How to Calculate

Cost to Acquire a Customer (CAC) and

Lifetime Value of a Customer (LTV or CLV)

Knowing how much it costs to acquire a customer and how much that customer is worth to you is an important validation of your business model.  

 

This article explains how to calculate these metrics and their importance in creating higher total revenue for your business.

Cost to Acquire a New Customer

The cost to acquire a customer is a marketing acquisition cost. It tells us how much money is required to get one new customer.  It helps a growing company make better business decisions on how to market to prospective new customers.

Total Sales & Marketing Costs for a Period

Sales and marketing expenses are any costs used to generate leads and close new business.  They can be easily retrieved from your company’s Profit & Loss statement. Use a period of a quarter or a year so that you have enough data to measure.  Fast growing companies dedicate virtually all their efforts to attracting new customers, so we’ll assume 100% of this expense should be included in the formula.   

Number of New Customers Acquired

You should have an easy way to monitor changes to your customer base.  If you are using shopping cart software such as Shopify, you can run a report showing how many new accounts were created during the period.  What want to know how many new customers were created before any customer losses. Don’t net out customer losses - that’s a customer retention issue that can be measured other ways.

Cost to Acquire a New Customer Formula

Total Sales & Marketing

Costs for a Period

Number of New Customers Acquired During Period

Example

A software company sells a monthly subscription for $29 per month.  It spent $50,000 in one quarter and signed up 250 new customers.

$50,000 spend

250 new customers

= $200 CAC

Why is Customer Acquisition Cost Important?

Many investors want to know the cost of customer acquisition of the companies in which they invest.  This metric provides an estimate of the cost and effort to land a new customer. It can be tracked against the value of that customer to your business during the life of your relationship with them.  It provides insight on the unit economics of your business and whether your business model is sustainable.

Lifetime Value of a Customer (LTV or CLV)

Lifetime Value of a Customer Formula

Total Gross Margin 

for a Period

Number of Periods a

Customer is Retained

Example

A software company selling a monthly subscription for $29 per month pays out a $2 per month commission on all its subscriptions.  The Gross Margin on each subscription is $27 per month. On average, each subscription lasts 36 months.

$27.00 / mo Gross Margin

= $972 LTV

36 months retention

The lifetime value of a customer is the profit delivered by a customer while they continue to buy from your company.  It may also be referred to as Customer Lifetime Value or CLV.

Total Gross Margin for a Period

We use gross margin because that is cash left over from a sale that covers overhead and profit.  Gross Margin is calculated on your Profit & Loss statement. The number of periods a customer is retained can be gathered from your company’s customer management system.  

Number of Periods a Customer is Retained

The number of periods a customer is retained is the average amount of time a customer buys from your company.  Usually this is available from your order management system. Make sure that your time periods match. If your customer retention is measured in months, use monthly gross margin.

 

If you are just starting out and have no idea how long each subscription will last, do a Google search.  Seek out terms for competitive or substitute products and just add keywords such as “how long is a customer retained” to it.   

Why is Lifetime Value of a Customer Important?

The lifetime value of a customer metric tells a company whether the amount of business they get from a customer is worth its cost.  While this is important to the overall business model of the company, it can also be used to inform sales teams about those customers who may be more open to upselling.  

 
How Much Your LTV Should Exceed CAC

A sustainable business model is one where the amount of cash your customers provide exceeds the cost to acquire and serve them.

The rule of thumb is that your LTV CAC ration should be at least 3-to-1.

Another way to think about it is that for every dollar you spend acquiring a customer, you get two dollars to cover overhead and profit.

$927 LTV

$250 CAC

= 3.88 ratio

CAC and LTV Define A
Sustainable Business Model

Every growing company should review their customer acquisition and retention metrics.  Companies that are experiencing rapid growth should have enough data to run the numbers and see to what extent their customer lifetime value exceeds customer acquisition costs.  

 

The difference between CLV and CAC should be reflected in your financials.  If you are a premium priced business with strong gross margins then your CLV CAC ratio should be larger.  If it is not, then you either have bad data or a flaw in your business model. Strive to continuously reduce customer acquisition costs while growing the lifetime value of a customer.  That is the formula for a sustainable business model that can attract capital and endure over time.

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