Are You Paying Attention to This “Golden Business Ratio?”

I’m a copywriter, but I used to be an accountant. I get numbers.

It’s something unique I like to bring to any business relationship I have with my clients.

And speaking of your business’s numbers, you always want to have a handle on key ratios.

One vital but kinda complex ratio is Customer Lifetime Value to Customer Acquisition Cost…

Or LTV:CAC.

This ratio is made up of several component metrics. I’m going to explain this ratio and break it down so it doesn’t sound like a different language (and so you can see all the component metrics).

I’ll also cover what it means, how to evaluate your LTV:CAC to find ways to improve your business, a target to aim for, and a word of caution when using LTV:CAC.

Let’s get into this.

LTV:CAC

Customer Lifetime Value (LTV) estimates how much revenue an average customer generates over their entire relationship with your brand.

Customer Acquisition Cost (CAC) measures how much $$$ it takes to acquire each customer.

In short, LTV:CAC compares the total revenue a customer will generate to the cost of acquiring them. It’s basically a more comprehensive ROI calculation.

A high LTV:CAC means your advertising is cost-efficient and brings in a lot of customers, and you’re able to retain a lot of those customers for a lower cost.

A low LTV:CAC means you’re burning a lot on advertising for few customers, and you’re churning through existing customers. In short, you’re not very operationally efficient.

Calculating LTV:CAC

First, CAC because it’s easier.

Marketing $ / # of customers acquired

So if you spend $10,000 on marketing and get 100 customers, your CAC is $10,000 / 100 = $100/customer.

LTV has a much longer formula:

LTV = [ARPU * GM] * CL

We’re about to break it down:

• ARPU: Average Revenue Per User (over a period of time, generally a month)
• GM: Gross Margin
• CL: Customer Lifetime

Let’s break it down further.

ARPU = Monthly revenue / # of customers

GM = Gross profit / revenue

CL = 1/Monthly Churn

(By the way, monthly churn = # of customers that leave your brand that month / total # of customers that month)

What LTV:CAC Tells You

LTV:CAC tells you a lot of good things.

At the top level, look at the two metrics we’re comparing. It tells you a customer brings you $X revenue over their entire time with your brand for each $Y spent.

It’s a lot like a modified ROI — it can tell you if your efforts are actually improving profitability. Sure, you increased your LTV… but if your CAC also jumped by triple the amount, are you really doing that well?

From there, of course, you can break LTV:CAC down into its component metrics to identify specific ways to improve your business.

For instance, you might notice your monthly churn is above the industry average. Reducing your churn would make your customer lifetime longer (both mathematically and logically). Per the formula:

LTV = [ARPU * GM] * CL

You can see that a higher customer lifetime would increase LTV.

A higher LTV means a higher LTV:CAC — all other variables held equal, of course. More on that in a second.

What’s a Good LTV:CAC?

Like with any metric, this can vary by industry. However, there are some broad targets to strive for (or away from):

• LTV:CAC ~ 3: 3 is usually considered an ideal LTV:CAC on average. You’re inefficient, but you’re not being too conservative about reinvesting cash into new growth.
• LTV:CAC of 1 or less: You could be spending a lot on customers, but you’re not able to get them to buy much or stick around.
• LTV:CAC of 5 or more: Too high an LTV:CAC isn’t always good, either. If you’re a smaller company with lots of room to grow, it could signal you’re not deploying your cash optimally to maximize growth. Or, if you’re in a hyper-competitive niche (or trying to break into one), you might not be working hard enough to get new customers… relying only on existing ones.

A Note on LTV:CAC and Unintended Consequences

Everything works in theory, where you can hold variables constant.

In practice? Not so much… because of the difficulty of holding variables constant.

In terms of LTV:CAC… working on improving one metric within the broader ratio can mess up another metric — canceling things out or even making you worse off.

The easiest way to see this is to imagine a price increase. Jacking up your prices earns you more revenue per customer.

One problem: when you raise prices, you naturally price out some customers. If you hike prices on a whim, without any mathematical analysis, you might end up with less revenue overall. You might end up with the same ARPU (more revenue per customer… but fewer customers).

Another example: maybe you cut expenses to boost your gross margins. Unfortunately, that might leave you with fewer marketing dollars to remarket to existing customers, causing a disproportionate number of customers to churn.

Of course, these all come down to planning and doing the math.

Monitor Your Metrics (Like LTV:CAC)

Overall, improving your LTV:CAC comes down more to increasing LTV. Yeah, you want to try and bring your CAC down.

But, in my opinion, the easier wins can be found among the people who already trust you: your existing buyers.

Speaking of…

Want help with ideas for boosting your LTV?

I can help — just reach out to me today.