Why CAC And CLTV Matter to Your Financial Health

CAC

What Is CAC?

Customer Acquisition Cost, or CAC, is the average amount of money a company spends to acquire a customer. Usually, it’s calculated per customer and shows you how efficient your marketing and sales efforts are during the lead generation cycle. However, CAC per ad campaign is also a helpful number to evaluate how well you’re doing.

It’s a core principle used to allocate resources to business growth. General CAC includes all the marketing and sales efforts, accounting for the number of customers. Here is the basic calculation formula:

CAC = Amount spent on sales and marketing ÷ number of customers

Expanding your business is always good, right? More customers mean more revenue. However, it’s not that simple. Spending more resources on CAC doesn’t always mean growth in accounts or revenue. Your top priority should be to strike a balance between the optimal number of new customers and resources spent.

While we can view CAC from the “overall costs” and revenue perspective, it’s also essential to consider the per-customer acquisition cost. Knowing how much money you spend on each one before they purchase your product gives you a level of detail where you can tweak the efforts to get more with less. The opportunity to compare this with other per-customer metrics can give you an understanding of efficiency at a much more in-depth level.

Some executives look at optimization radically, trying to cut corners at all levels. However, you need to understand that it’s not wrong to spend money on getting new clients. You just need to have other meaningful metrics that can put this one in a broader context.

Why Is It Important?

The resources flowing into client acquisition can drain your business very fast, especially with the growing number of places you can find clients. Plus, a lot of overlap exists between different channels. 

For example, if you’re trying to capture clients with Facebook and Instagram ads, many of the same people might be seeing the same ad. It can make campaigns less efficient. So with your campaigns, think about an integrated strategy to track customers from one channel to another.

To have the situation under control, your marketing department would need all the data they can get. Measuring the return on investment on their ads would let them make better decisions for the coming campaigns.

Investors are another group that’s interested in your customer acquisition cost. They want to know how easily you get consumers and how much it costs. They also use the metric to pinpoint how sustainable your business model is. 

CAC is also part of the cash outflow that leaves you with a profitability estimation. It’s clear that if your costs are more than earnings, the business isn’t successful. This is why investors look for a ratio that will show a healthy relationship between expenses and profit.

Another comparison that highlights the efficiency of your CAC is how much revenue you get from each customer. With so many marketing and sales funnels, you might fail to realize the amount of cash you spend overall. Finding out this number and comparing it to other metrics like the Customer Lifetime Value can indicate your business sustainability and health.

What Is CLTV?

CLTV or LTV stands for Customer Lifetime Value. It shows how much money a consumer leaves in the company while they use your services. Depending on the product and how often a client needs to buy it, this metric can differ from company to company. It also depends on:

  • How much a customer spends on an order
  • How often a customer buys the product
  • How long does a customer stay with your company

For example, if you sell a SaaS solution that costs $30 per month, and the customer decides to take your services for one year, that particular user’s lifetime value is $360. This is a straightforward example of calculating CLTV on an individual customer level. 

However, you can measure this metric as an average for all customers. This method gives you a general application for the same notion.

CLTV = Average order value × Purchase frequency × Average customer lifetime

Ideally, you should spend less money on a customer than you receive from them during the whole purchasing cycle; it’s the only way that your company can be profitable. To acknowledge the real spending, you need to recognize all the areas that they occur:

  • Cost of Goods Sold (COGS)
  • Sales and Marketing (S&M)
  • Research and Development (R&D)
  • General and Administrative expenses (G&A)

In SaaS companies, a large portion of the spending happens during acquisition and service phases. We’ve already talked about CAC and how it needs to be a fraction of the lifetime value. All other costs get added to the initial spend.

Why Is It Important?

Customer lifetime value is both a historical and a future-oriented method to understand your financial flows. Analyzing how your customers behaved in the past makes you better understand what they might do in the future.

Suppose your company is five years old. If you go back and track your customer behavior from the beginning until present, you’ll see patterns in the client lifecycle. For example, if they stayed with your company for an average of 10 months, you can assume that this pattern will continue. While there are ways that this number can change for the worse or the better, the general patterns stay the same unless you make a special effort.

