What is the LTV/CAC ratio?
The relationship between your customer's lifetime value (LTV) and customer acquisition cost (CAC) is measured by the LTV/CAC ratio. Within a specified time frame, you can calculate the LTV/CAC of a single client or a cohort of consumers. When comparing the amount you spend to acquire a customer to the total amount they have paid you for the duration of the relationship, the ratio displays your return on investment (ROI).Furthermore, by comprehending CLV, companies can spot possible churn hazards. Businesses may proactively resolve any issues or complaints and keep important consumers by analysing customer behaviour and spending habits.
How to calculate LTV/CAC?
The LTV/CAC ratio is computed by dividing the LTV by the CAC.
To calculate CAC, add any acquisition-specific expenses, such as marketing's use of social media, SEO, SEM, and PR tactics, any costs associated with sales representative travel, and department staff salaries to get CAC (the denominator). Next, divide that figure by the total number of new clients attained during that time frame.
The average amount of money you will earn from an account over the course of the client lifetime is the focus of your numerator, or LTV.
In order to calculate, you must first look at the average revenue per user (ARPU) over time and multiply it by your gross margin (net sales revenue less the cost of goods sold). Lastly, you will divide that figure by your churn rate, which is the total number of customers who left before the calculated period.
What are the LTV:CAC benchmarks for an Ecommerce industry?
An LTV of roughly three times CAC is recommended by numerous e-commerce professionals. An LTV:CAC ratio of 3:1 indicates that you are making $3 in revenue for every dollar you spend on acquiring new customers. For the majority of businesses, that ratio is sound and sustainable.
How to improve the LTV to CAC ratio?
The following tactics will raise LTV (customer lifetime value) without raising CAC:
- Identify the perfect client profile.
- Optimize your pricing strategy.
- By segmenting out distinct customer segments, you can determine the lifelong habits of your best customers.
- Look for methods to charge more, cross-sell, and upsell
- Think about displacing transactions with more possibilities for memberships and subscriptions for customers.
How to perform Cohort Analysis using LTV to CAC ratio?
Define your cohorts:
- Segment your customer base into groups (cohorts) based on a common characteristic. Acquisition date (month,quarter, year) is a typical starting point, but you can segment by marketing channel, demographics, etc.
Calculate LTV for each cohort:
- For each cohort, determine the average customer lifetime value (LTV). This is the total revenue a customer from that cohort is expected to generate over their relationship with your business.
Calculate CAC for each cohort:
- For each cohort, determine the average customer acquisition cost (CAC). This is the total cost you incur to acquire a customer from that specific cohort. This includes marketing spend, sales commissions, and other acquisition-related expenses.
Analyze the LTV/CAC ratio by cohort:
- Divide the LTV for each cohort by the corresponding CAC. This ratio indicates the return on investment for acquiring customers from that particular cohort.
Identify trends and insights:
- Analyze the LTV/CAC ratio across different cohorts. Look for trends like:some text
- Improving CAC: If CAC is decreasing over time for new cohorts, your acquisition strategies are becoming more efficient.
- Increasing LTV: If LTV is increasing for new cohorts, your product or service is becoming more valuable to customers.
- Profitable cohorts: Identify cohorts with an LTV/CAC ratio greater than 1. These are your most profitable customer segments.
How to monitor LTV:CAC in real time?
While perfectly real-time monitoring of LTV:CAC can be challenging, there are ways to achieve a close approximation that offers valuable insights. Here's how:
1. Centralize your data:
The key to near real-time monitoring lies in having all the data feeding into a central location. This includes customer acquisition costs (marketing spend, sales commissions), customer revenue data, and customer churn information.Consider a Customer Relationship Management (CRM) system or a marketing automation platform with robust reporting capabilities.
2. Utilize data pipelines and automation:
Set up automated data pipelines to regularly ingest data from various sources into your central location. This ensures minimal lag between data generation and its availability for analysis.
3. Update estimates regularly:
LTV is an estimate based on historical data and assumptions about future customer behavior. Regularly review and update your LTV calculations as you gain more data and insights.
