How to Understand Your Customer Acquisition Cost and Lifetime ValueRoss Katz
Two of the most important metrics for evaluating the performance of your business are the average Customer Acquisition Cost (CAC) of your customers and the expected Lifetime Value (LTV) of those customers.
When your CAC exceeds your LTV, then you will eventually go out of business. When your LTV exceeds your CAC, then your company will be profitable in the long-term as long as your overhead is reasonably low and your company can manage its operating margin to stay afloat.
In theory, your company should continue spending on customer acquisition up to the point where CAC = LTV. In practice, this depends on your goals for profitability and growth. If growth is your biggest priority, your company can continue spending on CAC until your CAC:LTV ratio is much closer to 1, say 1.3:1 or 1.2:1. If profitability is your larger priority, then your target for the LTV to CAC ratio will be much higher, say 3:1 or 2:1.
Customer Acquisition Cost (CAC) Calculation
Customer Acquisition Cost contains all of the costs your company deploys to acquire the customer. This includes:
- Marketing Spend
- Email Lists
- Sales Channel Fees
- Sales and Marketing Team Member Salaries and Contractor Fees
- Supporting Infrastructure for Sales and Marketing (i.e. CRM, Marketing Automation, Customer Data Platform)
Consider how long it takes you to acquire a customer. If your average prospect-to-sale cycle is 90 days, consider your quarterly costs for the above (and any additional costs you would categorize as being deployed to acquire the customer).
Then determine how many new customers you acquired in the last 90 days. A good proxy is the number of unique email addresses of users making their first purchase with your company.
Divide the total cost by the number of customers, and that is your CAC.
Can you do that same calculation by product category, sales channel, or marketing channel?
Lifetime Value (LTV) Calculation
Your customer’s lifetime value is the expectation of how much a customer will spend with your company over the course of their lives. The old adage goes: “It’s easier to keep an existing customer than it is to acquire a new one”. This is why LTV is so critical to the health of your business.
Use the questions below to estimate your LTV:
- Do customers execute multiple purchases/renewals from your company?
- What percentage of customers make 1-12 purchases from your company (or that number of renewals if you are a SaaS business)?
- What is the average purchase price?
For example, take the distribution below of customers making multiple purchases:
number of purchases * average purchase price * percent of customers = Weighted Contribution
Then, add the weighted contributions together:
Voila! You have calculated your Lifetime Value.
Manage Using CAC and LTV
These metrics can help you understand how to manage your business for long term growth and profitability. If your CAC:LTV ratio is growing, you are doing great! You may want to consider deploying additional marketing spend to acquire more customers. If your LTV is falling, you may want to explore how customers feel about your product or service and what is preventing them from making additional purchases from your company. If your CAC is going up without any change in strategy, dive into your marketing mix and discover the source of the increase. Your company may need to re-optimize its marketing portfolio.
At CorrDyn, we excel at helping business leaders understand their businesses more comprehensively. Our past projects have included a variety of data integration, data warehousing, and business intelligence efforts that enable business leaders to make better strategic and operational decisions, more frequently and more confidently.
If you want to discuss how we can enable you to understand your business more thoroughly, please start a conversation with us!