[Article] The Two Most Crucial Figures For Your Marketing Efforts
When it comes to running a business, there is a wide range of key performance indicators you can use to assess performance. Arguably two of the most important figures are the customer acquisition cost (CAC) and the lifetime customer value (LCV).
Your business lives and dies by its customers. Without them, you have no business. By knowing how many customers you want to attract, and the customer acquisition cost, you can loosely determine the required spend.
When this is coupled with the figure for lifetime customer value and the business goals, you can begin to make real progress structuring your marketing to attract the number of desired customers.
What are the customer acquisition cost and lifetime customer value?
The customer acquisition cost (CAC) is the total cost of acquiring a new customer. It includes every cost in leading customers from the initial point of contact to making a purchase, with this figure divided by the number of new customers acquired in the same period.
The lifetime customer value (LCV) is the projected revenue a customer will generate during their lifetime and unlike CAC, the LCV can be split into historic and predictive LCV values.
Historic LCV looks at the gross value for each customer and then takes an average reading. This is a good indicator of the LCV, but works on historic data and misses vital changes such as price increases, for example. The predictive lifetime customer value forecasts the value of a customer and, assuming the equation is accurate, will be much better indicator of the LCV.
Why are the cost per customer acquisition and lifetime customer value figures important?
These two figures are important for a few reasons.
Firstly, they help you assess your sales and marketing effectiveness through the CAC: LCV ratio. For-profit, your CAC cost must be lower than your LCV cost. If it is equal to or, heaven forbid, more than your LCV, then your business will struggle to make money. The ideal figure is 3:1. Any more, 5:1, for example, and you are possibly missing out on business.
Secondly, they help you understand when the acquired customer becomes profitable. When a customer is first acquired, the company is technically in a loss for that customer. If the CAC is £500 and the customer spends £250 per month, then the payback period is two months and the customer only becomes profitable in month three. This is useful information in forecasting budgets for your business.
Thirdly, both figures let you split your customers and learn which are the most profitable. Let’s say you run a business with both a monthly subscription model, and the option to make one-off purchases, by calculating both figures, you can learn which type of customer is the most profitable.
Calculating cost per customer acquisition and lifetime customer value
The formula to calculate the CAC takes into consideration the total expenses for all your marketing and divides that figure by the total number of customers acquired in the same period. This varies per business and what you include will be more detailed than the example we will use below, but the general formula is…
CAC = Total cost of sales and marketing / Total number of customers acquired
An example of this could be as follows…
CAC = £1000 (Sales and Marketing spend) / 10 (Customers acquired) = £100
This means that in this example, the cost per customer acquisition is £100 per customer.
The formula to calculate LCV can either be simplified or detailed. For the sake of this article, we will explain the simplified formula. The LCV value works using the following data…
Average order value (AOV): this is calculated by dividing the total revenue for a given period by the number of orders, typically over a year.
Purchasing frequency (f): this is calculated by dividing the number of orders by the number of unique customers, typically over a year.
Customer value (CV): Average order value multiplied by purchase frequency, typically over the year.
Average customer lifespan (t): this is the hardest value to determine but estimates range from 2–3 years for most businesses.
With this information you can now calculate the LCV. The simplest formula is as follows…
CLV = Customer value x Average customer lifespan
An example of this could be as follows…
CLV = £1000 (customer value) x 2 (average customer lifespan) = £2000
This indicates that the value of each customer is £2000 across the lifetime he or she is a customer. This figure is for the turnover value of each customer. If you wanted to work out the profit of each customer then you would need to factor in CAC costs or margin costs.
Improving cost per customer acquisition and lifetime customer value
The number one way to increase business profitability is to decrease the cost per customer acquisition and increase the lifetime value of a customer. There are a few ways to do this.
– Improve conversion percentages
The conversion percentage is the figure that marketers think about most often. Good conversion percentages indicate effective sales and marketing, while poor conversion percentages indicate holes in the pipeline. Poor conversion percentages also increase your CAC value which decreases a customer’s profitability. As mentioned, a customer becomes profitable only after the income exceeds that which it costs to acquire them. The lower the cost, the quicker a customer becomes profitable.
Improving conversion percentages will vary depending on the business, marketing platform and budgets, however, general rules of thumb would be to test small and only scale up efforts with proven results and split test. Without testing different designs, content and platforms, there is no way to know what will work.
– Use a CRM piece of software
“A good [sales-focused] CRM system can help your sales force stay organized and focused,” says Mack Dudayev, CEO, and co-founder,InsureChance, an online life insurance marketplace.
Implementing CRM system in your business can provide you with the feature such as lead prioritizing, automated email list, blogs, loyalty programs, and/or other techniques that capture customer loyalty.
Another benefit of CRM system is that “You can see how fast leads are being contacted, an amount of attempts made, total sales and idle time.