Decoding CAC and LTV
Do you know how much it costs to acquire a customer? Is it $5, $5000, $50,000? And do you know how much revenue each customer will generate for your business? If not- it’s time to find out.
One of my clients was doing a lot of email marketing for their product, and when my team and I started to dig into her CAC (Customer Acquisition Cost) we found that the client was spending WAY more to acquire a customer than each customer was purchasing. It was around $108 to acquire one customer from email and they were purchasing ~$25 per order and only a small percentage of those orders were repeat orders. It means that they either needed to reduce the cost to acquire down to less than $9 or they needed to bump up the average order value to over $300. This was tough news to hear and a big gap to correct.
The faster you learn your CAC and LTV and the LTV / CAC ratio - the faster you can be a profitable or more profitable business.
Both these metrics can give you a leg up on understanding where to invest your $$ to get more revenue.
HINT: it’s cheaper to retain customers than to spend all your $$ and time finding new ones.
The common pitfalls I see related to CAC and LTV:
> too much money spent on new customers (they're not working hard enough to keep customers)
> too little money spent on new customers (they could be getting more revenue by reaching more customers)
> no idea how much revenue is generated by each customer (no clue where to focus sales and marketing)
Key Terms;
CAC = Customer Acquisition Cost - This is what it costs to get a new customer, client, sale, etc…
LTV = Lifetime Value of each customer - this is the revenue generated over the lifetime of that customer
LTV/ CAC = a ratio that lets you know if you spend too much to acquire each customer. This is the most important part of the numbers. Anything above a 3 is good. This means if you get 3x the CAC for the LTV your business is in good shape. There is a WIDE range and it can take some time to see it clearly if you are FAR over 3 then you could spend $$ more to acquire customers depending on your goals and business structure.
How to think about CAC, LTV, LTV/CAC
There’s a cost to getting new customers and making sales. This is something all businesses should work to understand. For example, let’s say that you sell shoes, and the main way you market is via billboards. You spend $5K on a billboard and sell 150 pairs of shoes each time you put up a billboard. Each of those customers costs you $33.33. (5000/150=33.33)
The next part of this is - how much total revenue you get from that customer over the lifetime of that customer. For example, let’s say you sell coffee on a subscription. Each bag is $15 and that customer gets 1 per month for a year, that’s $15 x 12 months or $180.
$180 is their lifetime value.
Both of these numbers on their own are helpful, but what’s even more insightful is how they relate to each other.
If you are spending $33.33 to sell a pair of shoes and each customer only buys one pair of shoes that cost $150. Then your LTV/ CAC ratio is 4.5 - that’s pretty good!
But let’s say your shoes only cost $55 and each customer only buys 1 then your LTV / CAC is 1.67 - which isn’t great, but if you sell the shoes for $55 and each customer then buys 3-5 pairs of shoes because they love your brand and the fit and they’re just amazing… then you can start to see that LTV / CAC go in your favor and it has nothing to do with the price of the shoes!
Let’s return to the coffee subscription and play around with that one. You can see that this ratio can change easily and there are a lot of factors.
For this example, I’m going to make a basic assumption based on absolutely zero data that it costs $50 to acquire 1 customer. You can see below that if a customer stays for 12 months the LTV / CAC is 3.6 which is over 3, so that’s good. That means that you are making more per customer than you are spending to acquire them.
Then you can also see below that if a customer stays for 2 years, then you’re in excellent shape. And last, if they cancel after 1 month and that happens frequently or to more than 30% of your customers, there is something that needs to be corrected immediately. It is A LOT cheaper to keep a customer than to find new ones.
I recently bought something because the website funnel was so good that it seemed like a no-brainer. then the product didn't ship.
I emailed, and they said they would check.
Two weeks later still nothing
I asked for a refund. I didn't even get the product and now I won't order it again. And if asked, I would tell someone not to order from them. My compassionate side almost sent them an email asking if they needed a CFO. I felt bad for them because it probably cost a lot to get me as a customer and they blew their chance for any long-term value.
An often-overlooked way to be more efficient in your business is to find ways to increase the lifetime value of each customer rather than only spending time on new sales.
There are some industries – single-family real estate - for example where you rarely get repeat customers. If you are only going to buy and sell a single-family home once every 10 -20 years, you may or may not keep the same realtor. Some do, but in this industry, the LTV is simple – it is the revenue generated from one customer for one transaction.
How to find CAC
I love reviewing CAC. It’s not particularly difficult, yet it’s also not that straightforward. My jam when things require a nice balance between intuition and process and that’s exactly what CAC needs. Also required: a small amount of creativity and a deep understanding of how sales and marketing are done specific to each business.
The quick way:
All your marketing & sales costs / the number of NEW customers in a particular period.
