LTV:CAC Ratio: What Is It; How to Track & Improve Yours! [Tool Suggested]
Apr 28, 2023 | 11 min read | Leave a comment
Are you looking to optimize your marketing budget and increase your profits? The LTV:CAC ratio is a crucial metric to help you achieve those goals.
This ratio measures a customer’s lifetime value (LTV) compared to the cost of acquiring that customer (CAC). In other words, it tells you how much you earn from a customer over their lifetime versus how much you spend to acquire them.
In this blog post, we’ll walk you through all you need to know about the ratio: What it is, Why it’s important & How you can track and improve it [with tool suggested]
What is the LTV:CAC Ratio?
LTV stands for “Lifetime Value,” and CAC stands for “Customer Acquisition Cost.” The LTV/CAC ratio contrasts the average lifetime value of a customer with the average cost of acquiring that customer.
This eCommerce ratio serves as a profitability indicator. Specifically, it reveals if a customer’s lifetime value is greater or less than the marketing and sales expenses incurred to bring in that customer.
As its name might already suggest, to calculate the LTV:CAC ratio, divide LTV by CAC.
For example, if you spend an average of $30 to acquire a customer and that same customer spends an average of $90 over the course of their lifetime, your LTV:CAC is $90 / $30 = 3 (or 3 to 1). This is a good LTV:CAC ratio (we’ll talk more about this below).
However, unlike our hypothetical example above, calculating LTV:CAC ratio is quite complicated since LTV and CAC both include various smaller metrics – which we’ll show you right next!
Track Your LTV:CAC With TrueProfit
Explore your real-time LTV:CAC by country, traffic source, discount code, etc. Focus on more profitable groups!Improve Your LTV:CAC
How to Calculate LTV:CAC Ratio?
As previously noted, the average customer lifetime value and average customer acquisition cost are divided to arrive at the LTV:CAC ratio.
Thus, you must keep track of both your Customer Acquisition Cost and Lifetime Value of your customers to figure out the exact numbers so that you will accurately measure your LTV:CAC ratio.
#1. Calculate Customer Acquisition Cost (CAC)
All expenses incurred in obtaining a customer are referred to as customer acquisition cost (CAC). Although some businesses do not include Cost of Goods Sold (COGS) in their cost calculations when determining the CAC measure, we strongly advise doing so in order to know your precise CAC.
Your CAC would, therefore, be determined as follows:
|CAC = (Total Marketing Expenses + COGS) / Total Number Of Customers|
- All of the costs you incur for your marketing efforts are referred to as total marketing expenses. These costs differ greatly among businesses. Here are a few associated marketing costs you may discover:
- Ad campaigns (Facebook ads, TikTok ads, Google ads, etc.)
- Social media influencer shoutouts
- Content marketing
- SEO analysis and improvement
- Cost of goods sold (COGS) is the total of all labor and material expenses incurred in the production of your completed goods.
#2. Calculate Customer Lifetime Value (CLV)
The average purchase value, average buy frequency, and average customer lifespan of your customers are multiplied to arrive at the Customer Lifetime Value (LTV or CLV) metric.
|LTV = Average Purchase Value x Average Purchase Frequency x Average Customer Lifespan|
Step 1: Find your Average Purchase Value
Average Purchase Value (APV) is determined by dividing total revenue by the total number of orders generated during a specific period.
|Average Purchase Value = Revenue / Number of orders|
For example, if you generated $500,000 in revenue from 2,000 orders in 2022, your APV would be $500,000 / $2,000 = $250.
Step 2: Find your Average Purchase Frequency
Average Purchase Frequency (APF) is computed by dividing the number of purchases by the number of customers.
|Average Purchase Frequency = Number Of Purchases / Number Of Customers|
For instance, if you have 500 customers overall and 5,000 orders in 2022, your APF would be equal to 5,000 orders divided by 500 customers, or 10 times.
