What you need to know about working with lifetime value and customer acquisition cost
This post originally appeared on blog.up.co
Do you know and understand what drives your business?
Are you aware of the health of your business?
Do you know how to measure the return on your marketing investments and sales?
Numerous underlying values and factors affect how your business runs. Very few business owners are able to predict the state of their business in the near future. The idea is to move away from the usual growth rates, revenue, user engagement numbers, total user figures, and EBITDA, among others. Relying on this limits the health prediction to its current state instead of the future. This is a leeway for future losses. Secure your business by applying the LTV: CAC ratio.
What Is The LTV: CAC Ratio?
This ratio will help you work out your return and predict your future return. Subscription companies popularly use this ratio. It works out the connection between the customer’s Lifetime Value (LTV) and the Cost of Acquiring the customer (CAC). Most companies and businesses are faced with a lack of knowledge of the right amount to spend on the customer. These two concepts need to be appreciated one at a time in order to achieve successful results for your business.
What Is The Lifetime Value?
You need to have some insight on the time and value that an average customer places on your services and products. This period has a close relation to the value that the customer brings to the business; the longer the period the more the value. Below are a few steps to knowing the lifetime value of your customers.
- Churn rate- This is the rate at which customers cancel subscriptions within a period. This period is calculated in months. For example, if your business has five hundred customers and in a span of one month, twenty of them cancel their subscription then the rate will be four percent monthly churn. Working out this equation in an inverted position helps to work out the period that customers will stick around for your services.
- Gross margin- This margin is measured in percentages. It is the residual profit percentage after paying service and product costs.
- Average monthly payment for each customer- This record is also necessary to determine the lifetime value. Just as the name suggests, it is the average subscription payment made by each customer per month.
Thus, all the above values play a part in determining the lifetime value. The equation for determining this is as follows:
Average Monthly Subscription value per customer X (1/Monthly Churn) X Gross percentage margin
The lifetime value is dependent on the level of the business. At the beginning of the business, this value is very minute. In fact, it is lifetime value of the business increases with the growth.
How to Calculate the Customer Acquisition Cost
Calculating this is much easier and direct in comparison to the lifetime value. It includes the entire marketing and sales budget divided by the total new customers within a particular period. This calculation works well for enterprises with a short marketing and sales budget.
This ratio helps enterprises to maintain their numbers with respect to their return in a certain period. Experts advise on recovering the CAC within the first year or so of the business. Therefore, the ratio should technically be LTV: CAC= 3:1. This means that a customer’s value should be substantial enough for an enterprise to acquire the customer. This means that if this ratio gets to 1:1, then the enterprise is spending too much on customer acquisition and will most likely not be able to recover this amount within the stipulated time. It would be beneficial to note that this value does not include fixed costs such as rent, infrastructure or even company salaries. It specifically sticks to
How Does The Cost Affect Business Operation Costs?
Entrepreneurs are bold and confident about their services and products. This makes some of them believe strongly that they do not have to pay a cent in the acquisition of customers. They assume that customers will hunt them down for their services and goods. However, this is far from the real approach. This mentality makes entrepreneurs fail at the onset of their business startups, which is why they have to start appreciating the beauty of investing and reaping from their efforts after the customers make their purchases and service requests.
These values are handy for business owners who own enterprises that have a direct connection between the growth of users and revenue. This means that people who own advertising businesses are not likely to benefit from such calculations. Thus, the business that should use these calculations should be able to market to their customers in order for them to get the services and products. The aim of the calculation is to create a new plan that will make the future project of your enterprise more sustainable.