Which number is LTV to CAC?
The LTV to CAC ratio, or “customer lifetime value to customer acquisition cost ratio,” is a financial measure used in marketing and business to judge how well a company gets new customers and keeps old ones. It shows how much a business spends to get new customers compared to how much those customers could bring in throughout their relationship.
Like words
“LTV/CAC” or “LTV:CAC”
Why look at the cost to acquire vs. the lifetime value of a customer?
Companies must regularly compare the customer acquisition cost (CAC) to the customer lifetime value (LTV) because it gives them essential information about how well and how long their business plans will work. There are several important reasons why businesses should constantly check the connection between CAC and LTV.
Evaluation of Profitability: When businesses compare CAC and LTV, they can see if the cost of getting new customers is worth it based on how much money those customers could bring in. If CAC is much higher than LTV, it could mean that the business won’t make money in the long run.
Allocating Resources: Companies can better use their resources when they understand the CAC-to-LTV relationship. Businesses can put more money into marketing and sales that give them a good return on investment by focusing on customer groups with a good ratio.
Making Choices: The CAC and LTV metrics help with making wise choices. If the LTV is high compared to the CAC, a business might decide to spend more on getting new customers because it knows it will get a significant return on its investment. A low ratio, on the other hand, might mean that acquisition tactics need to be looked at again.
Long-Term Growth: A good CAC-to-LTV ratio helps growth last. Companies that regularly get customers for less than what they’re worth over their lifetime can safely grow and keep their operations going.
Grouping customers: Looking at the CAC-to-LTV ratio for each group of customers helps make marketing and sales plans that are more targeted and effective. Groups with a high LTV can get more resources and personalized care, while groups with a low LTV can be handled more effectively.
System for early warning: A growing difference between CAC and LTV can indicate problems with getting new customers or keeping old ones. If the number goes down, something might be wrong and must be looked at.
Customer Lifetime Value Maximization: The CAC-to-LTV analysis can help businesses develop plans that get the most out of each customer over their lifetime. This could include efforts to upsell and cross-sell, keep customers longer, and improve their experience.
Trust from Investors and Stakeholders: Investors and other partners will have more faith in a business if it can show that it understands CAC and LTV metrics well. It shows that the company is growing in a way that is based on facts and is suitable for the bottom line.
Competitive Advantage: If a company has a good CAC-to-LTV ratio, it can get ahead of its competitors in getting new customers and keeping old ones. It can make it hard for new rivals to get in.
Long-Term Planning: You need to know about CAC and LTV for long-term planning. Businesses that know how these two measures work together can set more accurate growth goals and create long-term business models.
How to Figure Out the LTV to CAC Ratio
To find the LTV to CAC number, do the following:
1. Customer lifetime value (LTV): This is how much money a business thinks it will make from a customer throughout its relationship with the business. LTV is found by looking at the average purchase value, the average number of times a customer buys, and the rate at which customers stay with the business over a specific time.
Here’s how to figure out LTV:
ATV = (Average Purchase Value / Average Purchase Frequency) / Length of Time with Customer
2. Cost of Getting a New Customer (CAC): How much does it cost to get a new customer? It covers the costs of advertising, marketing, sales, and other costs of getting new customers.
Here’s how to figure out CAC:
CAC = Total Cost of Acquiring New Customers / Number of New Customers Bought
To Find the LTV/CAC Ratio
To find the LTV-to-CAC ratio, divide the LTV by the CAC after you have found the LTV and the CAC.
From LTV to CAC Number = LTV / CAC
How to Read the LTV/CAC Ratio
CAC > LTV
If the ratio is higher than 1, the company makes more money from a person throughout their lifetime than it costs to get them. This is a good sign that the business is getting a good return on the money it spends to get new customers.
A number much higher than 1 (like 3 or 4) is even better because the business gets a lot of value from the money it spends on getting new customers.
LTV
If the ratio is less than 1, the business may be spending more to get new customers than it hopes to make from those customers over time. This could mean that the company’s acquisition costs are too high or that it needs to do a better job keeping customers.
LTV = CAC
If the number is close to 1, the company breaks even on customer acquisition and lifetime value. This may not be the best situation since customers don’t bring in much or any profit over time.
A bigger LTV to CAC ratio is usually a good thing because it means you’re getting customers in a more cost-effective and long-term way. Companies should monitor this ratio and try to improve it to ensure their customers stay profitable in the long run.
In the SaaS business, what is a good LTV/CAC ratio?
No proper LTV/CAC ratio exists in the SaaS (software as a service) business. It depends on the stage of the company, the target market, and the level of competition. A good LTV/CAC ratio for a SaaS company, on the other hand, is usually thought to be three or higher.
In the SaaS business, different LTV/CAC rates could mean the following:
1. LTV/CAC Ratio Less than 1: If the ratio is less than 1, the business is spending more to get new customers than it plans to make from those customers over time. This can’t go on for long and could mean problems with making money and growing.
2. The LTV/CAC number should be close to 1: The company is pretty much even on customer acquisition and lifetime value. It could mean you’re getting back the money you spent on getting the customer, but there’s little room for profit or growth.
3. As long as the LTV/CAC number is between 1 and 3, the company is making money from its customers. Most people think it’s fair, but there are ways to improve customer acquisition efficiency and lifetime value.
