02/02/2021
Improve your Customer Targeting with the CLV:CAC Ratio
Why is it important to understand the ratio of CLV to CAC?
The Customer Lifetime Value (CLV) to Customer Acquisition Cost (CAC) ratio is a useful value for marketers to use when targeting customers as it guides marketing and sales spend allocation. It gives the marketer an understanding of how much customers are worth compared to how much the business is spending to acquire them.
The ideal ratio is 3:1, meaning the value of your customers is 3x the cost of acquiring them.
If it’s lower than this, it indicates you’re not targeting profitable customers.
If it’s higher, you’re not spending enough on sales and marketing and are missing opportunities.
What is Customer Acquisition Cost (CAC)?
CAC is an important marketing metric that represents the sales and marketing cost required to gain a new customer over a specific period of time.
The marketer’s aim is always to reduce this value which will result in increased spend efficiency and better return on investment.
How is CAC calculated?
CAC = 'Sales & Marketing Spend' divided by 'Number of new customers gained in that period'
e.g. if a company spent €10,000 on sales & marketing in Q1 and acquired 10 new customers within that period, the CAC is €1000.
What is Customer Lifetime Value (CLV)?
The CLV metric represents the predicted revenue one customer will contribute to your business over the course of your relationship.
How is CLV Calculated?
Start here...
(a)
Average Purchase Value = 'Total Revenue' divided by 'Total Orders'
(b)
Average Purchase Frequency Rate = 'Number of Purchases' divided by 'Number of Customers'
Then do this...
(1)
Customer Value = '(a) Average Purchase Value' divided by '(b) Average Purchase Frequency Rate'
(2)
Average Customer Lifespan = 'Sum of Customer Lifespans' divided by 'Number of Customers'
Put it all together to calculate the CLV
CLV = ‘(1) Customer Value’ multiplied by the ‘(2) Average Customer Lifespan’
How do you calculate the ratio of CLV to CAC?
Now that you’ve calculated the CLV and CAC separately, compute the ratio CLV:CAC
So, if it costs you €1000 to acquire a customer and their lifetime value is €3000, your CLV:CAC is 3:1 which is the ideal ratio!