In Part 1, we discussed CAC (customer acquisition cost), how to use it and its limitations. In Part 2 here, we will explain about CLV and CLV to CAC ratio.
CLV – Customer Lifetime Value
CLV (sometimes referred to as LTV) represents the total amount of revenue a business gets from a customer over the length of the customer’s relationship with the business, before the customer stops paying (or “churns” in SaaS business model).
How To Calculate CLV
A simple formula:
(Annual revenue per customer X Customer relationship in years) – Customer acquisition cost
Example: A company generates $2,000 each year per customer with an average customer lifetime of 5 years and a CAC of $2,000 for each customer.
The company’s CLV is: $2,000 X 5 – $2,000 = $8,000.
How to Calculate CLV to CAC ratio
Formula:
(Average Revenue Per User (ARPU) x Profit Per User) / Churn Rate
(Churn Rate: the percentage of service subscribers who discontinue their subscriptions within a given time period.)
How to Measure the Health of a Business with LTV to CAC Ratio:
The LTV to CAC ratio gives you insight into the business’ overall efficiency. For a fast-growing and healthy business model, it can get a great bang for your buck with minimum spending while acquiring the highest value customer.
With LTV to CAC ratio at 3:1, every dollar you spend, you get three dollars back in customer lifetime value. For growing SaaS companies, the industry standard for LTV to CAC is 3:1, as expected by VCs.
A lower ratio at 1:1 signals near negative profitability. A higher ratio at 5:1 signals it is time to invest more on marketing.
CLV to CAC ratio helps a business to focus on going after the ideal customers whose lifetime value is worth the cost, and with marketing strategies for expanding to new markets. After identifying the most valuable group of customers, come up with tailored services to keep them as long-term clients.
Factors that will help with LTV to CAC ratio:
A company can improve LTV to CAC ratio with many strategies, such as:
- Lowing cost for sales, distribution and customer support with outsourcing,
- Invest in persistent SEO & digital marketing for high visibility on the search engines,
- Develop strategic referral partnerships that provide a steady supply of customers, and
- High exit barrier of inconvenience for customers to leave, easy customer onboarding,
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