Now, let’s take the above example of a $30 product (monthly payment) and say that last year’s average customer lifetime was 10 months. Here goes the calculation of LTV per client for that period:

Past: $30 × 10 = $300 per customer

Imagine what a two-month increase in an average lifetime would do to your result:

Present: $30 × 12 = $360 per customer

The time a customer stays with your company largely depends on customer satisfaction rates.

Per customer revenue retention (or expansion) is another point to consider for better projections. Taking this strategy will divide your attention between getting the client and keeping them longer. It’ll give your business a healthier value profile.

Another aspect you can tweak is the purchase frequency. More repeat purchases increase the amount spent by the client. Although this might not work for monthly subscription services, it’s relevant for many SaaS products with add-ons and other value propositions. 

To improve CLTV, companies that have taken the monthly recurring payment method can also optimize the average amount a user spends on the product.

As we can see, CAC is crucial, but you can tweak CLTV on its own for a better chance with each customer. Now, let’s get into the reasons why these two metrics are so interconnected.

Why Is it Important to Calculate LTV/CAC Ratio?

If you want to know your customers’ spending habits, LTV-to-CAC ratio is a significant consideration. It’s essential not only for the sales and marketing department but also for customer service. This number is the relationship you need to monitor for healthy and sustainable growth. 

Besides, the LTV-to-CAC ratio identifies if you’ll be making enough money with each customer in the future to justify its acquisition costs in the present.

As a general rule of thumb, the ratio should be 3 to 1; during acquisition, you should be spending roughly 30-40% of whatever value a customer brings during their lifetime. 

Anything less means that you’re burning much more than you can afford; anything more shows that you’re not spending enough to expand your customer base. In the first case, your profitability is at risk. In the second situation, you might be ,ossomg out on new opportunities.

This ratio is crucial for internal decision-making, as well as for investors. Here are a few strategies you can use to get closer to the ideal number.

Make it Easier for Leads to Become Customers

Your website, sales process, and customer service should be top-notch to remove any irritations on a prospective customer’s path. Make it easy for them to decide and go for your product. There are a lot of ways to achieve that. UI and color, button placement, mobile-optimization, easy checkout, and excellent content are all areas to improve.

Establish a Relationship

Every marketer knows that acquiring a client is more challenging and more expensive than retaining one. This point applies to the importance of customer retention by adding value to their experience. Customers are what keeps your business alive. You should listen to them and take a lot of inspiration to enhance the product in ways that matter to them.

Use the Power of an Existing Customer

The longer your customer’s lifetime value, the better the LTV/CAC ratio. Naturally, you should start making an effort towards extending the customer lifetime. While you can do it directly with loyalty programs, implementing referral tactics also proves useful.

If you manage to get the existing user base to “recommend a friend,” you’ll get an influx of new customers at the cost of $0. Moreover, people who recommend a product are more likely to use it longer. 

Keep in mind: investors like a healthy LTV-to-CAC ratio. It’s a future-proof method to show that your company is on the right track.

Best LTV/CAC Calculators

SaaS interactive calculators are an excellent way to make sense of your business’s financial and KPI metrics. While they’re useful internally, your customers can also make decisions about your product on the spot without leaving your website. Placing them in strategic spots during the customer life cycle can prompt them to engage with your content. They might start asking questions on live chat or browse longer.

Of course, this is a nice boost to bounce rate stats, but it also implies a higher purchasing chance. It can also showcase your product in a concise, clear-cut, and actionable way.

While it’s hard for finance executives and marketers to keep track of SaaS metrics, making sense of it can prove more challenging for ordinary customers and startup founders.

There are plenty of software integration options that account for various metrics such as cost formation, ROI, growth ceiling, and implementation time.

Many companies offer flexible solutions that help build content to fit your site, and Ion Interactive is one of them. It provides the best dynamic calculators and other visual solutions for SaaS businesses.

Conclusion

No customers means no business. In the SaaS world, consumers are the direct driving force of business metrics. In other industries, executives can be more general with the concepts and numbers they track. Applying “personality” to the estimates proves more useful in SaaS.

Tracking the companywide average CAC or CLTV is beneficial for the bigger picture. Still, per-account thinking helps founders, CFOs, and marketing managers get a more in-depth understanding of client-company dynamics.

Besides, the LTV-to-CAC relationship proves that metrics don’t exist in isolation. Working on one affects the other, improving the overall business standing.

Mateus Oliveira

Mateus Oliveira

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