on December 25, 2020 (last modified on April 20, 2022) • 18 minute read
When it comes to analyzing the financial health of your online business, the two most important metrics to pay attention to are customer acquisition cost (CAC) and customer lifetime value (CLV). Customer acquisition cost tells you how much it costs to acquire a new customer.
And, customer lifetime value signals how much a customer is actually worth to your business. When you turn these two metrics into a ratio – CAC/CLV – you can gain a ton of clarity around your business.
In this post, we’re sharing tips to help you analyze CAC and CLV and understand your business better, including:
As we alluded to above, CAC tells you how much it costs to acquire a new customer. And, customer lifetime value tells you how much a customer is worth.
Let’s say you run an eCommerce store selling custom furniture to bars and restaurants. It costs you $100 to acquire a new customer. However, customers spend about $500 on a purchase.
This means your CAC:CLV ratio is 5:1. In general, it is best if your acquisition costs are at least 3:1 of total customer lifetime value. This ensures that you have enough margin to pay your operating costs, COGS, and ensure that you remain profitable.
Knowing your CAC:CLV ratio is essential if you want to run a profitable business in a sustainable manner.Nothing will sink a business faster than spending more money to acquire customers than said customers spend in your business unless, of course, you have a rich relative or investors on speed dial who are willing to invest large sums of money in bailing your business out.Note: Just because you are acquisition costs are less than customer lifetime value doesn’t mean you are entirely out of the woods.
Bruce Hogan of SoftwarePundit explains what to focus on when measuring CAC/CLV ratio if your business is new, and not yet profitable.“CLV and CAC are two of the most important business metrics. To achieve profitability and long-term success, a business’ CLV must exceed CAC.
In addition, if the business is new and not yet profitable, CLV must exceed CAC by a ratio of roughly 3:1. If CAC exceeds CLV, the business should stop investing significant resources into customer acquisition, and instead focus on improving its CLV/CAC ratio.”
For newer businesses (under two years old), you should also pay more attention to average order value instead of customer lifetime value since you likely don’t have enough data to know the full customer lifetime value yet.
This can keep you from being in a precarious position where you spend a lot to acquire new customers, but you haven’t fully realized the revenue yet.
Juan Reyes of BoleARTE further adds why it’s vital to analyze CLV:CAC ratio, “When looking at CAC and CLV, these are two metrics that should be going in opposite directions for a healthy business, with CAC decreasing as your marketing efforts improve with continuous optimization and CLV increasing with the nurturing of current customers and launches of new products and/or services (innovation).
If you see these metrics start to plateau in your business that means that you have stopped optimizing a piece or all of your business (customer service, product/service, marketing, etc) and you will need to innovate in one or all of these areas by testing out new marketing channels, improving the customer experience, or launching new products/services.
A plateau in CAC or CLV is essentially a business’ first warning of troubling times and a need for change.”
“Customer Acquisition Cost or CAC encompasses the cost of converting a potential lead into a customer,” says Priya Kumari of Valasys Media. “This cost consists of the product cost and the cost involved in marketing, research, and accessibility.
Mathematically, CAC can be represented as follows:
(Annual revenue/customer)*customer relationship in years – The cost of customer acquisition.
CAC is a defining factor that defines the viability of the business model of SaaS companies. To maximize profitability the acquisition costs must be kept as low as possible. Ideally, the value of a customer should be three times the cost of acquiring them which means an LTV: CAC ratio of approximately 3:1.
CAC is amongst the most important business metrics as it shows the amount of money spent on attracting customers versus the number of customers acquired.
The lifetime value of a customer or customer lifetime value (CLV) is the total amount of money that a customer would supposedly be spending on a particular brand or business during their lifetime.
Mathematically, CLV can be calculated by the following formula:
CLV = Sum of revenue earned from a customer (annual revenue * average customer lifespan) – the initial cost of customer acquisition
The formula to calculate CLV itself signifies that prolonging customer lifetime or focusing on customer retention is important for any business to scale up their bottom line revenue goals.
In general, the higher the CLV the greater the profit. Whether it be the acquisition of new customers or the retention of existing ones, organizations will always require spending money. Acquiring new customers, however, can cost 5 times as much as retaining the existing ones.
Therefore, marketers who know their customer’s lifetime value can always work out ways to improve it.
Both CAC and CLV are correlated and give important insights on how efficiently a business is being run, whether money is being made or lost and where one can improve.
The two metrics together tell a comprehensive story about the success of the omnichannel marketing strategy of a brand.
CLV helps you understand the bottom line profit but that in turn requires an understanding of how much it costs to acquire a customer.
The two metrics in tandem help marketers holistically assess their business performance. These can further be broken down into more granular measurements that resonate with the specific parts of your business.”
However, calculating CLV can be more nuanced for some businesses than Kumari’s example.
Mike Catania of Locaris adds, “CAC is a great metric for the short-term understanding of how much it costs to acquire a new customer, but CLV is superior for medium and long-term evaluations.