Step 3: Find your Average Customer Lifespan
By adding together all of your customers’ lifespans and dividing that figure by the number of customers, you can compute the Average Customer Lifespan (ACL).
|Average Customer Lifespan = Sum Of Customer Lifespans / Number Of Customers|
You can also derive your average customer lifespan from the churn rate if you are just starting out and don’t have a big enough sample size for the computation. Churn rate is the frequency with which customers discontinue making purchases from you over a predetermined time period.
The churn rate formula can be derived by dividing the total number of customers by the number of churned customers. The number of churned customers is the proportion of customers that have discontinued using your service or buying your goods during the course of the period.
|Average Customer Lifespan = 1 / Churn rate|
For example, if you start 2022 with 500 customers but at the end of the year, only 100 of them are still purchasing from you, your churn rate is (500 – 100) / 500 = 0.8.
Thus, your Average Customer Lifespan (ACL) would be 1.25 months = 1/0.8.
Step 4: Calculate your LTV
You can now calculate your LTV metric by multiplying all the necessary metrics that you have just gathered.
- APV of $250
- APF of 10 times
- ACL of 1.25 months
Hence, your Customer Lifetime Value is $250 x 10 x 1.25 = $3,125.
#3. Divide LTV by CAC
Now that you have your LTV and CAC, you can formulate the calculation by dividing the LTV by CAC.
How to monitor LTV:CAC in Real time?
It won’t be helpful if you only calculate your LTV:CAC ratio once a year. So, you may want to continuously monitor LTV:CAC after you have collected metrics for doing so. Thus, your CAC and LTV need to be constantly monitored on a daily basis.
Plus, not all your customers have the same LTV:CAC ratio, so you have to do some segmentations and focus more on segments that have a good LTV:CAC ratio.
This is indeed a challenging and nearly impossible task because, as we’ve just shown you, how to calculate the ratio below. You have to constantly keep pace with the constantly-shifting data across different channels.
If you have a Shopify store, the optimal solution is using TrueProfit’s Customer Analytics Report to see your LTV:CAC in real time. You can filter to see the LTV:CAC of customers from specific countries, customers who use a discount code, etc.
The app syncs data seamlessly with all your ad platforms, marketing channels, and major shipping platforms. So you can rest assured that every metric you see (LTV, CAC, LTV:CAC, Repurchase rate, etc.) is real-time updated with laser precision.
What Is a Good LTV:CAC Ratio?
Typically, a good LTV:CAC ratio is considered to be 3:1. That means the money you generate from a customer should be 3 times higher than the amount you spend acquiring that customer.
If your ratio is lower or higher than this number, there are 2 things you must do. In case you have a lower ratio, you had better reduce your marketing expenses so that you can maintain good acquisition efforts in the future.
Otherwise, you should increase the budget for marketing to acquire more customers.
So does this mean that the higher your LTV:CAC ratio is, the better? Actually, nope! An LTV:CAC ratio that is over 5:1 signifies that you might not be investing in marketing enough and are missing out on scaling opportunities.
4 Best Tips to Optimize Your LTV:CAC Ratio?
If you have calculated your LTV:CAC ratio and it is at 2 or close to 1, your business is at risk of losing profitability. So, you must find ways to either raise your LTV or lower your CAC to optimize this metric. Here are 4 tips that you should remember to achieve the desired result.
#1. Prioritize important channels
Among those crucial profitability indicators are the LTV:CAC ratio, Customer lifetime value, and Customer acquisition cost.
By carefully monitoring your LTV:CAC ratio, you will be able to evaluate the efficiency of your marketing channels. After that, you can reallocate your funds to successful channels and decrease your investment in unsuccessful ones instead of spreading your money on every channel.
Thus, you need to optimize your budget and avoid wasting money on channels that don’t bring much of a positive impact.
#2. Invest in organic marketing in the long run
A high CAC can negatively impact your LTV:CAC ratio, even though your customer lifetime value may be satisfactory.
