Measure ROI Using Customer Lifetime Value to Customer Acquisition Ratiopaulruddy_nq4pen
Customer Lifetime Value to Customer Acquisition Ratio (CLV:CAC)
The Customer Lifetime Value to Customer Acquisition Ratio (CLV:CAC) measures the relationship between the lifetime value of a customer and the cost of acquiring that customer. Sometimes a company will make the mistake of comparing the cost per acquisition to a single purchase and not the lifetime value. A company will break even if their cost per acquisition is equal to the customer lifetime value.
So how do you know if you’re spending the right amount? You need some numbers. First, you need to know how long the average customer sticks with you before they cancel their service. Because of course the longer a customer sticks with you, the more valuable they are.
Start by looking at your churn rate – the number of people who cancel their subscription in any given month. If you have 1,000 customers and every month 20 of them cancel, that works out to two per cent monthly churn. By simply inverting this value ( 1 / Monthly Churn ), you can calculate how many months on average your customers will stick around. At a 2% monthly churn, that works out to 50 months.
You will also need to know your Gross Margin % (the percentage of profit that remains after you have paid your costs for the product or service), and then how much money the average customer brings in each month.
Lifetime Value = Gross Margin % X ( 1 / Monthly Churn ) X Avg. Monthly Subscription Revenue per Customer
So, for example, if you had a gross margin of 75% and monthly customer churn of 2%, and each customer spent an average of $40 with you every month, the calculation would look like this: 75% X ( 1 / 2% ) X $40 = $1,500 LTV
Now that you have the lifetime value of a customer, you can turn your attention to calculating how much you spend acquiring a customer.
That’s usually the sales and marketing budgets together. The cost of acquiring a customer is the entire sales and marketing budget divided by the number of new customers acquired in a given period. This works really well if your sales cycle is short, where your sales and marketing costs can be tied to new customers in the same period. If it’s longer, you may want to stagger your costs and new customer wins to get a more accurate picture.
Cost to Acquire a Customer = Sales and Marketing Costs / New Customers Won
If you had total monthly sales and marketing expenses of $500K and you acquired 500 new customers in a given month, the calculation would look like this: $500,000 / 500 = $1,000 CAC
Ideally, you want to recover the cost of acquiring a customer within the first 12 months or so. In other words, if the average customer brings you $1,500 over 50 months, you should be spending about $360 to acquire customers.
An ideal LTV:CAC ratio should be 3:1.The value of a customer should be three times more than the cost of acquiring them. If the ratio is close i.e.1:1, you are spending too much. If it’s 5:1, you are spending too little. In fact, you are probably missing out on business.
It sounds straightforward and it is. But the fact remains, you need to know these numbers. Because the more you understand what drives your business, the better the picture you will get of the levers you can pull to grow your business.
Monitoring Marketing CLV:CAC KPI on a Dashboard
Once you have established processes for measuring CLV:CAC, you’ll want to establish processes to monitor this and other KPIs. Dashboards can be critical in this regard.
Learn more about how to track your CLV:CAC at www.blood-analytics.com