Both these metrics are crucial for getting product growth insights into the financial health and sustainability of your SaaS business. Tracking them allows you to allocate resources effectively and optimize your sales and marketing budget.
But how do they differ from each other? Let’s dive in to find out and also discuss how you can improve both your customer acquisition cost and lifetime value.
Understanding the metrics that drive growth and profitability is crucial for any business Two such key metrics are customer acquisition cost (CAC) and customer lifetime value (LTV), Both CAC and LTV provide important insights into the financial health and sustainability of your business
In this article, we will compare CAC vs LTV to help you understand how they differ. We will also discuss strategies to optimize these metrics for product-led growth.
What is Customer Acquisition Cost?
Customer acquisition cost refers to the total cost involved in acquiring a new customer It represents the average cost incurred to acquire one new customer
CAC is calculated by dividing total acquisition costs by the number of new customers acquired in a period.
For example, if a business spent $100,000 on sales and marketing activities in 2022 and acquired 1,200 new customers, the CAC would be:
CAC = Total Acquisition Cost / New Customers = $100,000 / 1,200 = $83.33CAC helps businesses determine the efficiency of their customer acquisition efforts. It also aids in allocating marketing budget and evaluating return on investment.
What is Customer Lifetime Value?
Customer lifetime value (LTV) is the total revenue a business can potentially generate from a customer over their entire relationship.
For SaaS businesses, LTV estimation is critical for assessing customer profitability and making informed decisions about acquisition and retention.
LTV is calculated by multiplying the average purchase value, average purchase frequency, and average lifespan of a customer.
For example, if:
- Average purchase value = $100
- Average purchase frequency = 4 times per year
- Average customer lifespan = 5 years
Then, the LTV would be:
LTV = Average Purchase Value x Average Purchase Frequency x Average Lifespan = $100 x 4 x 5 = $2,000Key Differences Between CAC and LTV
CAC and LTV differ in the following ways:
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CAC measures costs while LTV estimates revenue: CAC is a definite metric that represents the cost to acquire customers. LTV gives you the expected profits from each customer.
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CAC is short-term while LTV is long-term: CAC gives insights into your current customer acquisition costs. LTV projects lifetime revenues from acquired customers.
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CAC informs sales process while LTV informs retention process: Optimizing CAC improves acquisition strategies. Boosting LTV enhances retention efforts.
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CAC vs LTV indicates profitability: The LTV should sufficiently exceed the CAC to ensure profitability per customer. A lower LTV than CAC means your customer acquisition strategy needs optimization.
Why is the LTV:CAC Ratio Important?
The LTV to CAC ratio evaluates the return on investment from acquisition efforts. It’s calculated as:
LTV:CAC Ratio = Lifetime Value / Customer Acquisition CostThis ratio shows whether you earn more profits per customer than the amount spent to acquire them.
A good LTV:CAC ratio for SaaS businesses is at least 3:1. This means you earn 3x more in revenues than your acquisition cost.
However, an extremely high ratio (e.g. 10:1) may also indicate excessive profits. Businesses should aim for an optimal range to drive growth through competitive yet profitable customer acquisition.
Strategies to Improve Your LTV:CAC Ratio
Here are some tips to improve customer lifetime value over acquisition costs:
1. Personalize the onboarding experience
Use techniques like assessments and surveys to segment users and offer tailored onboarding. Personalized onboarding improves engagement and satisfaction.
2. Provide in-app guidance
In-app interactive walkthroughs guide users to find value quickly. This increases adoption of key features that drive retention.
3. Promote feature adoption
Notify users of new features and how to use them. This prevents feature unawareness and improves utilization.
4. Drive account expansion
Upsell and cross-sell to increase customer value. Use in-app messages or notifications to nudge users.
5. Improve secondary onboarding
Continuously educate loyal customers to derive more value from products.
6. Identify friction in user journey
Analyze usage data to remove obstacles in achieving Aha moments and completed workflows.
