Running an eCommerce business means constantly monitoring a sea of metrics so you can find ways to improve. Two of the most important for Shopify brands specifically are customer acquisition cost vs customer lifetime value - or CAC vs LTV.
Customer acquisition cost speaks to how much you pay to get a new customer to make their first purchase, whereas customer lifetime value clues you into how much a customer spends over the course of their relationship with your brand.
Each is important, and they’re more closely intertwined than you may assume. A high CAC could be cause for concern - but if it’s supported by a high LTV, it might not be a problem after all. This is where an understanding of the LTV to CAC ratio comes into play.
Learn more about the LTV to CAC ratio below and how you can optimize this ratio for more sustainable, profitable growth in your brand today.
What’s the Difference Between Customer Acquisition Cost and Customer Lifetime Value?
So, what’s the difference between customer acquisition cost and customer lifetime value? These are two very important metrics, and you shouldn’t ignore one in favor of the other.
As you’ll see below, they work together to give you a better understanding of how viable your business is from a profitable growth perspective.
What is Customer Acquisition Cost (CAC)?
Customer acquisition cost (CAC) quantifies the total investment needed to convince a new customer to buy from your brand. It accounts for all expenses across marketing, advertising, sales, and any tools used to support acquisition efforts.
CAC helps you gauge whether the customer acquisition strategy is cost-effective and sustainable. A manageable CAC means your marketing efforts are working to attract valuable customers without exhausting resources.
Calculating CAC is simple. Just tally up all the costs associated with your acquisition efforts:
- Ad spend
- Marketing tools and personnel
- Content creation
- Customer service
- Sales team
- And anything in between
Then, divide that figure by the number of new customers you earned over a period - say a month. For example, if you spent $10,000 in a month to acquire 100 new customers, your CAC would be $100.
Now, the question is, what’s a good CAC? There’s no way to know without understanding your LTV - so let’s get into the other half of the customer acquisition cost vs customer lifetime value comparison.
What is Customer Lifetime Value (LTV)?
LTV measures the total revenue a customer is expected to generate for a brand throughout the duration of their relationship. It assesses the potential for repeat business, upsells, and referrals over time.
A high LTV suggests a strong relationship between the customer and the brand, whereas a low LTV could indicate that customers aren’t being provided with the value they’d hoped for in their initial order.
LTV is calculated using average order value (AOV), purchase frequency, and the average lifespan of a customer. So, let’s run a quick example with a few figures:
- AOV = $50
- Purchase frequency = 2 times a year
- Average lifespan = 4 years
The LTV in the case above would be $400 - again, though, this tells you nothing in isolation. That’s why you need to tie CAC back into this metric. More on that in a moment.
In general, though, a high LTV LTV indicates that a brand is not only acquiring customers effectively but also retaining them, fostering loyalty, and encouraging repeat purchases. It speaks to customer satisfaction.
Customer Acquisition Cost vs Customer Lifetime Value: How Are They Related?
Customer acquisition cost and customer lifetime value work together as a guide to help you determine just how profitable your brand is in the long run.
In the simplest sense, understanding the nuances between customer acquisition cost vs customer lifetime value is this: CAC reflects the cost of attracting customers, while LTV represents the revenue potential of keeping them.
That is to say that it’s not about choosing to prioritize one or the other. You need to keep a vigilant eye on both of them.
CAC is typically seen as more important for emerging brands trying to build awareness and get their first customers - but even at this point in time, you should be accounting for LTV.
After all, how can you know whether your CAC is “good” if you don’t know how much a customer is actually worth? This is why you need to rely on the LTV to CAC ratio.
Understanding LTV to CAC Ratio
LTV and CAC tell you very little in isolation. A $1,000 CAC sounds like a lot - but it’s actually really low for a company with an LTV of $10,000.
The LTV to CAC ratio gives you a better understanding of the actual ROI your marketing efforts are delivering. You can determine if money spent to attract new customers is being repaid over time through loyal, repeat purchases.
Calculating the LTV to CAC ratio is as simple as dividing LTV by CAC. So, in the example above where a business has a $1,000 CAC and $10,000 LTV, the ratio works out to 10:1. In other words, you can reasonably estimate that every dollar you spend on marketing returns ten.
What is a Good LTV to CAC Ratio?
It’s impossible to tell you where an LTV or CAC metric is “good” on its own. However, there are benchmarks for the LTV to CAC ratio you can aim for. So, what is a good LTV to CAC ratio?
While there is going to be some variance based on industry, business model, and growth stage, a generally accepted rule of thumb is 3:1 - so you earn $3 for every $1 spent on marketing.