Let’s say you want CAC for September. Take all the $$ you spend on marketing & Sales and divide it by the number of new customers, new sales, and new clients that you signed in that month.
This way is quick and has its flaws.
Flaw #1 - not all your new customers that you got in September are a direct result of the $$ spent in September. In my business model (professional services), I could have a conversation with someone 10 months prior, have 2 more meetings, and then get a referral. I cannot take my sales & marketing in a particular month and divide it by new customers.
Flaw #2 - not all the sales and marketing $$ are weighted the same. Sometimes you have a sales team and sometimes you’re solely relying on SEO. I take out the Sales team salaries when that team isn’t 100% directly focused on building a sales funnel.
The better way:
Do what makes sense to you and what matches how you run your business!
If you’re a SAAS business with a sales team of 10 and all your business is from direct outreach - you need to look at your CAC on a quarterly or annual basis only. Monthly isn’t going to be helpful - it could hurt.
If you are a product business and you ONLY run social ads. You’re going to get a pretty clear picture pretty fast, and you can look at it monthly and take only your ad spend / new customers.
The best way:
Get professional help. A second set of eyes on this is invaluable.
How to find LTV
LTV or Lifetime value can involve a lot of guesswork and update it as you have more data. Any data that has less than 5 years on it, isn’t the most helpful when calculating LTV because you simply may not know if your customers are going to stick to sound 2, 5, 10 years. Use some data and some intuition to help you determine how long your customers stay.
For the coffee subscription service, at some point you’ll have data that will tell you how long people are remaining customers. Use that, but until then you’ll have to guess based on how long comparable business models might stay or simply make your own assumptions.
For other businesses - especially those with less than 5 years of data, you will need to guess (or as the fancy finance people say - make some assumptions).
Here are a few I have used based on their business model and product:
App services - 2 years
Professional services - the length of a typical project or service
Physical products:
Cleaning products - 5-7 times per year depending on how long it takes to use an up a product
Apparel - 3-4 purchases in a year (choose an average order value that makes sense for your price point)
Any Home Depot customer that does “home projects” at least $50K per year (kidding… by maybe more like $5-10K per year).
B2B SaaS - 2x your average annual contract value
LTV / CAC: The Magic Number
Sorry if saying the word “Ratio” triggers some math PTSD, but at least this is applicable, and you won’t get tested.
CAC and LTV are a little helpful, but not meaningful until you look at them. As in all finance, individual numbers are only somewhat important, it’s the relationship to the other numbers on your P&L or balance sheet that tells the story.
To get LTV / CAC all you do is take your LTV and divide by your CAC.
Let’s use a service-based business as an example for this one. CAC is hard to calculate for any business where the sales cycle is referral-based, but I’ll do my best to develop something.
Referrals take time. Let's assume you spend a minimum of 3-4 hours a week on average sending emails, doing in-person and virtual networking, and staying on top of the sales pipeline of your service business. 4x4 = 16 hrs. (minimum hrs.).
Let’s just keep it simple and pretend that’s worth $200/hr to your business. It could vary a lot depending on different types of businesses and who is doing what.
That’s 16 x $200 = $3,200 of time per month. And let’s say that time brings you 1 client.
Again, to keep it simple - let’s say that you get 1-2 recurring clients a month that each pay between $1500/ month (and no, I don’t think this is 100% accurate because referral based businesses are unpredictable you can get zero 3 months in a row and 5 the next)
I’m going to exclude project-based clients and assume all are paying a monthly fee and stay an average of 18 months.
Average fees are $1,500 x 18 months = $27,000 lifetime value
LTV / CAC = $27,000 / $3,200 = 11.3 LTV / CAC which is fantastic
You can see in the table below there is a lot of variation between how long that customer stays, how much it costs to acquire 1 customer and your fees.
If you only charge $500 /month, but it takes 16 hours to get 1 customer and they only stay 6 months, your business isn’t profitable.
$500 x 6 = $3500 LTV
Divided by:
$3200 CAC
= 3500 / 3200 = 1.094 << not a good ratio! 3 and higher is the aim and in my personal opinion that 3 only applies to high-growth early-stage startups.
CAC and LTV change over time. You may have a CAC of 2 one month and 12 the next. That’s why it is so important to make sure how you calculate CAC and LTV are tied to the specifics of your business!
What next?
This is just the tip of the iceberg with CAC and LTV. If you have specific questions don’t hesitate to email me at hello@financefightclub.com and I will make sure to answer them in a blog, newsletter, and direct email to you.
Take some time to calculate your CAC & LTV and find that LTV/ CAC Ratio. This is especially helpful if you’re not sure about your pricing or sales strategy or both! It might lead to a new product idea, a sales funnel that’s more efficient, or shutting down a product or service that doesn’t serve your business.