Many companies put serious effort into getting the correct retention rate to two decimal places then guess at the discount rate. In reality, the discount rate is just as important and tells more of the story in your future projections.
This is particularly important with higher retention rates. As a simple example:
Margin = $100
Retention Rate = 95%
Discount Rate = 2%
CLV = $1357
Discount Rate = 3%
CLV = $1188
Changing the discount rate by 1%, which is sometimes an afterthought with some SAAS companies, represents a 14% change in CLV with identical numbers for the margin and retention rate. Having an accurate understanding of your CLV will inform you of your company’s longer-term health and provides material insight for investigating concerns if this number is trending downwards.”
It is one thing to know your CLV and CAC. It is another thing to be able to understand what’s happening well enough to make informed business decisions.
Here are some tips to help you with the latter.
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“One way to look at the CAC to CLV relationship is to evaluate the ratio between the two,” says Sasha Matviienko of growth360. “Ratios are perfect to understand how one metric does in relation to another. CAC to CLV is the metric you want to get just right. Too high CLV to CAC (e.g. 25:1) could mean that you are investing too little in growth and thus may be vulnerable to competition. While a flat CAC to CLV 1:1 means you need to look into lowering your customer acquisition cost.
An important tip here is to look at CAC to CLV ratio in dynamics except for evaluating the CAC to CLV for the past month and year to date, try looking at the past three months to spot immediate trends and understand where your company is headed. This is especially important when working in a dynamic environment such as eCommerce.”
Kevin Mercier of Kevin MRC adds, “Together, however, both these metrics answer the critical question of “What is the true value of each customer to my business? – which can by calculated simply by taking the ratio of CLV:CAC. For example, if your CLV is $300 and your CAC is $30, the ratio is 10:1.
Although there is no perfect CLV:CAC ratio as it is highly context specific, you can know a few things in order to interpret this “Magic Number”. A ratio that’s too low is not healthy as a 1:1 ratio would indicate that it costs too much to retain a certain customer. Too high a ratio, such as a 50:1, is also not ideal. That would indicate that your business is not spending on customers as much as it should.”
“By understanding your CLV and your CAC, you can predict how much profit you’re going to make but also know at what customer acquisition cost you start making profits,” says Jonathan Aufray of Growth Hackers Business.
“By knowing your CLV/CAC ratio, you’re able to know how much you may invest in marketing and CAC so your business continues growing while being profitable.”
“First, analyze them separately to make the metrics easier to interpret,” says Andrea Loubier of Mailbird. “CAC provides information on what gaining a customer may cost your company, while CLV shows the revenue each customer can bring to your business. By understanding these two metrics, you can better prepare your budgets and strategies with your marketing team.”
“Look at the classic calculation of dividing CAC and CLV by channel and then deciding if that channel should be stopped (less than 3x) or if that channel needs more investment (more than 5x) because that really gives you insight into what’s working and what isn’t,” says Nicholas Roberts of Global App Testing. “If you only look at it from a blended perspective you’re not looking granular enough at the data.”
“One thing I see missing from many marketing organizations is the discipline of factoring in the cost of labor and management to their cost of acquisition,” says Jordan Schneider of Soundstripe.
“In a channel like AdWords or Facebook, for instance, many will report on the ad spend allocated to the channel in a month, then divide that by the number of new customers acquired from that channel to determine their CAC.
But looking at ad spend alone is leaving out the cost incurred to the organization with regard to the labor managing those ads, which can sometimes be overblown.
At Soundstripe, we look at CAC in two ways.
The first is direct cost, which includes costs tied solely to a given channel (such as ad spend).
The second we call “total cost”, which factors in the a rough percentage of labor and management.
This gives the business a much better idea of what they are spending to acquire a new customer, and helps keep an eye on the cost of labor managing a given channel.”
“CLV shows the value of repeat business which helps you fine tune your marketing strategy and determine how much you should invest in your CAC,” says Paige Arnof-Fenn of Mavens & Moguls.
“CLV is very effective in both measuring where you make money and focusing resources on the most important activities that contribute to its value. It is critical to know what to keep doing and also what to stop doing to manage your budget most effectively and keep you on track.
Even when it is calculated correctly mistakes can happen if your CLV is not aligned with your business goals but make sure you use the correct inputs of customer data projections (not revenue) that start with actual performance to date and then forecast this out 2-3 years (not 30!) and include all your variable costs.”
Brian O’Sullivan of Mint adds, “One mistake businesses make is not using CAC and LTV to assess marketing on an ongoing basis.
Conversions, spend, and cost-per-acquisition are easily available and easy to understand. But you’ll end up allocating your budget inefficiently if you rely on them.
CAC and LTV can tell you which campaigns add the most value to your business overall. Most businesses look for a ratio of LTV:CAC of 3:1 or higher. Getting this number per campaign can tell you a lot about where to invest your marketing dollars.
The biggest barrier to using them is actually getting the data in the first place. The simplest way to start is to store the same unique ID per customer in Google Analytics and your backend sales data. You can then tie advertising cost data together with revenue in Google Sheets, Data Studio, or Tableau.”
