What is the LTV/CAC Ratio?
LTV stands for “lifetime value” per customer and CAC stand for “customer acquisition cost”. The LTV/CAC ratio compares the value of a customer over their lifetime, compared to the cost of acquiring them.
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.
Chart: CFI eCommerce financial modeling course.
What is the LTV/CAC ratio formula?
Below is the lifetime value to customer acquisition cost formula:
[(revenue per customer – direct expenses per customer) / (1 – customer retention rate)] /
(# of customers acquired / direct marketing spending)
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 direct costs of 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 this case, the ratio is quite high and the company is profitably acquiring customers, assuming there are not a huge amount of fixed costs in the business.
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Challenges with LTV/CAC ratio
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.
To learn more about other types of return on investment you may want to check out:
- Return on Ad Spend
- Return on Assets
- Return on Equity
- Profit Margin
- Contribution Margin
- What is Financial Modeling
- Financial Modeling for Dummies
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