The Customer Acquisition Cost (CAC) is the total average cost your company spends to acquire a new customer. It includes all costs related to marketing, sales, and any other expenses incurred to convince a customer to buy your product or service.
CAC = Total Marketing and Sales Expenses / Number of New Customers Acquired
A lower CAC means you are spending less to acquire each customer, which is generally positive. Monitoring CAC helps businesses optimize their marketing strategies to reduce costs and improve efficiency.
If your company spent $5,000 on marketing and sales last month and acquired 50 new customers, your CAC would be:
CAC = $5,000 / 50 = $100
This means it cost you $100 to acquire each new customer.
Implementing a strong referral program can significantly reduce your CAC. By leveraging satisfied customers to refer new clients, you decrease the reliance on costly marketing campaigns. Referrals often result in higher conversion rates since prospects come with a built-in level of trust, further lowering the overall cost per acquisition.
The Lifetime Value (LTV) is the total net profit a company makes from any given customer over the duration of their relationship. It helps businesses estimate the long-term value of their customer base.
LTV = Average Purchase Value × Number of Purchases × Gross Margin
A higher LTV indicates that each customer is more valuable to your business. By increasing LTV, you can generate more revenue without acquiring new customers, improving overall profitability.
If a customer makes an average purchase of $50, buys from you 4 times a year, and your gross margin is 60%, their LTV would be:
LTV = $50 × 4 × 0.6 = $120
This means each customer brings $120 in profit over their lifetime with your business.
Referrals often bring in high-quality customers who are more engaged and loyal. These customers tend to make repeat purchases and may even spend more over time compared to those acquired through traditional channels. Additionally, referred customers may have a higher satisfaction rate, leading to longer-term relationships and increased LTV.
The LTV to CAC Ratio compares the value of a customer over their lifetime to the cost of acquiring them. It helps determine the efficiency and profitability of your customer acquisition strategies.
LTV to CAC Ratio = Lifetime Value (LTV) / Customer Acquisition Cost (CAC)
An LTV to CAC Ratio of greater than 3 is often considered healthy, indicating that the value generated from customers is significantly higher than the cost to acquire them. A ratio that's too high may suggest under-investment in marketing.
If your customer's LTV is $120 and your CAC is $100, then:
LTV to CAC Ratio = $120 / $100 = 1.2
This ratio indicates that you are only making $1.20 for every $1 spent on acquiring a customer, which may not be sustainable. Strategies to increase LTV or decrease CAC should be considered.
By utilizing referrals, businesses can simultaneously increase LTV and decrease CAC. Referrals often lead to higher-quality customers who stay longer and spend more, thus boosting LTV. At the same time, the cost to acquire these customers through referrals is typically lower than traditional marketing methods, reducing CAC. This dual effect significantly enhances the LTV to CAC Ratio, leading to improved overall profitability.
Use REFERLY™ interactive CAC and LTV Calculator to analyze your own business metrics.
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