Why Are Customer Acquisition Cost and Lifetime Value Important to Calculate?
You’ve heard it before: Customer acquisition cost (or CAC) and customer lifetime value (or LTV) are some of the most important metrics to track in business. Even in product management, the amount it costs to convert a new customer will impact your product’s marketing, price points, and overall roll-out strategy. Understanding these values is the first step toward making them work for you.
It’s simple — the money, time, staffing, and other resources used to acquire a new customer must be lower than that customer’s lifetime value for the business to be successful. If your CAC is higher than your LTV, it’s only a matter of time before the business closes its doors.
We know we need our CAC to be lower than our LTV, but how do you actually calculate these costs? And what can you do to decrease your CAC while increasing LTV? In this article, I’ll outline how to calculate your CAC and LTV so you can use them to optimize your product roll-out strategy.
The keys to balancing these two critical metrics are keeping customers happy and creating meaningful relationships before and after a sale. In doing so, you’ll build a solid product roll-out strategy that increases your customer base while retaining those customers for as long as possible.
So, where do you start?
How to calculate your CAC and LTV
Determining the cost of acquiring customers is simple. You add the total resources spent on sales and marketing over time and divide that sum by the number of customers you gained in the same period. For example, if you’re spending $100,000 monthly in sales and marketing to acquire 100 customers, your CAC is $1,000.
Your CAC alone doesn’t provide the full story of your product offerings or success without also understanding how much each acquired customer will spend over their lifetime. This is a bit more complicated to calculate.
Start by finding your average purchase value (known as APV), which is your total annual revenue divided by sales volume. Then you calculate the average purchase frequency rate (or APFR), which is your sales volume divided by the number of unique customers you have. You can split your APV by your APFR to determine your customer value (referred to as CV).
You need one last piece, and that’s your average customer lifespan (or ACL). This is calculated by adding all your customer lifespans together and dividing that sum by the number of customers. Divide your CV by your ACL, and — voila! — you have your customer LTV.
At this point, remember that your LTV should be comfortably higher than your CAC. It’s best to aim for a 3-to-1 ratio. For instance, if it costs a company $1,000 to acquire a customer, it would want its lifetime value to be at least $3,000. If you’re short of that, it’s time to consider some immediate improvements in sales and marketing efficiency in your overall product strategy, along with customer retention.
Now let’s talk about how to actually do that.
How to improve your CAC and LTV
We’ve mainly discussed numbers (so far), but the root of these numbers is much more profound. It’s easy to get so buried in the day-to-day tasks of work that we forget about our customers, and these calculations provide an easy way to quantify our relationships with them. There are three ways to improve your CAC to LTV ratio by focusing on your customers first:
1. Find the right audience via the customer journey.
The customer’s journey with your product is a specific path your ideal customer will take through your roll-out, marketing, and sales funnel and into your business. As a product manager, it’s essential to map out this journey to ensure you’re addressing the right people with the right information at the right time. For example, users that are already familiar with your product might not need the same introductory newsletter as a new visitor, so design your journey with that in mind.
Customer personas will also help you better refine your targeted ads and marketing. Major discoverability platforms (such as Google and Facebook) can target particular demographics; you can even set them up to retarget visitors based on how far they got through your product. This will optimize the ROI of your overall ad and marketing spend and give you valuable feedback about product roll-out and quality.
2. Leverage referrals and influencers.
Another way to improve your CAC and LTV ratio is by leveraging referrals and sources of influence to introduce new people to your product. Customer referrals are a powerful force, and happy customers often recommend brands and businesses they love to friends and family. Research shows that 93% of people trust friends and family to obtain information about services and brands, while only 30% of consumers trust companies. This means that someone else singing your praises is more effective than even your best ad campaign. Don’t be afraid to use this superpower in your product strategy, whether that be in testing or after launch.
Referral programs encourage current customers to onboard friends and family, often in return for a discount or some other form of incentive. Meanwhile, influencer marketing involves upping the ante by partnering with sources of influence within your target audience who have similar interests in your product category and large followings in your target market. Either way (when done right), you’ll likely spend less than you do on your internal product marketing team and will get higher conversion rates.
3. Create valuable content.
Customers need to get to know your product. More than anything, you need to provide helpful, engaging content if you want to improve a product’s CAC and LTV ratio. Whether through your website, email, social media, print, or in-store marketing, your content should highlight your brand voice and unique offerings while giving authentic and engaging information to anyone who sees it.
Aim to optimize the user experience (known as UX) throughout every step of your product strategy. Whether it’s functionality, features or marketing, everything should be consistently assessed and evaluated to ensure that you always provide every customer with the best possible experience. Then, introduce them to that experience with targeted content. Whether they’re learning about you for the first time or they’ve been a customer for decades, creating valuable and customer-first content appeals to everyone.
CAC and LTV are two significant numbers you’ll need to calculate and monitor for your business. These metrics are quick ways to identify whether you’re running a healthy business or are on the path to insolvency. But keep one thing in mind: These numbers only indicate how you’ve done in the past — you can always aim higher for the future.
