There’s something about customer lifetime value (LTV) that business owners struggle to nail down. CAC they know. LTV can feel confusing.
So let’s simplify it.
Does each dollar of marketing get more efficient over time as your brand builds and repeat customers return? Or does it just keep costing the same amount to acquire customers who buy once and disappear? One of the reasons why understanding that CAC:LTV ratio is so so important. Ideally you want to see about $3 coming back for every $1 going in. Our client even said it: “every PE investor wants to see those numbers.”
This is simple unit economics.
Marketers know that your focus is better spent on extending the lifetime of your current customer base, and yet many companies still spend a significant amount on acquiring new customers (which does also play a a role when you are trying to scale up).
Marketing spend should have a defensible return tied to CAC:LTV ratios and payback period, not just “we need to keep spending to keep growing.”
How to Calculate Customer Lifetime Value
The customer lifetime value (LTV) is the net profit your customer brings to your company over a set amount of time (doesn’t have to be their lifetime as a customer). The formula for customer LTV is:
LTV = MRR (Monthly Recurring Revenue) x (Gross Profit %) x (# of lifetime months)
When I run my LTV & CAC workshop one of the FAQ is: “How can I guess the number of months of my customers’ lifetime when my site has only been live for x months?”
Say you’ve only been open for two month. In month two, start looking at the churn of the customers that signed‐up in month one (i.e. Month 1 Cohort). Keep track of the churn for the Month 1 Cohort in the third and subsequent months as well. Then use this simplified formula:
Lifetime (months) = 1 / (Monthly churn %)
The Magic Ratio for Customer LTV
Generally speaking, you want to aim for a ratio of 3:1 for LTV to CAC. In other words, you want the lifetime value of your customer to be three times the value to acquire them. If it’s less, you are spending too much; if it’s more, say 6:1, you are spending too little.
The benchmark LTV:CAC ratio is 3:1
The lifetime length caveat: Calculating LTV accurately involves cohorts, churn rates, average revenue per customer etc., which is why it’s dangerous to rely solely on this metric or your LTV:CAC ratio. If your LTV takes 5+ years to make that 3:1 profit, then you best be a massive company. Most small businesses don’t have time to wait for half a decade to make a profit on one customer. That’s why we recommend also tracking your payback period.
A CFO sidenote: remember your allowable CAC. If you’re achieving more than 3:1 LTV to CAC ratio, it is time to optimize your sales channels to acquire more customers.
LTV and CAC Calculator
We’ve created a quick interactive tool to help you calculate your CAC, lifetime value and payback period:
The Best 4 Ways to Increase Customer Lifetime Value
If you’re trying to reduce churn, here are a few places to start in order to increase LTV:
Step 1. Profile your best customers.
Calculate a more accurate LTV by segmenting your customers by channel, customer type or location. This allows you to see which channels have the highest LTV and which are struggling.
For instance, say your average CAC is $150 and your average LTV is $400. Your magic ratio is 2.67. Great, yes? But how do you know what customer to target? The overall average is simply a vanity metric and not all that helpful. If you take the same numbers and plot them by customer tier, for example, you get a ton more insight.
Run a cohort analysis over time to understand your churn. This will help you identify trends and get more bang for your buck.
Pro Tip: Target customers that will also do some of the selling for you. Using the profiling you did earlier can help identify the customers that could be brand ambassadors and help with cross-promotion.
Step 2. Cross-sell, upsell.
If you are in the ecommerce industry, one way to upsell is by product line expansion. Remember, it is always easier to sell more to current customers than it is to acquire new ones. Our ecommerce accounting services can help identify your best sellers.
If you have a SaaS company, offering different pricing tiers is a smart approach for increasing customer LTV. Aim to move existing customers up a tier once your product/service becomes valuable or, better yet, invaluable to them.
And of course, recurring revenue is essential to customer LTV. If you can offer products or services in a subscription format, each customer’s LTV is exponentially increased.
Step 3. Surprise and delight customers to reduce churn.
In B2B for example, this might mean increasing touch-points in account management to build better relationships. Check-in with questions or surveys. Face-to-face, Zoom or a phone call are always going to feel more personal than a quick email. But sometimes a survey allows people to feel like they can provide more anonymous feedback. “Are we meeting your needs? Is there an area we could do better?” or “What could we change so you can do your job better?”
In B2C industries, the possibilities are endless: Surprise discounts, presales, flash sales, samples or free gifts. Reward with an experience. Offer birthday gifts or birthday discounts. A handwritten thank you can make a shipment/gift feel personal.
And, in either B2B of B2C business models, the more you can solve your customers’ problems the better. If there is anything you can do to make your customer’s life easier, do it. Other ways to try and increase ltv:
- Have an exceptional return policy
- Self-serve support for your customers
- Be transparent
- Share what causes you stand for: social responsibility is becoming a bigger factor, especially for millennials and gen z (aka those with a lot of purchasing power)
- Showcase customer stories.
Step 4. Build out referral programs.
Referral programs are not to be ignored. Companies like AirBnB and Uber were built on them.
Customers that were referred are statistically more likely to stick around longer. Plus, according to Andrew Roth, a McKinsey partner in digital ventures, 20-30% of all new customers are driven by referral programs. He says that “it becomes a massive channel, because you’re relying on your own first-party data to drive growth, and you’re not doing anything complicated. I guess it’s like an Uber type of referral program, where both sides get some kind of benefit.”
This doesn’t have to be as simple as refer a friend, get a 10% discount. There are plenty of ways you can get creative with referral programs to keep customers from churning that will not hurt your bottom line. Here are a few referral program ideas you may want to try:
Cash Credits Referral Program
Cash credits: Uber offered referral credits for any riders that referred a friend. Then Uber needed to meet demand with supply, so they also offered drivers large rewards to refer drivers. We’re talking up to $1,750.
Product-based Perks
Product-based perks: Dropbox offered 500MB of free storage to a customer who makes a referral. The result: Membership grew by 60%.
No surprise they’re still running the same program today.
Point-based Referral Program
Points-based rewards: Customers that make referrals to Capital One get points that can be redeemed depending on their card. This has been integral to their growth engine.
Two-Way Rewards Program
Two-way rewards: Think “sharing is caring”. That’s what Ruggable did anyways. You give a little to get a little. They give a referred customer 15% off their first rug and if you referred a friend you get 15% off your next rug. So both parties save, plus it encourages you to make another purchase, or at least think about it.
Join-links Referral Programs
Join-links reward program: Provide readers with a personalized referral link, then reward them with points or prizes. Cross-promotion from business partners works especially well in these cases.
The bottom line? Increase LTV by combining customer data with creative referral programs. This will simultaneously reduce churn, increase your number of customers and grow customer profitability.
Need help running cohort analysis? Learn more about our outsourced CFO services and how we can help you discover your growth engine.
Don’t forget to try out our CAC, LTV and Payback Period tool. It’s a quick way to understand your unit economics. Because remember, investors want to know!
Try it out: use this quick, interactive tool to calculate your CAC, your customer lifetime value and your payback period
