02 Jul
Every marketing team is familiar with how to invest in customers. There are proportionately far fewer who even know whether such expenditure is sensible. This is where the CAC-LTV formula comes into play. It is a straightforward way to see whether your growth is viable or you are purchasing customers at a loss with the hope that things will work out in the future.
In this guide, you’ll learn what CAC and LTV are, how to calculate them and use that single ratio to decide smarter marketing.
What Is CAC?
CAC is the acronym for Customer Acquisition Cost. It’s the average monetary value you put into acquiring a customer.
The formula is simple:
- CAC is calculated using the following formula: Total Sales and Marketing Spend / Number of New Customers Acquired
If you have spent $50,000 on ads, content and your sales staff last quarter and that generated 500 new customers, your CAC is $100. That means you have to pay $100 for each of your new customers.
Every marketing approach related to acquiring that customer should go under the CAC umbrella, which is why it shouldn’t stand alone in tracking ad spend. That means:
- The finances of paid ad expenses (Google, Facebook, LinkedIn, etc.).
- Commission for sales personnel
- The following tools and/or software are used for campaigns.
- Content production costs
You might want to avoid leaving any of these items out because they make your CAC seem stronger than it really is, and that can result in poor decisions.
What Is LTV?
LTV is a term for Lifetime Value (also known as Customer Lifetime Value, or CLTV). It’s the lifetime value of all the revenue you can anticipate from one customer.
A simple formula is:
LTV = Average Purchase Value x Purchase Frequency x Customer Lifespan
Subscription businesses have it easier, however:
LTV = (AMRpC × ACL) / discounted number of customers.
Assume the customer pays you $50 per month, and stays on average for 20 months. Their LTV is $1,000.
LTV is not just telling you about the value of a customer on day one, but over the entire customer relationship. This is important as customer acquisition will become more expensive, but certain customers will have significantly longer life cycles and higher dollar value, and thus are worth the additional expense.
Understand the significance of the CAC-LTV ratio in marketing.
Knowing CAC and LTV, you can determine the important ratio is:
The ratio of LTV/CAC indicates the LTV÷CAC.
This one single number will tell you whether or not your business model is capable of survival. The following is an explanation of how to read it:
- Less than 1:1 – You’re out of money with every customer. However, it is an error to spend more to grow for the sake of growth, and thereby make matters worse, not better.
- At about 1:1 – You are even. No room for profit, overhead or mistakes.
- 3:1 – This is the benchmark that many SaaS and subscription businesses strive for. Acquiring a customer costs $1 and they return $3 times that. It takes $1, but it returns $3. It indicates healthy, sustainable growth.
- 5:1 or better – This would seem perfect, but may be a warning sign. It will normally mean that your spending is not adequate for growth and that you would be finding customers if you spent more on marketing.
While a 3:1 ratio may not be the magic number for all businesses, it is a popular metric because it allows for a balance of profits and investment in business growth.
Why so many businesses fail to get this right
Simple to calculate this on paper and yet it is easy to misread what they are saying. These are the most common errors.
- Error #1: Defining CAC too narrowly. The first mistake is that of making CAC too narrow a definition. Many teams only include the cost of advertising/marketing and don’t consider the costs of salary, tools, and overhead. This can result in an artificially low rate of CAC and result in over-demand for scaling spending.
- Error #2: An over-optimistic estimate of LTV. The initial temptation is to assume that customers are going to stay for a long time, especially if you don’t have a lot of churn data. A poor ratio can be made to appear healthy by overstating the LTV.
- Error #3: Not considering the payback period. If you’re able to recover the cost of the acquisition in 3 years, then you may not have a problem even if the ratio is 3:1. Just as important as a ratio is cash flow. The quicker the payback, the sooner you can reinvest in growth.
- Error #4: One-size-fits-all customers. When calculating either AC or LTV on a customer-wide basis, it’s easy to mask significant channel, segment, and/or plan disparities by aggregating across the entire customer population. It can be easy to overlook huge discrepancies between channels, segments and/or plans by calculating the average AC or LTV for your total customer base. One channel could be making lots of money while the other is making very little without you knowing it.
