LTV: CAC = Customer Lifetime Value / Customer Acquisition Cost
As a subscription business, you need to be able to determine the lifetime value of your customers (LTV) relative to what it costs you to acquire your customers. Depending on how much you are spending on your various lead generation efforts and the average length of your customer retention, you should be able to gain valuable insight into the health and sustainability of your company. But, first you need to understand what the formulas mean, as well as what other factors you need to consider (benchmarks, best practices and challenges).
If your gross margin is 75% and your churn (reduced and canceled accounts) is at 2%, you also look at the average amount that your customers spend, say $40, every month to get this calculation example:
75% X ( 1 / 2% ) X $40 = $1,500 LTV
Of course, there’s never just one thing to consider in benchmarking goals. You must consider what projections you are able to make as far as your customer’s Lifetime Value (LTV), but also other factors related to competitive advantage, positioning, and marketing strategy. Ultimately, a big factor in your CAC benchmarking relates to funding variables as well as where you are in the business life cycle: launch, growth, shake-out, maturity, and decline. Regardless of where you are in your lifecycle, you must be cognizant of your customer acquisition cost relative to the lifetime value of your customer.
As a SaaS company, you can decrease your customer acquisition cost by breaking down your sales funnel into tangible and differentiated parts. You must understand your sales process, not only from the initial lead generation stages, but also how you qualify your leads, and how you convert those leads into customers. Since you’re also looking at the best ways to optimize your profits, you need to look at your pricing structure, and how that figures into your customer acquisition cost. You can’t afford to wait a year or more to recover from the upfront acquisition costs, and you really don’t have to hold off. You can add value to the onboarding process, while being transparent about all costs and the value of your services.
You’re in a unique position to find creative ways to offer initial training, conversion, integration, and coaching services that will help to balance out all the CAC costs you’ve incurred. You may even find that you’ll immediately make profits, while creating a satisfied customer who appreciates all that initial training and hand-holding.
It’s important to understand and be able to analyze your customer acquisition cost, so that you can determine ways to balance out the costs and optimize your profit through the lifetime value of your customer. It’s just not as easy as it might seem to track every cost for acquisition. It all gets a bit muddied when you try to tag your ad spend to any one customer or even to a customer group. How do you really determine how much you’ve spent and which campaign was the final push that inspired him or her to sign up? And, even if you could neatly tie every dollar spend to a targeted customer acquisition, how do you account for the other benefits from your marketing efforts.
Despite the challenges, there’s one easy and cost-effective way to both reduce customer acquisition cost, while also contributing to the lifetime value of your customer. It’s referral generation, and it’s as easy as asking your customers to tell their friends, families, and colleagues about your services. Tap into your company’s most important asset: referrals.