The Hidden Connection: Why Customer Acquisition Costs and Customer Lifetime Value matters
Would you pay €1, €10, or even €100 to acquire a client?
What if she buys €1K/year?
What if she stayed for four years?
1000 a year for four years is €4,000!
Is a 40, or a 4X ROI enought?
Yes, when you mathing the maths that way.
But, what number do we enter in this field to get a 4X ROI?
No not take a guess, hope or throw ‘spaghetti at a wall’?
Let’s use maths.
Maths to determine Customer Acquisition Costs, CAC and Customer Lifetime Value, CLV.
‘How do I know I’m paying the right amount for new clients?‘
‘How much will I earn from one client over the years?‘
‘Is a lower acquisition cost better than a higher acquisition cost?‘
Most people ask “What is the least amount I should spend to acquire a customer?
Ask instead “What’s the most I can spend to acquire a new customer” and not go broke.
Customer acquisition cost is the key business metric to master to earn new and high-value clients.
Don’t worry, I am Urban Renström, there is always science and research involved in everything I talk about, teach, and demonstrate.
Here is the ->TL;DR<- version and the: FAQs
Do you know Jay Abraham’s ‘precepts’ of business growth, state revenues occur in three ways.
- Charging higher prices
- Sell more to the same clients
- Acquire new clients
Today we’ll deep dive into *option C* – acquiring new clients.
Don’t pay too much to Acquire New Customers
Balance that Customer Lifetime Value (LTV) exceeds your Customer Acquisition Cost (CAC).
LTV>>CAC = FTW!
Revenue growth is negative when the cost to acquire clients exceeds their lifetime value.
If CAC >> LTV then your business is in financial trouble.
CAC, CPA, Churn, LTV, and Net present value are used in the software as a service business (SaaS) models.
These same metrics apply to professional service, eCom and products-based businesses. e.g. Accountants, Restaurants, Solicitors, Marketing agencies and restaurants, medispa, PT etc.
What are Customer Acquisition Cost (CAC), Cost per Acquisition (CPA), and Customer Lifetime Value (LTV) formula.
Customer Acquisition Cost (CAC) is the cost to acquire a paying customer.
Cost per Acquisition (CPA) is the cost to get a phone call, web form submission, or a *newsletter* signup; CPAs are *broad marketing acquisition events*.
CAC is a subset of CPA.
Window shoppers; phone calls, and email enquiries, are greater than the number of paying clients.
Customer Acquisition Cost (CAC) is the total cost of converting a prospect into a client.
How to Determine Customer Acquisition Cost (CAC)?
CAC is the total sales and marketing expenses (divided by) the number of net new customers acquired in a period. CAC does not include which funnel stage or marketing channel was used.
The advanced next-level analysis is a funnel and channel-specific CAC, CLV and churn rate.
| SAAS Industry | CAC |
|---|---|
| Agtech | $712 |
| Adtech | $560 |
| Design | $658 |
| Education | $806 |
| Fintech | $1450 |
| Hospitality | $907 |
| Insurance | $1,280 |
| Medtech | $921 |
| Telecomms | $694 |
| Transport & Logistics | $483 |
CAC–is the cost to acquire a client.
LTV–is the average profit expected from new clients.
CAC–Customer Acquisition Cost Example
Marvel Tiny Toys, MTT, sold Iron Man, Hulk, Dr Strange, and Captain America soft toys and accessories.
During Q3 they spent €100K on sales (salaries) and marketing (indirect expenses: content creation, video, graphic, website, SEO; and direct expenses: search and social adverts (Google, Facebook ads), salaries).
MTT sold 10,000 soft toys and accessories.
The CAC = €100k expenses/10k sales = €10.
The €10 CPC is half the story. LTV is the other half.
If each of the 10,000 customers purchases €8 worth of soft toys and accessories, and only buys once (APF)
then MTT is paying more to acquire clients than revenue earned. #NotGood #LooseMoney #Bankrupt
A customer purchase frequency greater than 1 is the only way MTT can sustain a €10 CPA.
The missing expression in our equation is the customer lifetime value (LTV).
Customer Lifetime Value Formula – Earn back your Investment?
Definitions:
Customer Lifetime Value – (CLV) is the sum of revenue or profits from each client over the time they are a client.
Lifetime Value -(LTV)is the total revenue of all your customers.
Why care about the LTV? Because the LTV number is the true financial value of each client to your business over the lifetime your client is your client.
Why CLV Matters
The customer lifetime value is how much revenue you can earn from a new client–if they buy at the same rate as your existing clients.
A rule of thumb, a starting point, a baseline, an ‘SOP’, is to make your CAC to CLV ratio 1:3. CAC=1/3 x LTV.
Calculate (Customer Lifetime Value) CLV Like This:
- Customer Average Purchase Value – APV
- Average Purchase Frequency – How often people buy from you – call it average purchase frequency rate – APF
- Customer value – the product of AVP and APF. Customer value = AVP x APF
- Retention – the average customer lifespan – the average number of years a client is a client. Churn = Clients kept – client lost
🟦 1) Customer Average Purchase Value – AVP
Divide your business revenue e.g. Y2023, by the number of products/services purchased.
E.g. €11,000,000 in revenue and 1000 service packages sold.
€11,000,000/1000 = €11,000. Therefore the AVP = €11,000 for Y2023.
🟧 2) Average Purchase Frequency
Average purchase frequency is the total number of products sold (purchases) divided by the number of unique clients (excluding returning clients).
The APF = 4, 1000 divided by 250 = 4.
🟥 3) Average Customer Value
ACV is the product (multiply) of the purchase value times the frequency.
ACV = APV x APF = €11,000 X 4. The ACV = €44,000
🟩 4) Customer Lifetime Value
The simplest CLV formula is ACV times the customer’s lifetime.
CLV = ACV of €44K X 10-year = €440K.
The Churn Effect on Customer Lifetime Value
Churn – is expressed as a percentage.
Churn rate = (Lost clients / Total clients ) x 100. For some time.
Churn rate = (5/400)*100 = 1.25%
Thoughts on the CLV: CAC ratio
“The business that can spend the most to acquire a customer wins.”
Dan Kennedy
The goal of client acquisition is to get the highest-quality leads and the right clients, not the cheap leads and the wrong clients!
Armed with your CAC number you can budget to get a new client. And you know each new client has an LTV of €10K.
A truism–the more you spend the better clients you get, the higher prices they’ll pay, drive longer loyalty and get higher quality referral cases.
Armed with your CAC your competitors cannot compete and you win more clients.
A real-world example:
If you set your Facebook ads performance goal to maximize the number of conversions and set a budget of ∼€100/day.
Your web analytics shows, on average, one in 100 website visitors converts into a newsletter sign-up.
Your email marketing CRM data shows a new lead-to-client ratio for the trailing 30 days at 10%.
Therefore for every 1000 website visitors, you earn 3-€10K clients in 30 days.
Knowing your CAC numbers is clear and tangible.
TL;DR
Master these 3 key business metrics – CPA, CAC, and CLV (Cost per Acquisition, Custom Acquisition Cost, and Customer Lifetime Value).
If your CAC > CLV you are losing revenue. IF CAC < CLV you’re winning. Increase your CLV by serving clients better, exceeding their expectations, and keeping them longer as clients (so they buy more and up their individual and collective CLV).
Use the CAC and CLV numbers to inform your growth plan for 2024-5.
Armed with your CAC you can out spend the competition and win better clients.