- Error #5:Not updating the numbers regularly. CAC and LTV will change based on market, pricing and competition. The ratio is based on a year’s worth of data and may not match today’s circumstances.
Understanding how to enhance your CAC-LTV ratio.
When it’s not what you want, there are two places to go: either lower your CAC or increase your LTV. Most companies will require both.
Lowering CAC
Improve targeting.
One of the major contributors to a high CAC is the time and money you invest in attracting the wrong kind of customer. Narrowing your targeting down to your top existing customers can quickly prove to be rewarding.
Repeat what is working.
Review individual channels, one by one. Before spending money on costly paid avenues, allocate more resources to becoming more visible in the free channels that are driving traffic, such as search and referrals.
Fixing leaks in your landing pages, sales calls, or onboarding flow without spending more money on ads will reduce your CAC.
Leverage retargeting sequences and nurture sequences.
Not all visitors convert “on the spot. Unlike other new paid traffic, email sequences and retargeting ads can actually produce warm leads at a significantly lower cost.
Raising LTV
It’s typically the biggest lever in getting LTV up, particularly if you’re a subscription business. If you notice that you’ve made just a little bit better, that has a huge impact on your marketing outcomes over time.
Upsell and cross-sell.
Current customers are much easier to sell to than new ones. Providing relevant upgrades or add-ons in the mix boosts revenue per customer without increasing acquisition cost.
Improve onboarding.
If the customer realises their value early, they are much more likely to stay. The power of a great onboarding experience is that it directly prolongs customer lifespan.
Develop loyalty regimes or longer-term agreements.
Rewarding plans for the year rather than the month or for giving customers the value over a number of years will increase the average tenure and value of customers.
It’s illustrated with a simple example to easily apply.
Imagine that, for example, you are thinking of the following situation:
In the entire period, an average SaaS company spends $30,000/month for marketing, an equal amount on sales and ends up with 150 new customers.
CAC = $30,000 ÷ 150 = $200
This is true of every customer who pays $40/month and is there on average for 15 months.
LTV = $40 × 15 = $600
LTV : CAC Ratio = $600 ÷ $200 = 3:1
This is an excellent company to have in your portfolio. They spend $1 per customer acquired and can expect to receive $3 in their lifetime from those customers acquired. This ratio allows them to have the buffer to invest even more in growth, new channels, and profits.
What if there were a rise in churn and customers began to sign up for 6-month terms rather than 15-month terms?
New LTV = $40 × 6 = $240
New Ratio = $240 ÷ $200 = 1.2:1
Thereafter, the same number of acquisition costs is almost balanced by the break-even point. These numbers are indicative of the value retentions can bring to the overall profitability, often greater than acquisitions.
Final Thoughts
The CAC-LTV equation doesn’t just apply to a finance problem. It’s a valuable gauge to monitor to figure out whether your marketing system is developing a profitable business or just activity. If you feel as if you need to invest more in your business, you have one of the best ratios; if you don’t have a good ratio, then you know that you need to work on the pieces and parts of your business before you invest any more money.
In the long run, it’s not always the case that the more money the company spends on marketing, the more money the company earns. It is because they are the ones who know how, when and how much they can pay each customer, how each customer is valued and how they can value these customers more over time.
Track it. Review it regularly. Let the numbers and not just guesses inform your next move.
Vithusha
Vithusha is a skilled Business Content Researcher and Analyst with a passion for creating insightful, research-driven blogs and articles on business trends, market strategies, industry developments, and digital growth. With expertise in content analysis, data-driven research, and professional article writing, she delivers engaging and informative content that helps businesses and readers stay informed in a rapidly evolving market. Her work combines analytical thinking with creative storytelling to produce high-quality blogs, business reports, and strategic content tailored to modern industry needs.
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