CAC LTV

Customer Acquisition Cost and Customer Lifetime Value.

LTV / CAC Ratio

LTV stands for “lifetime value” per customer and CAC stand for “customer acquisition cost”.

This eCommerce metric compares the value of a new customer over its lifetime relative to the cost of acquiring that customer.

If the LTV:CAC ratio is less than 1.0 the company is destroying value, if the ratio is greater than 1.0 it may be creating value, but more analysis is required.  Generally speaking, a ratio greater than 3.0 is considered “good” but that’s not necessarily the case.

What is the LTV / CAC formula?

Below is the lifetime value to customer acquisition cost formula.

[(revenue per cust. – direct expenses per cust.) / (1 – customer retention rate)] /
(# of customers acquired / direct marketing spending)

See an example in Excel here.

Example calculation

An eCommerce company spends $10,000 on a Google AdWords campaign and acquires 1,000 new customers.  The average revenue per customer is $50 and the dict costs for filling each order are $30.  The company retains 75% of its customers per year.

Customer contribution margin = $50 – $30 = $20

LTV = $20 / (1 – 75%) = $80

CAC = $10,000 / 1,000 = $10

LTV/CAC ratio = $80 / $10 = 8.0x

In the case the ratio is quite high and the company is profitably acquiring customer, assuming there are not a huge amount of additional costs in the business.

Challenges with CAC LTV

Contribution margin is not necessarily a good indication of economic benefit.  Companies may have significant fixed costs that need to be factored in.

Retention rates (or churn rate) change with time and are not constant.

Customer acquisition costs also change with time and are not constant.

To learn more about CAC and LTV, check out our online course on eCommerce Financial Modeling. This course will who you step by step how to model the economics of a marketing campaign for an eCommerce business.

More learning

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