How to measure CAC
CAC consists of all the expenses incurred in acquiring new customers – such as advertising, marketing, sales staff salaries and other costs. This can often add up to a substantial amount. So unless your revenue from new subscribers is substantially more than your CAC, you’ll most likely be leaking money!
The formula for CAC is: Acquisition Spend/Total Number of New Customers Acquired.
So let’s say you spend $10,000 and acquire 500 new subscribers – your CAC would be $20.
CAC closely relates to the profitability of a business, particularly if it is EBITDA-negative and growing its market share.
CLV (also sometimes referred to as LTV or CLTV) is the average gross profit from a typical customer over the life of their relationship with the company. At a simplified level, CLV is measured by adding up the revenue earned from a typical customer and deducting what it cost you to acquire them.
An effective way to calculate CLV is:
ARPU (Average Revenue Per User) x Average Gross Margin x Average Customer Lifespan in Months, less CAC.
So if ARPU was $100, gross margin 50%, average lifespan 6 months and CAC was $30, we would end up with a CLV of $270.
A healthy CLV usually indicates you can afford to spend more on acquiring customers than otherwise.
Comparing CAC to CLV
The important metric here is your CLV/CAC ratio. At a minimum, your CLV should be 5 times greater than your CAC.
In a case where a customer generates $100 per month in gross profit as a subscription and has an average stay of 6 months, they would be worth $600 to your company. Therefore you should spend no more than one-fifth ($120) to acquire them.
A higher ratio than 5:1 is better of course, and it will improve your ability to scale up. A lower ratio may mean you need to focus more on retaining existing customers or reducing churn to improve profitability.
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