Lifetime Value (LTV), sometimes referred to as Customer Lifetime Value (CLV), is the average revenue a single customer is predicted to generate over the duration of their account.
Customer Acquisition Cost (CAC) is the average expense of gaining a single customer.
The ratio of lifetime value to customer acquisition cost helps you determine how much you should be spending to acquire a customer.
Calculating this ratio will show if you’re spending too much per customer or if you’re missing opportunities from not spending enough.
LTV to CAC Ratio Calculation
The average lifetime value of your customers is the average monthly revenue per customer adjusted for monthly churn and gross margin. You can also calculate LTV using annual recurring revenue and annual churn.
LTV can be calculated several different ways depending on business. For a SaaS company, it could be as easy as:
LTV = Average monthly revenue per customer ($) X customer lifetime (# months)
For a more precise calculation, it could be:
LTV = Average Order Value ($) X Repeat Sales (#) X Average Retention Time (# months) X gross margin (%)
The cost of acquiring a customer is simply the sum of all marketing and sales expenses (including salary and overhead costs) over a given period divided by the number of new customers added during that same period.
CAC = Total sales and marketing expenses ($) / new customers acquired (#)
For example, if your customer lifetime value is $3,000 and your expenses for acquiring a customer are $1,000, then your LTV:CAC ratio would be 3:1.
What Does It Mean?
- A ratio of 1:1 means you lose money the more you sell.
- A good benchmark for LTV to CAC ratio is 3:1 or better.
- Generally, 4:1 or higher indicates a great business model.
- If your ratio is 5:1 or higher, you could be growing faster and are likely under-investing in marketing.
Calculating your LTV:CAC ratio is a great way to see if your company is positioned for sustainable growth. This ratio acts as a “barometer” for determining how much or how little you should spend on marketing and/or sales to maximize your growth and stay ahead of the competition.
The LTV:CAC ratio is a leading indicator that’s great for predicting future growth, but it’s a prediction – and predictions can easily change. For example, your LTV could drop if a new competitor enters the market driving up your churn. Or your LTV might increase if you make a really positive product change.
Like any calculation, you want to have statically significant sample data. If you are a startup and have little data over a short period of time then your LTV:CAC will not be very useful. With a large data set over a long period of time, your calculation will be more meaningful.
LTV:CAC Ratio. Geckoboard. https://www.geckoboard.com/best-practice/kpi-examples/ltv-cac-ratio/
CAC LTV Ratio. Corporate Finance Institute. https://corporatefinanceinstitute.com/resources/knowledge/valuation/cac-ltv-ratio/
Special thanks to Greg Chapman and Steve Covey who remind me to think about these things.