LTV:CAC is a key indicator of your brand's profitability and growth potential, making it a crucial eCommerce metric to track. An optimized LTV:CAC ratio (typically above 3:1) indicates your business model is sustainable and that your brand is ready to scale.
Unfortunately, the days of almost-guaranteed rocket ship growth from Facebook & Instagram ads are pretty much over. Companies like Allbirds, Away, Blue Apron, Casper and others greatly benefitted from cheaper ads, but ad costs have substantially increased in the last two years. Combined with the recent iOS privacy changes, ads aren’t the guaranteed growth channel they used to be (though ads are still a good channel to invest in).
Some fast-growing brands (like Casper) obsessively pursued acquisition (CAC) while neglecting LTV. While this led to huge growth and an IPO, their stock performance has tanked because customers aren’t repurchasing mattresses every year. When it comes to managing LTV:CAC, the biggest goal is to find a LTV:CAC ratio that allows you to scale your brand profitably. Otherwise, your company might lose hundreds of dollars per customer if those customers don’t keep purchasing from your brand.
What is LTV:CAC?
LTV:CAC is the ratio of your brand's Customer Lifetime Value, i.e, how much the average customer spends on your business throughout their lifespan, and your Customer Acquisition Cost, i.e., how much your business spends, on average, to acquire a new customer.
Calculating, monitoring, and optimizing your LTV:CAC ratio is critical to your organization's success because it indicates how effective your marketing efforts are, and it projects your brand's long-term profitability.
An example of LTV:CAC in action
Let's say your company has an LTV:CAC ratio of 1:1, meaning the cost to acquire a customer is the same as the consumer's lifetime value. In this case, you're making zero profit on the acquisition.
Additionally, because LTV:CAC only takes your marketing expenses into account, a 1:1 ratio means your brand is losing money once you account for shipping costs and taxes. Worse yet, if the ratio is weighted towards CAC (e.g., 1:1.5), that means your brand isn't even breaking even on marketing costs.
Conversely, having a ratio greatly weighted in favor of LTV may not be completely positive, either. For example, while a 4:1 ratio indicates growth opportunity, a 7:1 might indicate that your brand is leaving growth on the table and needs to scale up its advertising and marketing efforts.
How to calculate LTV:CAC ratio
You can calculate LTV/CAC ratio by dividing the average lifetime value for a single customer by the customer acquisition cost. The ratio effectively measures the return on investment for each dollar your brand spends to acquire a new customer.
So, to calculate the ratio, you need to independently determine the acquisition cost and lifetime value of a customer. If your LTV turns out to be, say, $1500, and CAC is $500, then your LTV/CAC ratio is:
LTV:CAC = 1500/500 = 3/1
In your LTV calculation, it's important to remember that while no customer stays with a brand indefinitely, some are quicker to leave than others. That's why LTV calculations factor in customer retention and customer churn rate.
What is a good LTV:CAC?
The answer to this depends not only on your area of eCommerce but your company in particular. In most situations, you will want to see an LTV:CAC (at an absolute minimum) above 1.0 because anything below 1.0 means that you are losing money on every customer.
A common benchmark is to achieve a 3.0 LTV:CAC, and this is a common number that venture capitalists or other investors want to see, but this also may be higher or lower depending on your industry and how long your company has been around. Ideally, your LTV:CAC should improve over time.
How a high CAC harms long-term growth
As industries become increasingly expensive, brands have been scaling up their acquisition efforts to win the customer base over from their competition. But brands with a high CAC relative to their LTV suffer long-term.
Here are a few better-known examples of how high CAC impacts long-term growth:
Mattresses were late to the eCommerce game, with Casper starting the trend of online mattress retail in 2014. The startup hit the ground running with the concept of a "mattress-in-a-box," which made mattresses easier to package and transport.
Additionally, with none of the overhead costs that come with brick and mortar stores or expensive middle-men, Casper offered its mattresses at a fraction of the cost of traditional sleep brands. Thanks to its unique business model, Casper grew phenomenally in its first 4 years, reaching $750 million valuation.
But as more eCommerce mattress brands appeared in the space, Casper had increased competition, and all the brands were left fighting over the customer base, driving acquisition costs up.
Despite high average annual recurring revenue, Casper is failing to turn a profit, and has gained attention for all the wrong reasons. An article in Forbes called it the "Latest Money-Losing IPO.”
So why is Casper failing to turn a profit, despite its revenue stream?
Their mattresses have a lifespan of around 10 years (which is typical for mattresses), meaning customers don't come back frequently to make repeat purchases. And with acquisition costs peaking, a low LTV leaves little room for Casper to turn a profit.
Blue Apron is another fast-growing brand obsessed with customer acquisition that's suffering from high acquisition costs. The company has incurred net losses every year since it was founded.
Relative to its high CAC (Blue Apron claimed it is approximately $94 per customer, but analysts estimate it is more likely from $150 to $400+), Blue Apron has a low LTV, making it difficult for the brand to become profitable and causing stock prices to plummet.
Blue Apron's low LTV has been attributed to a combination of high churn rates, unsustainable retention strategies, and low average order values. Here's a quick look at their speculated churn rates:
Customer Acquisition Cost (CAC) Benchmarks
To know if your CAC is justified, you need to compare it to LTV to determine profitability. Here are some important benchmarks for LTV:CAC ratio:
How to leverage LTV:CAC for growth
Investors want to know about your LTV:CAC because it's one of the most reliable KPIs for long-term success. You should continually track the ratio and implement best practices to optimize it.
