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Growing a business

Why You Need to Know Customer Acquisition Cost and Lifetime Value

Many factors go into running a small business, and customers are one of the biggest factors in determining if your company is a success. Do you wonder how you can know exactly what your customers are worth to your business?

Two calculations, customer acquisition cost and customer lifetime value, can help you assess that. Knowing these values also helps guide your advertising endeavours, expansion efforts, and points to overall company health.

Customer Acquisition Cost Formula

Customer acquisition cost (CAC) is the average expense you spend to attract a new customer. It’s calculated by dividing your total expenses relating to sales and marketing programs by the number of new customers attracted during a specific time period. The total expenses for marketing and sales should include salaries.

If your total sales and marketing expenses for the period were $25,000 and you got 100 new customers, the CAC is $250, which means that you spent $250 per customer acquired.

Customer Lifetime Value Formula

The customer lifetime value (CLV) is the amount of revenue you expect to earn from any given customer. It’s a measurement that spans the customer’s entire purchasing relationship with your company.

In addition to product purchases, CLV incorporates ongoing services provided. The formula attempts to gauge the average amount of business generated due to a customer’s repeat business.

Although there are several complex formulas to calculate the CLV, the easiest way to get a rough estimate is to divide your net profit for a specific time period by the number of customers served over the same period of time.

For example, if you had net profits of $750,000 over five years and served 1000 customers during that time, your CLV is $750.

Most CLV guides identify three variables that should be tracked for your customers. These are:

  1. Recency
  2. Frequency
  3. Monetary value

Higher customer lifetime values correlate with longer periods of time making purchases, higher frequency of purchases, and more money spent per purchase.

The idea is to use this information to segregate your customers into high-, medium-, and low-value groups. From there, calculate the CLV for each segment.

Relationship Between CAC and CLV

There is a direct relationship between the CAC and CLV that can easily signify the prospective future of your company. In general, it’s most advantageous for the CAC to be low and CLV to be high.

Or in simpler terms, it’s a good idea to spend less money on acquiring a customer while selling more to existing customers over a longer period.

If your numbers aren’t favourable, make changes to keep your business profitable and growing in the future.

For example, if it costs $100 to obtain a customer that produces a CLV of $500, your company experiences a long-term benefit. But, when the CAC is greater than the total value to be received, it isn’t worthwhile to pursue the new customer under current conditions.

For example, you don’t want to spend $500 to acquire a customer with a CLV of only $100. In this case, perhaps you want to consider lowering your marketing costs while increasing sales to existing customers through upselling.

It isn’t always possible to know all elements required for the calculations of CAC and CLV at any given point. For this reason, it’s important to take a conservative approach when performing the calculations.

Although it may be advantageous to omit future costs, all calculations should project reasonable figures to give an accurate representation of where your business stands. To get the most benefit from your figures, it’s imperative to incorporate all associated variables, including:

  • Estimates
  • Accruals
  • Forecasts
  • Projections
  • Contingencies

Incorporating CAC and CLV Into Marketing

These two metrics directly correlate to how much is spent on marketing campaigns and the success of the outcomes. So, the general premise behind CAC and CLV is that these advertising endeavours should provide the greatest value per dollar, as opposed to overall savings.

For example, a project costing $20,000 could generate 200 new customers for a CAC of $100. If the project budget is cut in half and only 100 new customers are brought in, the CAC is still $100.

For this reason, it’s a good idea for your company to manage marketing spending while targeting specific strategies that can lower your CAC.

Knowing where your money goes and how much return you see on various investments is essential for a small business owner. Using an accounting system, such as QuickBooks Online, you can generate a Profit and Loss statement automatically. Learn how today.

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