7. Collect user feedback
Run in-app surveys to gather insights into improving satisfaction and retention.
8. Focus on high LTV customers
Evaluate LTV across customer segments and focus acquisition efforts on the high LTV segment.
Other Important SaaS Metrics to Track
Along with LTV:CAC, here are some other key SaaS metrics to track:
- Customer retention rate: Percentage of customers retained over a period
- Customer churn rate: Percentage of customers lost over a period
- CAC payback period: Time to recover CAC through customer revenues
- ARR expansion rate: Year-over-year increase in average revenue per account
- Gross margin: Revenue remaining after costs of goods sold
- Customer satisfaction (CSAT) score: Metric for gauging customer happiness
Understanding the difference between customer acquisition cost and lifetime value is key for making data-driven decisions to fuel growth. While CAC gives you the cost of acquiring users, LTV projects the long-term revenue from customers.
A high LTV:CAC ratio ensures profitability of your customer base. You can optimize this ratio by boosting customer retention and engagement through personalized onboarding, in-app guidance, and continuous education.
What strategies have you found most effective for lowering CAC and raising LTV? Share your tips and experiences in the comments below!
Customer acquisition cost vs lifetime value
How is customer acquisition cost different from lifetime value?
CAC measures costs and is more of a definite metric than LTV. On the other hand, LTV is an estimate of profits. It gives the expected revenue generated per customer instead of a definite number.
Ideally, the average lifetime value of the customers should exceed the acquisition costs to drive business growth. It means you are earning more money from users than you are spending acquiring them.
If the CAC surpasses the LTV consistently, it indicates that either your customer retention efforts are insufficient or your acquisition costs require optimization.
Important metrics to track apart from LTV:CAC ratio
Let’s briefly discuss the key metrics you should track besides the LTV:CAC ratio.
- Customer retention rate: This is the percentage of customers a business can retain successfully over a specific period. It helps businesses evaluate their ability to build long-term customer relationships.
- Customer churn: It refers to the rate at which customers stop using a product or service. You should track both monthly and annual churn regularly to make adopt relevant churn reduction strategies.
- Average revenue per user (ARPU): This metric measures the average revenue earned from each customer within a given period. It helps you assess the financial performance of your customer base.
- Conversion rate: This is the percentage of web visitors or users who complete a specific goal, such as converting from a free trial/freemium user to paying customer. The trial-to-paid conversion rate helps to measure the effectiveness of your sales and marketing campaigns.
- Gross margin: This is the percentage of revenue left after subtracting the direct costs associated with delivering your service to customers and maintaining your product. It measures the profitability of your core product offering before accounting for operating expenses.
Customer Acquisition Cost vs Lifetime Value
What are customer acquisition cost and customer lifetime value?
[ 1] Customer acquisition cost (CAC) and customer lifetime value (LTV) are great examples of metrics that are more telling when measured in tandem than on their own. Together, they create a narrative about the value your customers provide in relation to the amount you’ve spent to acquire them.
What is customer lifetime value (CLV)?
While CAC is important, it doesn’t tell the whole story. That’s where customer lifetime value (CLV) comes in. Three of the most important functions of customer marketing are retention, cross-selling, and upselling. If your product is subscription-based, you want to make sure your customers are retaining that subscription for as long as possible.
What is Customer Acquisition Cost (CAC) & customer lifetime value (LTV)?
Customer acquisition cost (CAC) is the money a business spends on acquiring new customers. Customer lifetime value (LTV) refers to the expected revenue stream from one customer throughout their business with you. To measure CAC, divide the total acquisition cost by the number of new customers acquired during a given period.
Should you know the cost of acquisition compared to lifetime value?
From a strategic point of view, it is advantageous to know the cost of acquisition compared to the customers’ lifetime value. For instance, ExactBuyer has proven to improve business KPIs as their success metrics show 40% more booked demos for Brex, 55% more qualified deals for Gorgias, among others.