4. LTV/CAC Ratio Above 3: A ratio higher than 3 is usually seen as positive, meaning that the business makes a lot of money from customers throughout their lifetime compared to how much it costs to get them. This points to a robust and long-lasting business plan and effective ways to get new customers.
5. The LTV/CAC ratio When the percentage is above 4 or 5, it’s considered good and could mean that the SaaS company is running very well. It shows that the business is getting new customers well and making a lot of money from those customers over time.
Remember that what is “good” for LTV/CAC can change depending on the situation. It’s also essential to consider the payback period: how long it takes for a business to get back the money it spent on getting new customers. A faster payback period is usually better because the company quickly gets back the money it spends on getting new customers.
SaaS companies should also keep an eye on customer turnover rates since keeping customers longer can significantly affect the lifetime value and, by extension, the LTV/CAC ratio. High churn rates can make a high LTV/CAC number less useful.
For the most part, references and industry standards can help. Still, each SaaS company needs to examine its business model, customer acquisition costs, and behavior to find the proper LTV/CAC ratio for its growth goals and situation.
Problems to solve: Getting the LTV to CAC ratio
Finding the LTV to CAC percentage is an excellent way to see how well and healthy a business’s strategies are for getting new customers and keeping old ones. But there are a few problems that can come up when businesses try to get this number right:
Amount and Quality of Data: The LTV to CAC ratio depends a lot on how good and correct the data used for the estimates is. It’s possible to get the wrong customer lifetime value and acquisition cost estimates if your sales data isn’t complete or accurate.
Customer Behavior and Retention Predictions: To determine a customer’s lifetime value, you have to guess what they will do in the future, like how long they will stay with the company, what they will buy, and how those habits might change over time. It can be hard to make these predictions, and they may differ for different customer groups.
Changing Customer Behavior: Because customers’ behavior can change over time, it’s hard to tell if they will buy or stay with you in the future. Changes in the economy, market trends, or customer tastes can change these expectations.
Customer Segmentation: The LTV and CAC numbers may differ for each customer group. Dividing customers into groups based on demographics, behaviors, and usage patterns is essential to getting more exact ratios. This might be hard to do if the customer data isn’t organized well or the grouping criteria aren’t clear.
Figuring Out the Right Costs: It’s not always easy to figure out the CAC. Businesses need to consider which costs should be included, like marketing and sales costs, as well as any other costs that help them get new customers. There may be different ways for different companies to divide up these costs.
Timeframe for estimates: It can be hard to figure out the suitable timeframe for LTV and CAC estimates. A longer time frame may give a more accurate picture of customer value, but it can also be less reliable. Shorter time frames can help you learn more quickly, but they might not show you the total long-term value of a customer.
Seasonality and Market Fluctuations: Changes in the market and the seasons can affect how customers act and how much it costs to get new customers. If you don’t consider these changes, your LTV to CAC estimates could be wrong.
Rates of Discount: To find LTV, it is expected to use discount rates to account for the time value of money when figuring out the current value of future cash flows. Picking a discount rate isn’t always easy and could change the end LTV calculation.
Keeping an eye on customer costs over time: It is essential to keep track of these metrics and ensure they are always up-to-date because customer acquisition prices and lifetime value change over time. For this to work, there must be a robust and constant way to collect and analyze data.
Outside Causes: If the competitive environment, the economy, or something unexpected happens, like a pandemic, it can change how customers act, making LTV and CAC calculations less accurate.
To deal with these problems, companies should focus on getting and keeping correct data, improving how they divide customers into groups, following industry trends, and using suitable statistical models to figure out LTV and CAC. Reviewing and updating these calculations regularly can help a business adapt to new situations and make better choices about how to get new customers and keep the ones it already has.
Six Ways to Raise the LTV to CAC Ratio
Businesses can improve their LTV to CAC ratio by planning to be more thoughtful about getting new customers and keeping old ones. Here are six things a business can do to raise its LTV-to-CAC ratio:
1. Raise the number of conversions: Make your conversion funnel work better by looking at each step of the customer journey.
Use A/B testing to make landing pages, email campaigns, and other places of conversion better.
Give people useful information and tempting deals to make them more likely to become paying customers.
2. Lower the cost per lead by putting money into more focused marketing and reaching the right people.
Use data and analytics to find the best marketing platforms and use your resources best.
To spend less on expensive ads, look into organic platforms, content marketing, and referral programs.
3. Cross-sell and up-sell
Find ways to upsell or cross-sell to current customers to make them worth more over time.
Create upsell strategies based on customer data and personalization to get people to upgrade or buy more goods or services.
Draw attention to the extra value of premiums or increased options.
4. Lower Customer Churn: Give excellent customer service after the sale to keep customers returning.
Check out customer surveys and reviews to find ways to make things better.
Start customer success programs and deal with problems before they happen to keep customers from leaving.
5. Make things better for customers
Spend money to improve the customer experience, from the first contact to the help they need after the purchase.
Personalize your conversations and interactions with people to build a solid emotional bond with them.
Always ask your customers for feedback and use it to improve your services and better fit their needs.
6. Teach the teams in charge of sales and service
Ensure that your sales and customer success teams have many chances to learn and grow.
Give your staff the information, tools, and resources they need to help customers better and find ways to upsell.
Encourage a culture that puts customers’ needs first on these teams so that you can build long-term ties with customers.
