How much does your company spend on acquiring new customers? How much revenue do you generate from each customer over the course of their relationship with you?
When it comes to keeping tabs on your company’s profitability, two key metrics can help you out: Lifetime Value (LTV) and Customer Acquisition Cost (CAC).
Not only can you calculate these metrics individually, but you can combine and compare them to calculate your company’s LTV:CAC ratio. This ratio can reveal how effective your customer acquisition efforts are as well as how much money each customer is generating for your company.
The LTV:CAC ratio reveals the returns you get on the cost of acquiring a single customer.
Lifetime Value (LTV) refers to how much revenue (on average) a customer is generating for your company over the lifetime of their account.
It’s a metric that uses historical revenue data to estimate the average value of a typical user over the duration of their account.
To calculate your company’s LTV, you’ll use this calculation:
LTV = Average revenue per user / Churn rate
To breakdown this formula down a bit further:
- Average revenue per user (ARPU): the average amount of revenue a user brings in during a specific time period (a month, a quarter, a year etc.).
- Churn rate: the number of users you’ve lost during that same time period.
Acquiring new customers takes time and money. Customer acquisition cost (CAC) puts a dollar figure on how much it costs to gain a new user.
CAC uses historical data to tally up how much you’re spending on sales and marketing efforts.
To calculate your company’s CAC, you’ll use this formula:
CAC = Sales + Marketing Expenses / New customers
For example, take a company who in the last month spent $1000 on sales and marketing, and acquired 50 new customers as a result.
CAC = 1000 / 50
CAC = $20
LTV:CAC = Lifetime value (LTV/CLTV) / Acquisition cost
The ratio essentially measures your return on investment in sales and marketing. It’s most effective when used in conjunction with other metrics, or when broken down by various acquisition channels.
An LTV:CAC ratio higher than 1 shows that you’re generating more value from your users than you’re spending to acquire them. There’s no ‘ideal’ LTV:CAC ratio to be aiming for. You’ll need to compare the ratio with other metrics to understand things like which marketing channels you could be prioritising and whether customer retention needs to be a greater focus for your company.
With metrics, like your LTV:CAC ratio, you can start to understand the ROI of your users and whether your acquisition strategies are cost-effective or not.
Alone, the LTV:CAC ratio can’t tell you which marketing channels are delivering the most ROI. But, if you’re able to compare the CAC of different marketing channels (e.g. paid social advertising to Google Adwords campaigns), you’ll be able to pinpoint the platforms that are delivering the greatest returns.
Optimizing this ratio means reviewing your acquisition strategy and finding ways to improve your customer experience to keep users using your platform for the long term.
Do you know which marketing channels are helping you win customers in the most cost-effective way? If not, now is the time to dig into your acquisition analytics.
By segmenting your CAC by each channel you’re using, you’ll be better placed to understand which channels are the most effective in winning new users, without blowing your budget.
From there, you can start to re-evaluate how you’re managing your marketing budget. If you’re heavily investing in lower-performing acquisition channels, it could be time to rethink your marketing mix.
This could also free up more budget to spend on your most cost-effective marketing channels with a lower CAC, too.
Alongside user acquisition, retention needs to be a key focus if you’re looking to optimize your LTV:CAC ratio. By looking for ways to boost customer loyalty, you can extend the time users are engaging with your company and ideally increase their lifetime value.
That could mean gathering user feedback and using these insights to inform upcoming product features and platform functionality and even make changes to the way you handle customer service.
By calculating your LTV:CAC ratio, you can start to drill down into how cost-effective your acquisition strategies are, how much value your users are generating and what changes might need to be made to boost the ROI of each user you’re acquiring.
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