Customers won’t just appear in your business. Although at first glance, entrepreneurs see only the result in the form of an invoice or the last click, the entire customer acquisition process starts much earlier. It begins when a user becomes aware of the existence of your product or service (they don’t even have to be a potential customer yet!).
The process of grabbing the user’s attention can be lengthy and expensive. Hence, it’s essential to know how much you’re genuinely investing in acquiring a customer to see if it’s profitable for your business. How to do it? In this article, you’ll learn how to calculate the CAC and LTV metrics.
What is the CAC metric in marketing?
CAC (Customer Acquisition Cost) is a metric used in e-commerce that shows the average cost of acquiring a new customer. It is most commonly the sum of all advertising and marketing costs divided by the number of customers acquired in this manner. CAC is an essential metric that should not be overlooked in your business analysis because it indicates how much it costs you to acquire new customers and whether this investment is profitable – the costs are lower than the profits.
CAC: How to calculate customer acquisition costs?
Calculating CAC isn’t as straightforward as it might seem. Many entrepreneurs overlook crucial variables in this process – for example, the size of the business.
- For small businesses, it’s beneficial to use a simplified calculation model. All incurred advertising expenses (e.g., paid actions on social media, SEO, events) should be divided by the number of customers in a specific time frame.
CAC = Advertising costs related to acquiring customers in a given period / Number of acquired customers
NOTE: It’s a good practice to calculate the CAC metric for each advertising channel. This way, you can determine which one is the most effective and where it’s worth investing more money.
For larger companies, the simplified variant isn’t always accurate. When calculating the cost of acquiring a customer, you should consider not only advertising expenses but also:
- employee salaries,
- costs of external services,
- the price of purchased marketing materials,
- the cost of used tools.
Also, specify a time frame – a month is too short to measure CAC. You’ll obtain more reliable results by conducting calculations quarterly, for example.
OK, calculations aside, how should one correctly interpret the obtained results and apply them to business? To get the most out of this analysis, you should also calculate the LTV metric.
Want to learn more about customer loyalty methods?
What is the LTV metric in marketing?
LTV (Lifetime Value) is a metric that shows the benefits a customer brings to a company throughout the entire collaboration period. Calculating the LTV metric is essential because it allows you to assess whether the cost of acquiring a new customer is profitable, considering their future purchases. Moreover, it will enable you to identify those customers who are the most valuable for your business.
Suppose you run an online clothing store. Your products were purchased by Martyna, Tobiasz, and Magda. Acquiring each of them cost you the same, but Martyna only shopped once for 550 PLN. Tobiasz made purchases from you 4 times for a total of 500 PLN. In contrast, Magda joined your loyalty program, clearly indicating a desire for longer cooperation, and the amount she spent in your store has already exceeded 1,000 PLN. Based on the LTV metric, which customer is the most valuable to you? Of course, it’s Magda! She brought the most profit to your business.
LTV: How to calculate the customer’s lifetime value?
The formula for calculating the LTV metric can vary depending on which data is crucial for your company. Most often, the primary consideration is the value of purchases made by the customer in the e-store since the beginning of the relationship with the brand.
Suppose you sell household appliances in an online store. One of your customers made purchases for 12,000 PLN over the past year and then ended the relationship with your brand. In this case, the LTV is precisely the amount of 12,000 PLN. There are also other ways to calculate the lifetime value of a customer – more complicated ones that require a much larger set of data.
How to improve the LTV metric in marketing?
Let’s go back to the previously described example of the online clothing store. Martyna’s first few transactions amounted to relatively small sums. At the same time, Tobiasz made a one-time order for a more significant amount. Does this mean that Martyna is a more valuable customer for you? It’s possible. However, there’s a chance that Tobiasz, given that he shops regularly, will be more valuable to you in the future. A lot depends on the kind of relationship you maintain with your customers and whether you conduct personalized communication tailored to their needs.
A loyal user who regularly shops in your store guarantees higher profits. Remember that not all customers are created equal. However, there are ways to positively influence the long-term value of a customer while maintaining an optimal acquisition cost.
CAC and LTV metrics — summary
Both metrics should be vital for marketers operating in e-commerce, as they allow for evaluating the effectiveness of the marketing strategy and spend advertising funds more wisely.
Besides optimizing customer acquisition costs, it’s also worth considering increasing the LTV metric. Especially since, in some cases, increasing customer retention can be more profitable for the business than acquiring new ones. Even if acquiring a new consumer is associated with relatively low costs, sometimes it’s more profitable to allocate the same resources to retain current consumers.
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