic move to gain market share or to operate with a high-volume, low-margin model, which can be successful for certain businesses.
- The recommendation to focus on improving services and raising prices in service industries may not be viable for all service-base ...
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Financial Metrics and Ratios For Business Performance
Alex Hormozi dives deep into the financial metrics and ratios that are crucial for gauging business performance. He stresses the importance of understanding and leveraging these metrics to foster growth and ensure health in business operations.
Ltv to Cac Ratio: Key Business Health Indicator
Hormozi explains that different business dynamics require varying LTV (Lifetime Value) to CAC (Customer Acquisition Cost) ratios for optimal health and scalability. He outlines several scenarios based on the degree of human involvement in business operations.
Businesses Without Humans: 3:1 Ltv to Cac Ratio
For a business model like a SaaS product that operates with unlimited scale and zero operational drag, Hormozi points out that the target LTV to CAC ratio should be 3:1. This ratio applies mainly to approximately 5% of businesses that fit within certain conditions, such as having no human interaction in their attraction, conversion, and delivery processes.
6:1 Ratio Better Accounts for Training Inefficiencies
When a business adds a human element to the process, such as running ads through a salesperson or human-delivered services, Hormozi asserts that a 6:1 LTV to CAC ratio is necessary. This ratio accounts for the inconsistencies, or "lumpiness," introduced by human involvement, including the costs of training and potentially lower initial performance of new hires.
Ideal Cushion Ratio For Scaling: 9:1 or 12:1
In instances where business models encompass two points of human interaction, such as manual sales and service delivery, a 9:1 LTV to CAC ratio provides a stronger safety net to cover scaling inefficiencies. Hormozi explains that higher inefficiencies can arise from inducting new salespeople or technicians who may not match the performance levels of existing staff, hence the need for a substantial cushion before scaling.
High Ltv to Cac Ratios (E.G. 100:1) Drive Growth
Hormozi shares his personal experience, recalling that during the first year of his gym launch, he achieved a 100:1 LTV to CAC ratio, which amounts to spending $100,000 and making $10 million. He has also seen an LTV to CAC ratio above 30:1 four times, attributing this to a significant arbitrage between what it costs to acquire a customer and their worth. A favorable LTV to CAC ratio—whether it’s a near-zero CAC like Facebook’s or high LTV per customer like Salesforce’s—can lead to substantial business growth.
Gross Margins Cover Costs to Achieve Net Profit
Hormozi stresses the importance of high gross margins for covering costs effectively and thus achieving net profit.
Service Businesses Should Have Minimum 80% Gross Margins
For service businesses, Hormozi suggests that a minimum 80% gross margin is essential. If the cost of delivering a service is $100 per month, Hormozi explains that the service should be priced at $500 to attain this min ...
Here’s what you’ll find in our full summary
Financial Metrics and Ratios For Business Performance
Additional Materials
Clarifications
- LTV (Lifetime Value) measures the total revenue a business expects to earn from a customer over their entire relationship. CAC (Customer Acquisition Cost) is the total expense incurred to acquire a new customer, including marketing and sales costs. Understanding the balance between LTV and CAC helps businesses determine profitability and efficiency in acquiring customers. A higher LTV relative to CAC indicates a more sustainable and profitable business model.
- Different LTV to CAC ratios reflect the varying risks and inefficiencies in customer acquisition and service delivery. Lower ratios like 3:1 suit automated businesses with minimal variable costs and consistent performance. Higher ratios like 6:1 or 9:1 account for human factors such as training, turnover, and inconsistent productivity, which increase costs and reduce predictability. These larger cushions ensure profitability despite operational challenges and scaling difficulties.
- Operational drag refers to inefficiencies or costs that slow down or limit a business's ability to scale smoothly. In businesses without human involvement, operational drag is minimal because automated systems handle processes consistently and at scale. It includes factors like manual labor, errors, delays, or resource constraints that reduce efficiency. Eliminating operational drag allows for near-unlimited growth without proportional increases in cost or complexity.
- "Lumpiness" refers to irregular or uneven performance and results caused by human factors. Humans can vary in skill, speed, and consistency, leading to unpredictable outcomes. Training new employees often results in temporary dips in efficiency and quality. This variability creates challenges in forecasting and scaling business operations smoothly.
- Training inefficiencies increase the cost and time needed for new employees to perform effectively. This raises the overall Customer Acquisition Cost (CAC) because more resources are spent before achieving full productivity. As a result, the Lifetime Value (LTV) must be higher to maintain profitability. Therefore, businesses with human involvement need a higher LTV to CAC ratio to offset these initial inefficiencies.
- Gross margin is the percentage of revenue remaining after subtracting the direct costs of delivering a product or service. It is calculated as (Revenue - Cost of Goods Sold) ÷ Revenue × 100%. An 80% gross margin means that for every dollar earned, 80 cents remain to cover other expenses and profit. High gross margins are crucial in service businesses because they often have lower variable costs but significant fixed and operational expenses.
