What is CAC?
The CAC (customer acquisition cost) is the amount of money that a business spends in order to acquire a new customer. This includes a wide range of expenses such as marketing and advertising, sales salaries, and any other costs associated with acquiring new customers.
Total cost spent to acquire customer / Amount of acquired customers = Customer Acquisition Cost
What is the CLV?
Customer lifetime value (CLV) represents the estimated revenue that a customer will generate for a business over the course of their relationship with the company. Most companies do not have a single CLV for their entire customer base; instead, they use separate calculations for different customer segments to then identify segments that are most valuable to the company.
There are different approaches to calculating the CLV – the historical model is the easiest and it uses past data to predict the value of a customer without considering whether the existing customer will continue with the company or not. With the historical model, the average order value is used to determine the value of your customers. This model is especially useful if most of the customers only interact with a business over a certain period of time.
Historical Approach – Calculation CLV:
Average order value * Average purchase frequency * Profit Margin = (Historical) Customer Lifetime Value
Unlike the historical customer lifetime value model focusing on past data, the predictive CLV model forecasts the buying behavior of existing and new customers. It aims to model a customer’s transactional behavior and predict what the customer is likely to do in the future. It is more precise than the historical CLV because it predicts the total value of a customer. Along with past purchases, this approach accounts for a customer’s actions. There are many ways to calculate predictive CLV – below, we list one of the methods.
Predictive Approach – Calculation CLV:
Average order value * Average purchase frequency * Customer Lifespan * Profit Margin = Customer Lifetime Value
A healthy ratio between CAC and CLV
The ideal ratio between CAC and CLV varies depending on the type of business and industry it operates in. However, a general rule of thumb is that a healthy ratio between CAC and CLV is 1:3, meaning that a business makes $3 in revenue for every $1 spent on customer acquisition. In some cases, a business may have a higher CAC, particularly if it has a longer sales cycle or a more complex product offering.
Maintaining a healthy ratio between CAC and CLV requires continuous monitoring and optimization of marketing and sales efforts. Businesses can focus on the channels and tactics that deliver the best results, optimize their sales process to reduce CAC, and implement customer retention strategies to increase CLV.
Rule of thumb CLV : CAC
- 4 : 1 Business is doing well, marketing can be more aggressive to bring the ratio closer to 3 : 1
- 3 : 1 Recommended target size at a perfect level
- 1 : 1 Close to losing money on every new acquisition
- Smaller than 1 : 1 Company makes losses
Impact of seasonality and external factors
Seasonality and external factors can also have an impact on the ratio between CAC and CLV. For example, businesses that experience high levels of seasonality may need to adjust their marketing and sales efforts in order to maintain a healthy ratio. It’s important for businesses to monitor their metrics closely and make adjustments as needed in response to external factors.
In conclusion, the customer acquisition cost and customer lifetime value are two critical metrics that are essential for measuring the success of a business’s marketing and sales efforts. Maintaining a healthy ratio between CAC and CLV is key to building a sustainable and profitable business. By continuously monitoring and optimizing their marketing and sales efforts, businesses can ensure that they are spending an appropriate amount of money to acquire new customers and that the revenue generated by these customers is sufficient to cover the costs of acquisition. By continuously monitoring and optimizing their marketing and sales efforts, companies can ensure that they spend an appropriate amount on acquiring new customers and that the revenue generated from these customers is sufficient to cover the costs of acquisition.
To achieve a balance between customer acquisition costs (CAC) and customer lifetime value (CLV), companies can enlist the help of GANDT Ventures. Their team of experts provides valuable support in the continuous monitoring and optimization of marketing and sales strategies. By using effective customer engagement methods, they can help increase CLV while lowering CAC, resulting in a profitable and sustainable business model. Get on the path to seamless success with GANDT Ventures.