Why CAC and LTV are ‘must know’ concepts for every entrepreneur

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Do you know what your business pays in sales and marketing costs to attract one additional customer? Do you know the average profit your business realises from a future customer relationship? Gaining insight into your Customer Acquisition Cost (CAC) and Lifetime Value (LTV) is crucial.

The long-term success of your business depends, at least to some extent, on how the cost of attracting a customer compares to the lifetime value of that customer. Let’s provide an example. You have a company that sells bicycles. To calculate your customer acquisition costs, you need to add up all your marketing and sales expenses incurred in a certain period. Let’s say, for instance, one month. These costs include all offline and online marketing expenditures, as well as that portion of your marketing and sales staff salaries dedicated to trying to sell bicycles to new customers. If the total monthly costs amount to £20,000, you need to divide this amount by the number of customers acquired in that month to determine your CAC. Let’s assume you were able to sell a bike to 50 new customers. Therefore, your customer acquisition cost becomes £400.

Alright – but then what? Why is this number a crucial KPI for so many business owners? Because it becomes interesting when you compare this number with the typical Lifetime Value (LTV) of a customer. The LTV indicates the total long-term profit you make from a customer. In our example, it’s the sum of the company’s profit from selling bikes, bike-related gear, and bike maintenance to this customer, provided that the customer returns to you for these additional purchases and services. You immediately sense that – to have a long-term healthy business – the LTV must be higher than the CAC. And ideally, much higher.

The CAC only takes into account sales and marketing costs and no other expenses. David Skok, an American serial entrepreneur, argues that a company should aim to make the LTV at least three times larger than the CAC.

Does it sound complicated to calculate these metrics? Probably. But some initial simple calculations on the back of an envelope can already give you an idea of how the CAC compares to the LTV in your business. Even if the numbers aren’t 100% accurate, understanding these concepts will help you think more about the importance of long-term customer relationships and efficient spending on sales and marketing.

It is important to revisit these metrics regularly, as they can change over time. A successful marketing campaign might lower your CAC, or an increase in repeat customers might raise your LTV. By keeping a close eye on these figures, you can make more informed decisions about your business strategy.

In addition to monitoring these metrics, it’s also crucial to understand the factors influencing them. For instance, external market conditions, changes in customer behaviour, or changes in your product or service offerings can all significantly impact your CAC and LTV. Regularly conducting market research and customer feedback surveys can provide valuable insights to help manage these factors.

Moreover, always remember that while striving for a higher LTV and lower CAC is generally beneficial, it is equally important to ensure the quality of your customer relationships. High customer satisfaction and loyalty often translate into higher LTV, as satisfied customers are more likely to make repeat purchases and recommend your business to others, thereby potentially lowering your CAC.

Lastly, the CAC and LTV metrics are not static. They should be continuously optimised as part of your business’s growth strategy. This optimisation could involve refining your marketing strategies, improving your product or service quality, enhancing customer service, or any other initiatives that increase customer value and decrease acquisition cost.

Remember, understanding and managing your CAC and LTV is not just about crunching numbers. It is about strategically shaping your business decisions and practices to foster sustainable growth and profitability.