- Gross margin is the revenue left after covering the direct costs of delivering a product or service. This leftover money must then cover customer acquisition costs (CAC), which are expenses to attract and convert customers. After CAC, the remaining funds contribute to fixed overhead, which includes rent, salaries, and other ongoing business expenses. Sufficient gross margin ensures these costs are covered while still allowing for profit and growth.
- The payback period is the time it takes for a business to earn back the money spent on acquiring a customer. Aligning this period with credit card payment terms means the business recovers costs before interest charges begin. This helps maintain positive cash flow and avoids debt from financing customer acquisition. A short payba ...
Counterarguments
- The LTV to CAC ratios suggested may not be universally applicable, as they can vary greatly depending on the industry, market conditions, and specific business models.
- A 3:1 LTV to CAC ratio for businesses without human involvement might be too conservative for some highly scalable digital products, where the marginal cost of serving additional customers is negligible.
- The 6:1 and 9:1 LTV to CAC ratios for businesses with human elements may not account for the potential efficiencies gained through technology and process improvements in sales and service delivery.
- Aiming for very high LTV to CAC ratios could lead to underinvestment in customer acquisition, potentially slowing down growth if the focus becomes too heavily skewed towards profitability.
- The assertion that service businesses should have a minimum of 80% gross margins does not consider the diversity of service industries, where such margins may not be feasible or standard.
- The 30-day payback period for customer acquisition costs may not be realistic ...
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Customer Acquisition and Retention Strategies
Alex Hormozi emphasizes the importance of rapid responses and content creation in boosting sales and the pivotal role of customer retention in increasing a company's value and scalability.
Contact Leads Within 60 Seconds For Critical Response Time
Quick Responses Boost Sales 4x; Slow Responses Hurt Conversion
Hormozi stresses that calling leads within 60 seconds vastly increases the likelihood of conversion. He warns that slow response times allow potential customers to cool off and consider competitors, which can hike up the cost of customer acquisition, trim close rates, and shrink gross margins. He suggests that quick response times can quadruple sales, positioning rapid reactions as critical to conversion rates and overall business success.
Content and Advertising Drive Steady Lead Flow
Businesses Creating 10x More Content/Ads See 10x Results Over Competitors
Hormozi notes that a business producing content only once a day might see limited growth, as compared to his business, which creates around 450 pieces of content per week, amounting to 25 to 30,000 pieces of content annually. Despite diminishing returns for individual content pieces, the sheer volume of output leads to substantially better outcomes compared to competitors.
Boost Retention Through Quality Products and Excellent Experience
80%+ Retention Is a Good B2B Benchmark
Retention is highlighted by Hormozi as crucial for both business value and ease of operation, especially in B2B settings. He sets a good benchmark for annual retention above 80%, pointing out that retention rates are integral to calculating the lifetime value of a customer. For ...
Here’s what you’ll find in our full summary
Customer Acquisition and Retention Strategies
Additional Materials
Clarifications
- Close rates refer to the percentage of leads or prospects that a business successfully converts into paying customers. Higher close rates mean more sales from the same number of leads, improving revenue without increasing marketing costs. This efficiency boosts profitability by lowering the cost per acquisition and increasing gross margins. Conversely, low close rates require more spending to achieve the same sales, reducing overall business profitability.
- Gross margin is the difference between revenue and the cost of goods sold (COGS), expressed as a percentage of revenue. It shows how much money a company keeps from sales after covering direct production costs. To calculate it, subtract COGS from total sales, then divide by total sales and multiply by 100. Higher gross margins indicate more efficient production and greater profitability per sale.
- The 60-second response time is critical because studies show that leads contacted within this window are significantly more likely to convert. This is due to the lead's interest and intent being highest immediately after inquiry. The measurement comes from analyzing response times and conversion rates across many sales interactions. Faster responses reduce the chance of leads losing interest or choosing competitors.
- Producing "450 pieces of content per week" means creating a very high volume of marketing materials across various formats like social media posts, videos, blogs, emails, and ads. Each "piece of content" can be anything from a short tweet to a full-length video or article. This volume increases brand visibility and engagement, reaching more potential customers frequently. The strategy relies on quantity to build momentum, even if individual pieces have diminishing impact.
- "Diminishing returns" in content creation means that each additional piece of content tends to have less impact than the previous ones. Early content may attract a lot of attention, but as more is produced, the audience's engagement per piece often decreases. This happens because the market becomes saturated or the audience's interest plateaus. Despite this, producing a high volume can still lead to overall greater results.
- Customer retention rate measures the percentage of customers who continue buying over time. Higher retention means customers stay longer, increasing the total revenue they generate. Lifetime value (LTV) sums all future profits from a customer, so longer retention raises LTV. Thus, improving retention directly boosts the financial value attributed to each customer.
