LTV:CAC (or Lifetime Value to Customer Acquisition Cost) is an important financial metric used by marketers to understand the profitability of an acquisition channel. It allows them to quantify the predicted return on their marketing spend and helps to inform decisions on which channels should be used to drive the maximum ROI.
The LTV:CAC ratio calculation requires the input of two key metrics, the Customer Lifetime Value (LTV) and the Customer Acquisition Cost (CAC).
Customer Lifetime Value (LTV) is the total value a customer will generate for a business throughout their relationship. It takes into account all of the profitable activities that the customer engages in and is typically calculated over a specific time period (e.g. 12 months). To calculate the LTV for a customer, you need to determine their Average Order Value (AOV) (i.e. how much they spend each time they purchase from your business), the number of purchases they make (over a given period), and the average length of their relationship with the business. For example, if the Average Order Value (AOV) was £50 and this customer purchased 10 times over 12 months and their relationship with the business lasted, on average, 3 years, then the LTV would be calculated as follows:
LTV = AOV * Number of Purchases * Average Length of Relationship
= £50 * 10 * 3
= £1,500
The other metric used in the LTV:CAC ratio is Customer Acquisition Cost (CAC). It is the total cost of acquiring a new customer, including the cost of sale (i.g. advertising, sales commission, etc.) and any other associated expenditure. It is typically calculated as the total marketing spend divided by the number of new customers acquired.
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The LTV:CAC ratio is then simply the output of dividing the Customer Lifetime Value by the Customer Acquisition Cost. This will give you a ratio which can then be used to make informed decisions on how to allocate resources and which channels to focus on to get the best return on investment.
A good rule of thumb is that the LTV:CAC ratio for an acquisition channel should be at least 3:1. So, for every £1 spent to acquire a customer, the business should be able to make at least £3 back in the lifetime of that customer. If the LTV:CAC ratio is less than 3:1, then it’s likely not a profitable channel and should be avoided.
The LTV:CAC ratio is an incredibly useful metric with lots of potential applications in marketing. It can help inform decisions on which channels and tactics to use, how to allocate resources optimally, and can give insights into how to improve and refine customer acquisition strategies.
However, there are some things to consider when using the LTV:CAC metric. Firstly, it is important to note that the LTV:CAC ratio is a prediction, based on your current and past transactions, so it will never be 100% accurate. This means that it is important to be aware of any external factors that might influence the results of the calculation (e.g. economic conditions, seasonality).
Secondly, the LTV:CAC metric should be used as part of a broader marketing strategy. It should not be used as a single indicator of success or as the only data point.
Finally, it is important to remember that the LTV:CAC ratio is only relative to the channel it was calculated from. It will not necessarily give an indication of the LTV:CAC ratio of a different channel.
The LTV:CAC is an incredibly important metric for marketing teams and can be a useful tool in helping to inform decisions on how to allocate resources and which channels to focus on to get the best return on investment. It is important to remember that it is only a forecasting tool and its results should always be interpreted as part of a broader marketing strategy.