When it comes to running a business, understanding the metrics that drive success is crucial. Customer acquisition cost (CAC) and customer lifetime value (LTV) are two of the most important metrics businesses of all sizes should pay attention to, as they help in understanding the effectiveness of marketing and sales efforts and making data-driven decisions. Let’s delve into each metric in more detail.
What Is CAC and Why Is It Important?
CAC measures the cost of acquiring a new customer. One of the primary reasons this metric is so important is that it helps businesses determine how much they should spend on acquiring new customers. By analyzing the cost of acquiring a customer, businesses can optimize their marketing and sales efforts to reduce the cost of acquisition. This, in turn, helps businesses to allocate their resources effectively and focus on the channels that provide the best return on investment (ROI).
Understanding their CAC also allows businesses to monitor the effectiveness of their marketing and sales campaigns and to make adjustments as needed. This is particularly important for startups and small businesses that may have limited resources to invest in marketing and sales.
Calculate your CAC with this formula:
CAC = (marketing + sales costs) / # of new customers acquired
A low CAC is generally a good thing, as it indicates efficient and cost-effective customer acquisition. If your CAC is too low, however, it may suggest poor resource management in acquiring customers. A high CAC in relation to LTV (more on that later) may indicate inefficiencies in the customer acquisition process. Your ideal CAC largely depends on your industry, as well as other factors like marketing and sales channels, competitors, and target audience.
The industries with the highest average CAC include:
- Higher education ($1,143)
- Real estate ($791)
- Financial services ($784)
- Legal services ($749)
- Manufacturing ($723)
The industries with the lowest average CAC include:
- B2B SaaS ($239)
- Entertainment ($260)
- Construction ($281)
- IT and managed services ($454)
- Commercial insurance ($593)
What Is LTV and Why Is It Important?
On the other hand, LTV helps businesses understand the total value a customer brings to the business over their lifetime. This is critical because it enables businesses to identify and focus on high-value customers. By identifying these customers, businesses can develop targeted marketing and sales strategies to retain and upsell them. This helps increase customer retention rates and ultimately leads to higher profits over time. For businesses that operate on a subscription model, LTV is particularly critical, as it helps them understand the lifetime value of a customer and determine how much they can spend on acquiring new customers.
Comparing LTV against CAC can give business owners greater strategic insight than they would get analyzing either metric alone. An LTV-to CAC-ratio of 3:1 is a good general rule of thumb, meaning the value a customer brings to a business should be three times the cost it took to acquire them.
Benefits of Tracking CAC and LTV
All businesses should consider measuring their CAC and LTV, but especially startups and small businesses with limited resources. Here are the main benefits of tracking these metrics:
- Optimize resource allocation: When you understand the cost involved in acquiring a new customer, you can allocate sales and marketing resources more effectively.
- Improve efficiency: A CAC that’s too high or inconsistent may indicate business inefficiencies. Use the insights from your CAC to identify areas for improvement and improve your ROI.
- Align CAC and LTV: Tracking both of these metrics can help you balance your CAC-to-LTV ratio.
- Make more strategic decisions: Tracking CAC data can help you make more informed business decisions that align with your overall growth goals.
- Evaluate performance: Your CAC can help you assess the effectiveness of your marketing and sales efforts over time.
- Improve financial planning: Gleaning data insights from your CAC can help you determine viable customer acquisition channels, project revenue, set realistic budgets, and more.
- Gain investor confidence: A healthy CAC demonstrates that you understand your industry and target market, can handle resources effectively, and have a well-developed customer acquisition strategy, all of which can help instill confidence in potential investors.
CAC and LTV are also important for businesses that want to scale quickly. By understanding the cost of acquiring a customer and the total value a customer brings to the business over their lifetime, businesses can develop strategies to acquire new customers at scale while maintaining profitability. This is particularly important for businesses that operate in highly competitive industries where customer acquisition costs are high.
Conclusion
As we’ve discussed, CAC and LTV are two of the most critical metrics every business should measure and track. By understanding this data, businesses can make informed decisions that help them grow their business and achieve long-term success.
