Hello! It’s the team at REM Web Solutions again, back to tell you more about marketing-industry-specific terms and why they’re so important.
Today, we’re covering Customer Acquisition Cost (CAC) and Lifetime Value (LTV).
Customer Acquisition Cost (CAC) is a measurement of how much an organization is required to spend to acquire new customers. CAC is an essential business metric that accounts for the total cost of sales and marketing efforts (including property or equipment) required to convince a prospective customer to pay for a product or service.
On the other hand, Lifetime Value (or LTV) estimates the anticipated revenue a customer will generate throughout their lifespan or contract with your business. This is essentially a value measurement of a customer that helps determine essential economic decisions for a business, such as a marketing budget, resources allocated, profitability, and more.
Both are often considered in tandem because they provide essential metrics to help you determine where to allocate your business' budget based on a customer's output versus input, from onboarding to services provided and money earned. This is a great way to make important business decisions and determine where your resources are best utilized to maximize your efforts and profitability.
It's important to analyze CAC in conjunction with Lifetime Value to determine your company's operation efficiency. The more efficient your business is, the better not only for you - but your customer's benefit by receiving value through the money they spend. Maximizing efficiency ensures that customers are always getting what they paid for on a timely basis while keeping your business adequately funded.
So, let's dive a little bit deeper into these two industry terms and elaborate further on their functionality and how to make the most of them.
Let’s shall, let’s shall, shall we?
A Deeper Dive into CAC - A Management Tool for the Masses
Although some of us are more inclined towards writing, today, we're going to have to bust out some math.
Calculating CAC can be done in two ways: a simpler way and a more complex way. We'll demonstrate both for context.
The simple equation consists of three metrics:
- CAC: The cost of acquisition.
- MCC: The total marketing costs involved with the acquisition.
- CA: The total number of customers acquired.
The equation would be broken down as such: CAC = MCC ÷ CA.
But of course, like most math equations, there’s a more complex version that breaks down a larger scope of your business operations. They consider several additional metrics, including:
- MCC: Total marketing costs, as mentioned.
- W: Wages required by marketing and sales.
- S: The cost of all marketing and sales software.
- PS: Any additional required services - such as consultants required in any of the marketing or sales efforts.
O: Overhead. - CA: The total customers acquired.
That equation breaks down looks like such: CAC = (MCC + W + S + PS + O) ÷ CA
If you’re finding that your CAC has been consistently high, there are several ways to help reduce those metrics.
Understanding Your Customer Base
You need to have market research and industry know-how, along with some general people skills to understand your customers' wants and needs so you can carefully create products and services they find valuable.
Get Customers Involved Early On
The faster you engage your customers in the product, the lower your acquisition costs are for each customer.
Give Them a Reason to Come Back
This goes without saying, but creating a positive customer experience lowers your CAC because it's much easier (and cheaper) to keep a customer coming back for more than to find and acquire more.
Diving Deeper into LTV
Ah, more math. There are several ways you can calculate LTV as well, depending on how you sell the products to the customer. For example, the equation for a business that offers a subscription service is going to be different than a business that offers a service through a contract with the anticipation they'll be able to upsell.
We won't go through every possible equation, but we'll break down the equation for total income expected to be gained from a new customer plus any additional costs, such as upsells.
You would calculate this by multiplying the Average Order Value by the number of Expected Purchases and Time of Engagement.
AOV x EP x TOE - respectively.
It's important to keep in mind that the LTV of a customer can also ebb and flow, growing or shrinking over time based on your business' offerings and ability to grow the account. Ideally, you want to see your customers grow with your company, finding deeper value in your business by a proven track record of worthwhile services. The better the relationship you have with your customers (including the timely and valuable delivery of essential services), the more likely they are to invest in additional services.
For (hypothetical) example, let’s say you provide blog writing services to a customer who needs help boosting their website’s SEO. You write the content, and they upload it independently. They’ve been with your business for several months and have been very happy with their progress, but the influx of additional business has left them with little time to upload those blogs independently.
Perhaps, as an additional service, you could offer to take over the uploading and additional SEO configuration of their website on their behalf, providing additional value and ease for them while earning your business more money. This is a prime example of GROWTH.
This not only makes it worthwhile in terms of money, but it also encourages the customer to keep working with your business. By continuously providing and growing value, the more likely a customer is going to stick with your business - increasing their LTV over time.
The Don’t of Calculating LTV and CAC
Following along so far? Excellent. Now it’s time to consider some key things to AVOID.
Considering an Unrealistic Customer LTV
If your business is prone to change, or your services are currently evolving, it can be hard to determine a precise customer lifetime. Otherwise, you're making an educated guess at best when it comes to calculating an accurate LTV.
You also have to adjust LTV as more data becomes available to your business, so it's important to try and get an accurate LTV from the start by being realistic about how long you anticipate a customer will stay with your company. This makes it easier to determine if you have accurate and up-to-date data or utilizing a delivery method (such as contracts) to determine cost.
If you don't have this option, try to choose a realistic LTV timeframe with the information you do have. It’s better to underestimate than it is to overestimate.
Applying One LTV to All Your Customers
Being able to measure LTV across your customer base is great, but knowing how to segment those LTVs is essential. You have to make sure each LTV is unique to each customer and break down the key data points and insights based on several variables, including demographic or purchasing behaviour.
If you try to apply a general LTV to every single customer, you're going to be missing out on key information that helps you determine a customer's LTV.
Not Recalculating LTV as You and Your Customers Change
If you're operating a startup or small-to-medium business, things are going to change for you over time. Your products and services will eventually evolve, and you may start offering new ways to grow your business and increase your revenue. Also, your customers, with your help, may begin to grow and find their needs changing over time. That's a lot going on, so it's absolutely necessary to reassess LTVs regularly, especially when your customer increases or reduces the number of services/products they purchase.
As your business and customer needs change, you need to refine your model.
Not Accounting CAC for Variable Costs
A very typical mistake we see when calculating CAC is to include the fixed costs of marketing and sales, including metrics like salaries, software, and overhead. However, where you could be missing out is the variable costs that can change depending on the column and type of customers you acquire.
Variable costs have a big impact on your CAC, especially if you utilize different channels and tactics to reach a broader segment of your targeted market. You always have to account for potential variable costs to correctly calculate CAC.
Use CAC and LTV to Drive Business Growth
So, there you have it! CAC and LTV are two essential metrics that, when used together, can provide powerful insights into your business's financial health and customer relationships. The key is to continuously monitor and adjust your approach as your business evolves. Staying on top of your CAC and LTV helps you ensure that your business remains profitable and continues to grow.
Need help making sense of these metrics or implementing a growth strategy? Contact REM Web Solutions today and let us help you maximize your business potential!