“Calculate your CLV/CAC ratio for different customer segments to better understand what each segment is worth to your business,” says Sara Al-Mughrabi of The Yes Ladder. “This can help you make decisions about which segments to prioritize as you plan ahead.
For example, it may be worthwhile to increase your investments in segments with a high CLV/CAC ratio to remain competitive and encourage loyalty.
This doesn’t mean you have to give up on segments with a lower CLV/CAC ratio. Think of ways to upsell or cross-sell to those segments or create offerings that prolong their lifetime with your brand.
Don’t forget absolute revenue and segment size when planning out your efforts- a segment with a lower CLV/CAC ratio that brings in a considerable portion of your annual revenue may be worth the organizational effort needed to increase the ratio.”
For example, Jonas Sickler of Terakeet adds, “PPC ads that leverage hefty discounts may have a higher conversion rate and higher average order, but if the channel costs four times as much as SEO, your profit margins will shrivel up. Furthermore, those conversions are based on a deal, and you’ll need to keep baiting the hook to essentially “buy” conversions.
On the other hand, customers acquired by targeting top-of-funnel queries through organic search might take longer to convert and have a lower initial transaction value, but they could become lifelong customers and brand advocates that don’t wait for huge discounts to make purchases.”
“CLV to CAC ratio is often misused to determine the current and static state of a business’s profitability,” says Jay Toral. “However, it is a much better indicator of the general direction a business is heading over a longer period.
Typically, a CLV to CAC ratio of 1:1 or lower is considered unhealthy for a business since it implies that a customer costs the same to acquire as the revenue they bring in. This is a deceptive metric and can be a faulty assumption since CLV is a long-term measure, and CAC is an immediate upfront cost.
Newly acquired customers won’t yet have a calculable lifetime value, but they will have an acquisition cost. It’s more helpful to a business to look at the longer-term ratio trends.
Looking at the quarterly cycles, if the CAC has been trending down while CLV has been trending up, then having a 1:1 ratio is only temporary and should not be a cause for worry.
By watching the change over time on your business dashboard, you can more accurately measure the current health of the business and more reliably predict the future CLV/CAC ratio.”
“One thing we get our customers to do in the early phases of launching a digital product is to look at successful competitor products that have similar features to use as a benchmark for calculating expected future earnings but remember that these are simply projections,” says Bobby Gill of Blue Label Labs.
“When you develop an app or another piece of software, you’re often going to release an MVP that isn’t at full earning potential due to not yet having every planned feature incorporated, plus you’ll be dumping more into marketing and sales especially if your brand has yet to be established.
Your short-term financials need to be continually adapted around the actual earnings you receive in the early days (while factoring in CAC) as it’s common to see spells of dramatic growth surface for any number of reasons.
Once things stabilize, you’ll have a sturdy baseline for earnings established that needs to be used as the foundation for projecting your future earnings.
From here, you can derive a more accurate CLV against this observed, stable revenue stream as well as factor in expected earning earnings from future updates (i.e. new features.)”
The quickest way to improve your CAC/CLV ratio is to improve your customer referral engine.
Neal Johnson of NOW Property Investments says, “One proven way to increase pipeline velocity is by giving referral rewards to anyone that refers someone to your business that you actually work with. This has been proven to be our best marketing. Referrals produce our greatest ROI.”
Bruce Harpham of SaaS Marketing Services adds, “I recommend focusing on ways to increase CLV by generating referrals. Many companies focus all of their CLV efforts on selling more to the customer. In addition to that, asking a happy customer for referrals is a great strategy.”
While this lowers acquisition costs, it can also help you attract more customers that look like your ideal customer persona. That’s because existing happy customers are likely to refer new customers that are similar to themselves. However, the best way to improve your ratio long-term is to ensure that marketing and product are aligned. For example, Chris Jordan of Digital Current says, “For marketers, understanding the relationship between CAC and CLV has a lot of implications for your strategy and budget: If CLV has been consistent for a sustained period of time, then CAC either needs to be stable or decreasing. STo increase CLV, it might be time to work with your product development team to develop new revenue streams or develop marketing strategies around upsells and cross-sells. But if CLV is on an upward trend, that’s a very positive indicator. IT means your business is “moving upstream”—you’re getting better and more loyal customers. When that happens, it’s time to start re-evaluating your marketing acquisition channels and brand positioning. Because your loyal customers are spending more money and staying longer, you have to hedge for sustained growth. Taking on higher CACs to acquire better customers who spend more and generate an even better CLV is worth serious consideration at this point. This isn’t where the relationship ends—there’s many ways to interpret these numbers in combination with the rest of your data. But the biggest lesson is to track these numbers using a business dashboard software and constantly re-evaluate what you can do to optimize them.”
Running a profitable business means that you should be regularly monitoring your CAC and CLV metrics. If your CAC:CLV ratio is less than 3:1, you should proactively work to either lower your acquisition costs, increase customer lifetime value, or both.
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