This is a healthy balance where acquisition costs are efficiently repaid through customer loyalty and repeat purchases, while still leaving ample profit for the brand to invest in new products or experiment with other advertising channels.
It’s easy to assume that a high LTV to CAC ratio is better - but that isn’t always the case. It could indicate that you’re leaving room on the table to invest in acquisition. You may want to spend more on marketing to bring in more customers and scale your brand sustainably.
That being said, you shouldn’t throw money at opportunities that aren’t delivering an ROI. This is why we suggest figuring out the CAC for each and every channel you find customers on. You can optimize your marketing spend accordingly.
Tips on Improving LTV to CAC Ratio
At this point, you might be wondering whether you should focus on improving customer acquisition cost vs customer lifetime value. Why not both? You can work to lower your CAC while raising your LTV simultaneously. We’ll share tips on how to do just that below.
Lowering Ad Budget for Underperforming Channels
The first thing we recommend you do is figure out where you’re bleeding money if CAC is not at a healthy level. While it could be a disconnect between your brand and the market, there’s a good chance a specific segment is underperforming.
That could be a specific ad set within your Facebook ads campaign, or it could be a certain demographic that isn’t converting. Whatever the case, cut (or lower) spend accordingly.
We’re all for testing new angles and opportunities, but only to a certain point. You need to be able to recognize when it’s time to shift your marketing dollars to areas you know will return sales.
Increasing Average Order Value and Purchase Frequency
There are two ways you can raise LTV across your customer base - get them to spend more money on every purchase, and get them to make more purchases. If you can accomplish both goals, great! But even just improving one will provide a lift.
Raising AOV can be done by offering bundles, more tailored product recommendations, or volume discounts. You can offer free shipping at a certain threshold to get customers to spend more, too.
Improving purchase frequency is just a matter of staying top of mind with customers. Create email flows that send out offers on a recurring basis based on a customer’s last order date.
You can sweeten the pot with deals as you see fit, but be careful about devaluing your brand with frequent, heavy discounts. One of the best ways to get customers to keep coming back for more without having to slash prices is by rolling out new products on a regular basis.
Using Customer Feedback to Drive Engagement
Use surveys, product reviews, and social media insights to gather feedback on their preferences and expectations.
We know what you’re thinking…what does this have to do with CAC or LTV? It clues you into what motivates your customers, so you can incentivize them accordingly.
For example, you might discover customers aren’t nearly as motivated by a 10% discount as they would be exclusive access to a certain SKU. Or, maybe you’ll find that the idea of “buy one, get one free” moves the needle more than a percentage discount.
Aligning Product Offerings With Customer Needs
We encourage every brand to constantly strive for improvements not just in their KPIs but the products they sell.
While your flagship product may have met customer needs early on, it may be lagging behind the competition’s innovation. Or, maybe your customer’s needs have changed over the course of a few years.
Whatever the case, you need to identify underperforming products and enhance them to better meet customer expectations or phase them out in favor of more sought-after products. This will bring down other costs associated with inventory, indirectly improving CAC.
Other Important Metrics You Might Want to Track
While you came here to learn about the LTV CAC ratio, there are many others that you need to keep an eye on. Here are just a few others you may dive deeper into:
- Customer retention rate: The percentage of customers who stay with your brand over a given period. Divide the number of customers at the end of the period (minus new customers acquired) by the total at the start, then multiply by 100.
- Customer churn: The percentage of customers lost over time. Use it to identify retention issues. Divide the number of customers lost during a period by the total customers at the start, then multiply by 100.
- Conversion rate: The percentage of visitors who complete a desired action, like a purchase. Dividing the number of conversions by the total visitors, then multiply by 100.
- Gross margin: The percentage of revenue left after production costs. Calculate by subtracting the cost of goods sold (COGS) from total revenue, then dividing by total revenue and multiplying by 100.
But, the LTV CAC ratio serves as a great barometer for your business viability. Get started improving it today with Rivo.
Parting Thoughts on Customer Acquisition Cost vs Customer Lifetime Value
Hopefully, this comparison of customer acquisition cost vs customer lifetime value has left you with a clear understanding not just of what each is, but how they’re closely related.
CAC shows you what you’re investing to gain each customer while LTV shows the greater impact of that spending over time. The key takeaway is that you need to utilize the LTV to CAC ratio as a means of determining how efficiently you’re spending marketing dollars.
Fortunately, improving the CAC LTV ratio is as simple as rolling out a tailored Shopify loyalty program and Shopify referral program for your brand. We make it easy to personalize yours here at Rivo. Take the next step below or see how Rivo compares:
