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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.
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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.
But what do these numbers mean in context?
That’s where CLV comes in.
Measuring CLV
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.
Example:
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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