Do you know the value of your customers?
More specifically, do you know the value of your customers throughout their lifetime with you as it compares to what you spent to gain those customers?
I know, I know. We should all place the highest value on our customers but I’m not talking about some ethereal, emotional stuff or your company culture here. I’m talking about real numbers - the true monetary value of your customers.
You absolutely MUST know this metric. The overplayed excuse of “my company is different” doesn’t fly here. (For the record, it doesn’t fly for any of the metrics leadership teams care about because no business is too complicated or different to know how they’re actually performing.)
The good news is that this article, our third installment in our “Metrics How-To” series, will help you figure out your LTV:CAC, along with why it matters to your company’s overall performance. Let’s get to it!
Prerequisites: Metrics How-To: Customer Acquisition Cost (CAC)
What is Ratio of Customer Lifetime Value to Customer Acquisition Cost (LTV:CAC)?
While the name of this metric sounds long and complicated, the actual definition is quite simple.
It’s an estimate of the total value your company receives from each client in comparison to what you spent to acquire that client.
The formula itself is a simple ratio calculation. We’ll dive into how to derive this ratio shortly, but let’s examine why this ratio is even important.
Why LTV:CAC is Important
Put simply, your LTV:CAC ratio allows you to easily define your Return on Investment (ROI) performance and develop a more educated growth strategy.
For example, a higher LTV:CAC means your sales and marketing teams are delivering more ROI to your bottom line. In other words, a higher customer lifetime value coupled with lower acquisition costs always results in stronger ROI.
Yet, believe it or not, the highest possible LTV:CAC is not always an ideal end result. “Are you crazy?! Who wouldn’t want the highest ROI possible,” you ask?
Well, consider this. A LTV:CAC that’s too high often means that while your current customers are delivering great ROI, your new customer acquisition initiatives are suffering – reducing the speed of your business growth. Thus, you must use this metric as a benchmark against your general business growth goals.
Like most things in life, the key here is balance.
How to Determine Your LTV:CAC
To determine your LTV:CAC, you must first have a grasp on your Customer Lifetime Value (LTV).
Here’s how to determine your LTV:
LTV = (Customer Revenue in a Period of Time – Gross Margin) ÷ Estimated Churn % for that Customer
Now, once you’ve got that figure you can simply compare it to your Customer Acquisition Cost (CAC) in a formula outlined below.
Let’s look at a quick example:
LTV = $500,000
CAC = $150,000
LTV:CAC = $500,000:$150,000 = 3.3 to 1
Beyond Your LTV:CAC
So what makes a good LTV:CAC? Unfortunately, I can’t answer that for you since you’re the only one that can say whether or not this ratio aligns with your revenue and growth goals. You now know how to derive this number and leverage it toward your own strategies.
If you’re looking to gain more control over your marketing reporting and performance, we can definitely help you with that. It’s an integral part of the inbound marketing services we provide our clients every month, quarter and year.