LTV:CAC Ratio for Brands
LTV:CAC Ratio is a primary indicator of your brand's profitability, growth potential, and the overall health of your business.
In other words, LTV:CAC ratio a must-track metric.
What is LTV:CAC?
LTV:CAC (also written as CLV:CAC) is the ratio of your brand's Customer Lifetime Value (i.e, average gross margin per customer over their lifetime with your brand) 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 brand's success because it indicates how effective your marketing efforts are, and it projects your brand's long-term profitability.
What different LTV:CAC ratios mean for brands (& What is a good LTV:CAC ratio?)
LTV and CAC are even (1:1)
If a brand has a 1:1 ratio, it means the cost to acquire a customer is the same as the consumer's lifetime value.
While it may appear that the brand is breaking even per acquisition, it actually means that it's likely losing money per acquisition. Because LTV:CAC only takes your marketing expenses into account, a 1:1 ratio means the brand is losing money once it accounts for taxes, shipping, and other costs.
LTV is lower than CAC (e.g., 1:1.25)
If a brand has a ratio like 1:1.25, the brand is spending more to acquire a customer than it will ever make from that customer, even when only marketing costs are taken into account. Bringing other costs into consideration, it's likely losing a significant amount of money per acquisition.
LTV is higher than CAC (e.g., 2:1 - 4:1)
If a brand has a ratio of 2:1 or 3:1, it can expect to make 2 or 3 times what it spent to acquire a customer.
A 3:1 ratio is a common benchmark for a "good" ratio. This is also a common number that venture capitalists and other investors want to see (though their preference may be higher or lower depending on your industry and how long your company should be around).
A higher ratio, such as 4:1, however, may indicate greater growth opportunity: it means you may consider increasing your marketing spend.
LTV is much higher than CAC (e.g., 5:1+)
If a brand has an LTV:CAC weighted heavily in favor of LTV, it may be leaving growth on the table. This may be a great opportunity to scale up advertising and marketing efforts.
For more on acquisition costs, LTV:CAC benchmarking, and analysis, here's Daasity co-founder Sean Corson:
How to calculate LTV:CAC ratio
You can calculate LTV:CAC ratio by dividing your average customer lifetime value (over a given period) by the customer acquisition cost (over the same period). The ratio effectively measures the return on investment for each dollar your brand spends to acquire a new customer.
To calculate average customer lifetime value, use two formulas. First, calculate gross margin by subtracting landed cost from gross revenue (over a particular time period). Then, divide gross margin by your total number of customers (from that same time period).
Next, to calculate Customer Acquisition Cost, you'll need to add together all of your marketing-related expenses from the same time period as your LTV calculation.
- variable marketing costs ($ spent on your ad platforms)
- recurring costs of marketing/eCommerce tools used
- ad vendor cost
- costs to create ad creatives
- team salary
- agency costs (if applicable)
Finally, when you have both an LTV and CAC figure, plug them into the formula below:
How a high CAC harms long-term growth
As industries become increasingly competitive, brands have been scaling up their acquisition efforts to win the customer base over from their competition. But over time, brands with a high CAC relative to their LTV suffer.
Here are a couple 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:
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. But even without investors, you should continually track the ratio and implement best practices to optimize it. Here's how:
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 consumer brands, 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 limited organic reach. You can also employ post-purchase marketing strategies to drive repeat purchases, increasing LTV.
- Building a retention marketing strategy around zero-party data and first-party data (read: your owned data) is the best way to create more personalized, thoughtful, and targeted experiences for your customers. By knowing, for example, what customers like and what their purchase behavior is, you can send more appropriate product offers and even time when you send promotions and offers to customers.
Identify the most profitable and costly customer segments
You may be 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 customer lifetime value a metric owned by all teams
LTV is a vital KPI that affects almost all areas of your business. Every team should focus on this metric and should work together to help improve it. This can be done in a few 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 operations 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 customer lifetime value 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:
- 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 your LTV:CAC ratio in real time
To track LTV:CAC ratio, brands need to centralize their data in order to track both LTV and CAC in real-time. Centralization is vital because LTV and CAC are dependent on your efforts across multiple channels.
So, to monitor your LTV:CAC ratio in real-time, you need to leverage an analytics platform for consumer brands (like Daasity) that lets you access centralized data directly from the dashboard:
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.
To learn how Daasity can help improve your reporting, help you track your LTV:CAC, and help optimize your growth, we'd love to show you a demo.