LTV/CAC Ratio can be used to determine the profitability and growth potential of your brand, as well as your overall business health. Also, LTV/CAC ratio is a crucial metric.

This guide will help you understand it, calculate it, optimize it, track it, and avoid LTV:CAC problems that companies such as Casper or Blue Apron had to face as they grew.

What is LTV:CAC?

LTV (also known as CLV:CAC), is the ratio between your Customer Value (i.e. average gross margin per customer for their lifetime with your brand), and your Customer Acquisition Price (i.e. how much your company spends on average to acquire a customer).

Your brand’s success depends on your ability to calculate, monitor, and optimize your LTV/CAC ratio. This ratio shows how effective your marketing efforts were and projects your brand’s long-term profitability.

What do different LTV/CAC ratios translate into for brands?

LTV and CAC can be even (1:1)

A brand with a 1:1 ratio means that the cost of acquiring a customer is the same value as the customer’s lifetime.

Although it might appear that the brand is making money on each acquisition, it is likely that it is losing money. LTV:CAC does not take into account marketing expenses. A 1:1 ratio indicates that the brand is losing money after accounting for shipping and taxes.

LTV is lower that CAC (e.g. 1:1.25).

A brand with a ratio of 1:1.25 will spend more to acquire a client than it will ever make from them, even if marketing costs are included. It’s possible that it is losing significant money per acquisition if you take into account other costs.

LTV is greater than CAC (e.g. 2:1 – 4:1).

A brand that has a ratio of 2:3 or 3 can expect to make 2 to 3 times the amount it spent to acquire customers.

A ratio of 3:1 is considered a good benchmark. Venture capitalists and other investors also want this number. However, it is not a standard benchmark for a “good” ratio.

However, a higher ratio like 4:1 could indicate greater growth potential: it may mean you should consider increasing your marketing budget.

LTV is significantly higher than CAC (e.g. 5:1+).

A brand with a LTV:CAC heavily favoring LTV may not be able to grow. This could be an opportunity to increase advertising and marketing.

How to calculate LTV/CAC ratio?

LTV:CAC can be calculated by multiplying your average customer lifetime value over a period by the customer acquisition costs (over the same period). This ratio measures the return of investment for every dollar that your brand invests in acquiring a new customer.

To calculate average customer lifetime value, use two formulas. To calculate gross margin, subtract landed costs from gross revenues (over a specific time period). Divide gross margin by the total number of customers for that time period.

To calculate Customer Acquisition Cost, add all of your marketing-related expenses within the same time frame that you used for your LTV calculation.

These include:

• Variable marketing costs ($ expended on your advertising platforms)
• Recurring costs for marketing/eCommerce tools
• ad vendor cost
• Costs to create ads creatives
• team salary
• Agency costs (if applicable).

How high CAC can harm long-term growth

Brands have increased their acquisition efforts in order to gain customers from their competitors as industries become more competitive. Brands with high CAC relative their LTV are more likely to suffer.

Here are some examples that illustrate how high CAC can have a negative impact on long-term growth.

How to use LTV:CAC to grow

Because it is one of the most reliable KPIs to ensure long-term success, investors want to know your LTV/CAC. Even if you don’t have investors, it is important to continuously monitor the ratio and use best practices to optimize it. Here’s how: Reduce your CAC by not relying as much on paid ads

Paid ads can be a great way to generate initial brand awareness and quick results in the early stages of your brand. However, rising ad cost costs can drive up your acquisition costs and make it difficult to sustain long-term.

After you have used paid ads to build your brand, it is time to invest in sustainable ways to increase long-term growth. Based on your business model and other factors, there are sustainable ways to reduce CAC and decrease reliance on ads.

Start an affiliate program

Consumer brands are particularly fond of affiliate programs. Affiliate commissions make up your acquisition costs for customers who are acquired via affiliates. This gives you greater control over CAC.

Refer customers to your company

Referral programs are similar to affiliate programs and can lower your marketing costs. Referred customers are more likely to repeat their purchases and have an average retention rate that increases their lifetime value.

Search engine optimization (SEO)

SEO is not like paid ads. It’s a slow game. It may take several months to reach Google’s first page, which is traffic-oriented. SEO is a long-term investment that requires significant effort and a substantial initial investment.

Brands will see an increase in conversions when SEO is implemented.

Retention is the key focus

Social media channels can be a great way to generate brand awareness and acquire new customers. However, these platforms are borrowed territory. It is important to build an email subscriber and/or SMS list. These are your own channels. Retention is key to reducing CAC and increasing LTV. You can also increase LTV and boost your program by pushing your data into SMS/Email or paid channels. This will bring back customers and increase LTV.

You can reach your customers with SMS and email (for almost free), without restrictions like Facebook’s limited organic reach. Post-purchase marketing strategies can be used to increase repeat sales and LTV.