Here's how to leverage LTV:CAC for growth:
Lower your CAC by relying less on paid ads
In your brand's early stages, paid ads are ideal for quick results and generating initial brand awareness. But rising ad costs drive your acquisition costs up; they're not sustainable in the long run.
So after leveraging paid ads to grow your brand initially, consider investing in more sustainable methods to drive long-term growth. Depending on your business model, some sustainable ways to lower CAC and reduce your reliance on ads are:
Launching an affiliate program
Affiliate programs are especially popular among eCommerce businesses, with good reason. Your acquisition costs for customers acquired through affiliates are the affiliate commissions, giving you more control over CAC.
Leveraging customer referral programs
Similar to affiliate programs, referral programs mitigate your marketing costs, lowering CAC. Wharton Business School estimated that the acquisition cost for referred customers was $23.12 less than non-referred ones. Additionally, referred customers are more likely to make repeat purchases and have a higher average retention rate, thus increasing their lifetime value.
Using search engine optimization (SEO)
Unlike paid ads, SEO is a long game - it can take many months before you reach Google's traffic-orientated first page. However, while SEO requires a large initial investment and considerable effort, the results are highly sustainable. After SEO takes effect, brands gain free search engine traffic, and targeting keywords helps prospects discover you, increasing conversion rates.
Focus on retention
While social media channels are great for generating brand awareness and acquiring new customers, it's important to remember that these platforms are borrowed territory. This is why building an email and/or SMS subscriber list is so important: they are your owned channels. You can reduce CAC and increase LTV by focusing more on retention and you can supercharge that program by pushing your data into your SMS/Email and paid channels to bring those customers back and increase their LTV.
With SMS and email, you can reach your customer base (for virtually free) without limitations like FB's pitiful organic reach. You can also employ post-purchase marketing strategies to drive repeat purchases, increasing LTV.
Identify the most profitable and costly customer segments
We're all familiar with the rule of 7, but some customers don't convert even after coming across your creatives for the fifteenth time. The sixteenth or seventeenth display might do the trick, though. But are these customers worth the retargeting costs?
LTV:CAC answers that question. Because while some customers cost more to acquire, they can still be highly profitable if their lifetime value is greater. Similarly, some prospects might convert more readily, but their LTV could be low. Think bargain hunters during Cyber Week—they'll buy your best deals out, and then disappear, never to be heard from again.
By segmenting your customers and calculating the LTV:CAC ratio for each cohort, you can accurately determine which audiences are worth investing your marketing spend on.
Make LTV a metric owned by all teams
LTV is a vital KPI that affects almost all areas of your ecommerce business. Every team should focus on this metric and should work together to help improve it. This can be done in many ways:
- Increasing the number of purchases/total sales: Mainly handled by marketing, this includes increasing average order values, subscription opt-ins, and repeat purchases.
- Optimizing your gross margin: Your Ops team can negotiate better rates with fulfillment partners, optimize internal operations to improve efficiency, and make improvements to your cost of goods sold (COGS).
- Customer Service: Focuses on creating a great experience to keep customers around and implementing customer-friendly returns policies.
Increase LTV by making decisions driven by data
Data and analytics related to factors that directly influence LTV help brands identify problem areas and also determine their successes. For example, if your referred customers exhibit higher loyalty and spend more, it might be worth investing more to grow your referral program.
Conversely, if your brand's repeat purchase numbers are low, you'd want to consider factors like:
- Your post-purchasing marketing efforts. Do they need scaling up?
- Customer experience. Are your customers happy with their first purchase experience?
- Product Catalog. What are products that someone else would naturally buy after their first purchase.
- Channel mix. Which channels are acquiring customers with the highest LTVs?
- First Product purchased. Which product in your catalog are customer purchasing that generate the highest LTV?
How to monitor LTV:CAC in real-time
To monitor LTV:CAC in real-time, brands need to centralize their ecommerce analytics to combine data and monitor both LTV and CAC in real-time. Centralization is vital because LTV and CAC are dependent on your efforts across multiple channels.
Thus, to monitor your LTV:CAC ratio in real-time, you need to leverage an analytics platform that lets you access centralized data directly from the dashboard.
How Daasity makes it easy to grow with data
Daasity is a leading ecommerce analytics platform that helps the fastest-growing ecommerce brands centralize data, monitor KPIs, and streamline their growth efforts.
Unified Customer View
With Daasity, you can create a repository of centralized customer first- and zero-party data, including purchase, channel and marketing engagement information. Having a single, unified customer view helps brands better understand their customers and deliver more personalized experiences.
Daasity's real-time inventory reporting gives ecommerce managers access to live inventory levels and sales velocity across all sales channels, including your ecommerce store, Amazon, retail, and subscriptions.
Easily create a Single Source of Truth
Daasity solves the data management problem by centralizing your data from different platforms and making it directly accessible from one central dashboard. With a single source of truth, brands can keep data up-to-date and relevant, and mitigate technical issues like duplicate entries and record validation times.
Daasity Audiences Marketing Personalization
Daasity Audiences allows you to automatically sync all your customer data (updated daily), such as LTV, RFM Scores, CS data, and more into marketing platforms such as Facebook, Klaviyo, and Attentive. In other words, enrich your marketing channels with your preferred data, create net new experiences, build segments, trigger events, and update customer profiles.
Now that you have a better understanding of the LTV:CAC ratio, it’s time to determine your ratio and see how your business is performing. Optimizing your LTV:CAC is a great long-term decision that will ultimately help your business.
To learn how Daasity can help improve your reporting and help optimize your growth, we'd love to show you a demo.