- In customer retention, a "turn" refers to one complete cycle of a customer's subscription or purchase period, typically one year. It measures how many times a customer renews or continues their relationship with the business. The number of turns helps calculate the total duration a customer stays active. This duration directly impacts the customer's lifetime value.
- An 80% retention rate in B2B means most customers stay for multiple years, ensuring steady revenue. B2B sales cycles are longer and relationships deeper, so high retention reflects strong trust and satisfaction. This stability reduces marketing costs and increases lifet ...
Counterarguments
- While rapid response times can improve conversion rates, the quality of the interaction is also crucial; a quick but poor response could be detrimental.
- Some industries or customer segments may not require immediate responses, and a well-crafted response later could be more effective.
- High volume content creation may lead to quantity over quality, potentially damaging brand reputation if the content is not valuable or relevant.
- Content saturation could lead to customer fatigue, where the target audience becomes desensitized to the company's marketing efforts.
- The 80% retention benchmark may not be applicable to all B2B businesses, especially those in volatile markets or with longer sales cycles.
- High retention rates are important, but focusing too much on retention could lead to missed opportunities for innovation and attracting new market segments.
- Customer acquisition should not always be prioritized over retention; a balanced approach may be more sustainable for certain business models.
- The assumption that high retention automatically enables ...
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Operational and Financial Best Practices
Alex Hormozi and other commentators discuss strategies for businesses to manage operational and financial aspects efficiently.
Implement "Rule of 100" for Consistent Growth
100 Daily Actions for 100 Days in a Growth Area
Hormozi introduces the "rule of 100," which he suggests can lead to consistent business growth. He explains that by committing to 100 actions every day for 100 days in one specific growth area, such as marketing, sales, or content creation, a business will likely see rapid traction and results, with some obtaining their first customer by the third week.
This Approach Leads To Rapid Traction and Results
The benefits of the "rule of 100" include overcoming the "feast or famine" cycle, especially for smaller businesses, by creating a steady flow of sales. Hormozi equates following this rule to having the heart of a missionary and insists on its potential for delivering substantial outcomes.
Optimize the Sales Team's Time and Utilization
Target 70% Utilization: Higher Reduces Close Rates, Lower Hurts Morale
For sales teams, the podcast recommends finding the right balance of utilization, targeting around 70-75%. Going above 85% can lead to overutilization which negatively affects conversion rates and increases customer acquisition costs. This is because an overutilized sales team won’t have time to follow up with potential leads properly.
Conversely, letting utilization fall below 60% might hurt morale as salespeople may become desperate to close sales, known as "commission breath." The aim is to maintain a balance where salespeople have enough time to work their pipelines effectively and maximize lead conversion.
Align Payment Terms With Customers' Cash Flow Cycles
Hormozi also suggests aligning sales payment terms with customers’ cash flow cycles. This encompasses setting payment dates when clients are most cash flush, such as on days they get paid or their deposits hit. By doing this, the business increases the chances of pulling cash forward.
Leverage Prepayments, Financing, and Other Creative Payment Structures
Offer Discounts and Benefits to Incentivize Prepayment and Pull Cash Flow Forward
Hormozi shares strategies like charging setup fees or selling defined programs to incentivize upfront payments, urging businesses to collect money within the first 30 days to cover the cost of delivering the service and acquiring the customer. ...
Here’s what you’ll find in our full summary
Operational and Financial Best Practices
Additional Materials
Counterarguments
- The "rule of 100" may not be feasible for all businesses, especially those with limited resources or staff, as committing to 100 actions daily could lead to burnout or diminished quality of work.
- Rapid growth strategies like the "rule of 100" might not be sustainable in the long term and could lead to operational challenges if the business is not equipped to handle the growth.
- A 70-75% utilization rate for sales teams is an average that may not apply universally; some teams or industries might require different utilization rates for optimal performance.
- Aligning payment terms with customer cash flow cycles could complicate billing processes and may not be practical for businesses with a diverse customer base.
- Incentivizing prepayment can be effective, but it might also limit the customer base to those who can afford to pay upfront, potentially excluding customers who prefer or need to pay over time.
- Offering discounts for prepayment could potentially reduce profit margins and might not be the best strategy for all businesses, especially those with tight financial controls or high costs.
- Relying on third-party financing companies introduces a third party into customer transactions, which could lead to complications or additional fees that might not be favorable for the customer or the business.
- Layaway a ...
Actionables
- You can create a personal growth tracker to apply the concept of consistent daily actions by setting a goal in a personal development area, such as learning a new language, and committing to specific, measurable actions each day for 100 days. For example, dedicate 30 minutes to language learning apps, engage in a 10-minute conversation with a native speaker, and write a daily journal entry in the language you're learning.
- If you're a freelancer or run a small business, consider adjusting your payment terms to match your clients' cash flow by having a conversation with them about their payment cycles and proposing a schedule that aligns with when they are most likely to have funds available. This could mean setting payment due dates right after a client's major sales period or after they receive their own payments, which can help ensure you get paid on time.
- Encourage yourself ...
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