If you are facing this issue, you should invest more in long-term marketing initiatives, especially in branding.
When you are able to build effective branding leading to improved brand recognition and reputation, you can expect to lower CAC as you can obtain more organic traffic and eliminate your dependency on paid advertising.
Besides, businesses with good brand identities can charge more for the identical items that their rivals are selling, according to Investopedia. Therefore, you can also increase revenue by raising your pricing while still receiving their consent.
#3. Focus more on more profitable customer segments
If you calculate the LTV:CAC for each of your customers, you may get a sense of whether or not you are making a profit.
However, it is crucial to segment your customer base into groups and then determine the LTV:CAC for each group if you sell a variety of product lines with vastly different prices.
You will gain a better knowledge of which customers are more profitable than others as a result. Be mindful that even if some customers cost more to acquire but their lifetime value is higher, they can still be very profitable. Otherwise, the LTV of some prospects may be low, even though they may convert more quickly.
For example, bargain hunters during Black Friday Cyber Monday occasions. They may purchase all of your greatest deals, then vanish and never come back.
Overall, you will be able to accurately find out which customers it is worthwhile to spend your marketing budget on by segmenting them and establishing the LTV:CAC ratio.
#4. Run upsell and cross-sell campaigns
Increasing the lifetime value of your customers is the most effective strategy to raise your LTV:CAC ratio. There are many ways to do so, yet cross-selling and upselling campaigns are among those with the high effectiveness and easy-to-conduct method to boost LTV.
Through cross-selling and upselling, a higher customer lifetime value can be achieved by encouraging them to buy additional goods or services. Offering a more expensive good or service, or a good or service that complements your main offerings, can be a good idea.
Take a look at Kitchenaid’s upselling strategy. You can see that the brand is offering additional accessories compatible with the main mixer that will cater to their customer’s cooking habit.
Frequently Asked Questions
What is a good LTV to CAC ratio?
A typical standard for a “good” ratio is a 3:1 ratio. However, depending on your industry and how long your business should be operating, venture capitalists and other investors may want to see a higher or lower number.
How is LTV to CAC calculated?
By dividing your average customer lifetime value (in a particular period) by your average customer acquisition cost (in the same period), you can determine your LTV to CAC ratio.
What is too high for LTV to CAC?
If your ratio is considerably greater than 3:1 (the recommended value), say 5:1 or above, you may not be investing enough in sales and marketing and may be losing out on important chances to draw in new customers. Even worse, if your company has an LTV:CAC ratio at this level, you might pass up chances for growth.
Why does LTV to CAC matter?
The LTV:CAC ratio is among those key profitability metrics. Monitoring your LTV:CAC is essential since it will show you whether or not your marketing efforts are yielding results.
Then, you can reduce your investment in unsuccessful channels and reallocate your funds to successful ones.
In addition to helping you optimize your customer acquisition and retention methods, the LTV to CAC ratio can be used to measure your company’s growth and profitability against those of your rivals as well as industry standards.
You can evaluate your competitive advantage and market fit, as well as pinpoint opportunities for innovation or improvement, by contrasting your CAC and LTV ratios with those of other businesses in your industry.
Overall, the overview of LTV:CAC ratio, its calculation, and how to optimize it have all been covered in this blog. So, we believe that you now know how to track this ratio and have a clear understanding of its significance.
Generally speaking, from CAC to LTV, as well as the LTV:CAC ratio, they all can clarify how much money you make from each new customer. Besides, they also help identify areas for improvement for your business as a whole, then you can find ways to fix them and raise your brand’s profit margin.
In the end, if you find yourself struggling with all the tasks related to tracking your LTV:CAC ratio in real time. So install a profit-tracking tool like TrueProfit to closely monitor your LTV:CAC and make timely adjustments to improve it!
Discover what proper profit-tracking looks like at trueprofit.io