3 Ways That CAC-LTV Ratio Can Help Your Startup Grow

One of the most important metrics to understand for your start-up is the Client Acquisition Cost (CAC) to Customer Lifetime Value (LTV) ratio. The CAC to LTV ratio is the formula that will tell you exactly how much you can/ should be spending to on marketing to bring in new business. If your ratio is low, it could mean that you could be wasting money in the long term.

Let's start by understanding CAC and LTV

What is Customer Acquisition Cost (CAC)?

Customer Acquisition Cost means the total cost it takes to bring paying customers into your business. The way you calculate this is by taking the total amount of money spent on customer acquisition in a certain period and dividing that number by the total number of customers acquired within that same period. This cost should include the total amount spent on lead generation (ie ads, partnerships, etc) and sales personnel and commission.

CAC= Total Sales & Marketing Spend during a specific period/ Number of customers acquired in that period

For example, if you spend $1000 acquiring new customers in Q4 and acquire 500 customers, then your CAC is $2.

Lifetime Value (LTV)

Customer lifetime value is the average order total or contract value multiplied by the average number of purchases in a year multiplied by the average retention time in years. This provides the average lifetime value of a customer based on existing data. This information can be used with data from certain segments to better target retention and promotional efforts. It also provides a data point for use during customer segmentation.

Customer Lifetime Value = Average Total Order Amount * Average # Purchases Per Year * Retention Rate

Not only that, having a favorable CAC to LTV ratio showcases how valuable your company is. For example, if your CAC to LTV ratio is 1:3, that means that your customers' value is 3x the cost it takes to acquire them.

If you are just starting out, the best way to move forward on this is to take your best guess. For memberships and subscription models, I usually like to aim for at least 1-year retention as a model.

Calculating CAC-LTV Ratio

Now that you've discovered your CAC and LTV numbers, it's time to discover your CAC-LTV Ration. This part is simple.

Lifetime Value/ Customer Acquisition Cost

What is a good CAC-LTV Ration?

The target you should be working towards for CAC-LTV Ration is 1:3. That means, you are making back 3x what you are spending to acquire a customer. If you work all these calculations (or projections if you're just starting out) and discover your CAC-LTV Ration is less than 3, this is an indication that you are spending too much on marketing with not enough ROI. You may want to rethink your strategy and find a most cost-effective way to bring new customers through the proverbial door.

3 ways that CAC-LTV Ration can help your Startup grow

1. Insights on what type of customer to acquire

  • Looking closely at CAC-LTV Ratio for different customer segments is a smart way to understand which type of customer to spend your time/energy/ resources on and helps you double down on what's working for possible exponential growth.

2. How much you should spend to acquire customers

  • Understanding the CAC-LTV ratio provides a guide and benchmark for marketing spending regardless of how values differ depending on product cost and customer volume.

3. Raising investment

  • Remember, having a favorable CAC-LTV Ration is proof of your Startup's value. By focusing on this metric, you will be assured that your business will be profitable in the long run.

Remember, you can't improve what you don't measure.

Even if you feel like your marketing spent is out of control, I invite you to begin tracking your CAC-LTV ratio so you and your team can begin to hone in on what is working to consciously get more mileage out of all your sale and marketing activities.

Take a listen!👇🏻

You'll also love...

Victoria is a Marketing Mentor to early-stage founders. She has built compelling brands around the globe and has worked as a marketing director across several verticals. She is passionate about helping women think BIGGER about their businesses and giving them the tools to grow. She'd love to connect on LinkedIn or email her at hello@ugliboss.com.