The cost of acquiring new customers can be a real drag on your profits. But if you understand customer acquisition cost lifetime value, you can make sure that your acquisition costs are sustainable. I remember when I first started my business, I was so focused on getting new customers that I didn’t even think about the long-term costs. Thankfully, my mentor set me straight and showed me how to calculate customer acquisition cost lifetime value. Now, I always make sure that my customer acquisition costs are in line with my projected lifetime values.
What is Customer Acquisition Cost Lifetime Value?
The customer acquisition cost (CAC) lifetime value is the total amount of money that a company expects to spend on acquiring new customers, divided by the number of new customers that it expects to acquire throughout its lifetime.
The lifetime value of a customer (LTV) is the total amount of money that a customer is expected to spend with a company throughout their lifetime.
The CAC lifetime value is the ratio of the two metrics and is used to measure the efficiency of a company’s customer acquisition efforts.
Customer Acquisition Cost vs Customer Lifetime Value
How can you determine exactly how much you should be spending on your marketing efforts? How can you figure out what you can afford to spend on marketing while remaining profitable?
In e-commerce, the most important metric to answer this question is the customer’s acquisition cost and the value they bring to your business.
Both are important, but one of them is more important than the other.
Let’s go over what CAC is, why it matters to online retailers, and how to use it.
What Is Customer Acquisition Cost?
Customer acquisition costs describe the total cost of acquiring a new member of your customer base. This includes both direct costs and indirect expenses.
Online retailers face a wide range of costs.
The customer acquisition cost of a product is the total cost of advertising, marketing, and selling that product. This also includes any costs associated with storing and shipping that item to the customer.
This KPI is important because it helps a business achieve its profit goals. This is usually tracked by marketing, sales, and customer service departments.
Why Knowing Your CAC Matters
As a basic measure of a business’s profitability, CAC is a simple way to see if your business is on the right track.
If your CAC (customer acquisition cost) is much higher than your AOC (average order value), you need to lower it. You can do this through better marketing and by improving AOA.
Some ways you can do this are by raising your prices, offering a loyalty or rewards program, and other strategies.
A 60% increase in CAC is probably due to increased competition from other companies. This statistic helps you understand how much you’re spending to acquire new customers.
How to Calculate CAC
You can calculate the CAC with this equation:
Total sales and marketing costs can include:
- The salary or contract cost of anyone involved in your marketing campaigns.
- Overhead expenses such as equipment or office space used by your marketing staff.
- Any tool needed to acquire customers such as payment processing system and email marketing software.
- Direct advertising costs for search engines, social media, programmatic display, etc.
- Costs of delivering the product to your customers such as packing, shipping, and handling.
If a business spent $1000 on marketing in one year and acquired 20 new customers, their CAC (customer acquisition cost) is $50.
If you want to get reliable insights from measuring your customer acquisition costs (CAC) over time, it’s important to be consistent in which types of costs you include in the formula. This will allow you to accurately compare your results and make informed business decisions.
What Is Customer Lifetime Value?
Customer lifetime value is the amount of money you can expect to earn from the average client over their average life span.
For instance, a customer stays with your company for about 2 years and makes five purchases from your website each worth an average of $50. Your CLV then would be $250.
Why Knowing Your CLV Matters
Customer lifetime value (CLV) is incredibly important when attempting to sell products through e-commerce. This is because it presents a more holistic view of the customer’s revenue and profit potential for the seller.
Instead of looking at AOV, you get a better sense of the total value of a customer over their lifetime.
This metric can help you know not only how successful your marketing efforts have been, but can also help you focus on customer retention rather than acquisition. By understanding your CLV, you can make decisions that will help improve long-term customer relationships instead of just focusing on new customers.
The AOV of your first customer doesn’t matter too much if they aren’t going to be making major purchases from you in the future.
Loyal customers are worth their weight in gold. They spend 31% more than new customers, and 50% more than them will try new products and services.
Focusing on Customer Lifetime Value (CLV) means shifting your marketing strategy to focus on building a loyal, more profitable base of customers.
How to Calculate CLV
Calculating Customer Lifetime Value (CLV) can be simple or complicated, depending on how you approach it. Here is a basic formula for doing it:
To figure out your AOV, simply take the total amount of money you’ve earned from customers, and divide it by the number of purchases they’ve made. Your repeat purchase rate is the percentage of customers that buy more than once from you in the same period.
How CAC and CLV Work
CAC (Customer Acquisition Cost) and CLTV (customer lifetime value) are two sides of the same coin. They work best when considered together, as they provide a complete picture of business success.
The CLV to CAC ratio is a metric that compares the full value of a customer to the cost of acquiring that customer.
If the CAC to CLV ratio is less than one, it means the company loses money every time it gains a customer.
If the ratio is 1 or higher, it is a good indicator that a company is making money, but other factors, such as overhead, need to be taken into account.
Most businesses prefer to have a CLV to CAC ratio of 3 or higher. This can vary based on the company’s stage of growth and the level of competition.
A ratio of 5 or higher can indicate that more marketing investment could improve customer acquisition and boost sales.
4 Ways to Improve CLV to CAC Ratio
There are many ways to reduce your CAC while raising your CLTV. Below are just some examples.
Focusing on retaining customers is essential to achieving both.
1. Roll Out a Subscription Program
In the traditional e-commerce business model, your CLTV depends on your customer making a purchase every time they visit your site.
A subscription service allows you to automate the process of billing customers, which can increase convenience and predictability for your business.
2. Launch a Customer Loyalty Program
A customer loyalty program is an excellent way to encourage repeat business. It benefits both you and your customer, as the customer receives discounts for their continued patronage, and you receive increased revenue.
That, in turn, increases your CLTV without raising your CAC.
Loyalty programs are also known to increase customer loyalty and, as their name implies, brand affinity.
Unique, tangible rewards, especially for repeat customers, increase the chance of repeat business while lessening the chances of your buyer moving to another competitor.
3. Incentivize Referrals
Customer referrals are a fantastic source of new business. A happy client recommending you to their family and friends or in their industry is completely free.
Rewarding referrals is more cost-effective than investing heavily in ads that target specific demographics.
Of course, referrals only work well if customers actually like your brand and product. But when they do, strategic encouragement can have a big impact on your CAC/CLV ratio.
4. Reduce Reorder Friction
Imagine if you could have a system in place that automatically reminded customers that it’s time to order more products from you when their supply is running low.
In reducing friction, you also optimize your customer retention rate. By identifying the right times to reach out to your customers, you can save money while maximizing your revenue.
That’s great news for your lifetime value! By focusing less on CAC, you can improve your overall profitability.
Both CAC and CLV metrics are essential in measuring your marketing efforts. By focusing on the CLV/CAC ratio, you can gain tangible insights that will help improve your strategy and execution.
If you want to be successful in business, it’s important to understand the customer acquisition cost lifetime value. By doing so, you can make sure that your customer acquisition costs are sustainable. Keep this in mind as you grow your business and acquire new customers!