What's Wrong With Your CLV & CAC Metrics?
Customer acquisition cost (CAC) and customer lifetime value (CLV) are two of the most crucial KPIs for any firm. The entire revenue a customer is anticipated to bring in during their association with your business is known as CLV. The entire cost of gaining a new customer, including expenses for onboarding, marketing, and sales, is known as the CAC.
You may obtain a clear picture of your company's profitability and identify areas for improvement by monitoring your CLV and CAC measurements. But a lot of companies calculate CLV and CAC incorrectly, which can result in poor choices and lost chances.
When calculating CLV and CAC, keep in mind the following typical pitfalls:
Combining contribution margin and revenue: It's crucial to account for additional variable costs and the cost of goods sold (COGS) while computing CLV. Since revenue and profit are not the same thing, it's critical to deduct these expenses in order to determine a customer's lifetime worth.
Taking time dimensions into account: Both CAC and CLV are metrics with a temporal limit. This means that when computing these KPIs, you have to account both the average client lifetime and the acquisition cost. To achieve a similar measure to your CAC, for instance, divide your CLV by 3 if a customer's average lifespan is 3 years and it takes you 1 year to acquire a new customer.
Ignoring to segment your consumer base: Not every customer is the same. A variety of metrics, including average order value, frequency of purchases, and customer churn rate, determine whether clients are more valuable than others. It is crucial to divide up your customer base into segments and compute your CLV and CAC metrics for each one in order to obtain a more realistic picture of your business.
With a constant ratio of CLV to CAC: One common statistic used to evaluate a company's profitability is the CLV:CAC ratio. It's crucial to remember that this ratio has meaning only if it is computed over an extended period of time. It is not always the case that a high CLV:CAC ratio in a single year indicates profitability for your company. Monitoring your CLV:CAC ratio over time will help you evaluate how it's trending and pinpoint any areas that require improvement.
Determining Payback Period
In certain situations, figuring the payback time rather than the CLV:CAC ratio can be more helpful in determining the ROI of your company. The time it takes to recover the expense of bringing on a new client is known as payback time.
Divide your monthly contribution margin per customer (CAC) by the payback time. Your payback period is five months, for instance, if your CAC is $100 and your monthly contribution margin per customer is $20.
Payback time is a valuable indicator for newly established businesses or those experiencing quick expansion. It might assist you in figuring out how soon you can turn a profit from your new clientele.
Tips for Increasing CLV and CAC Metrics
You can take several steps to raise your CLV and CAC measurements, such as:
Decrease the CAC: Streamlining your sales process, cutting down on onboarding expenses, and refining your marketing initiatives are just a few strategies you may use to lower your CAC.
Raise the CLV: Increasing client interaction, boosting customer loyalty, and providing value-added services are just a few strategies to raise your CLV.
Group your clientele: As was previously indicated, it's critical to divide up your consumer base into several segments and determine your CLV and CAC metrics for each one. This will enable you to recognise which of your clients are the most valuable and concentrate your efforts on keeping them.
Monitor your metrics throughout time: Monitoring your CAC and CLV indicators over time will help you see how they're trending and pinpoint any areas where you need to make improvements.
Two of the most crucial KPIs for every company are CLV and CAC. Through precise computation and monitoring of these parameters, you can gain a clear picture of your company's profitability and identify areas in which you want improvement.
Here are some more pointers to raise your CAC and CLV metrics:
Invest in customer loyalty programmes: These can help you raise the lifetime value of your current customers and retain them.
Provide outstanding client support: Maintaining a positive client base and lowering attrition can be achieved with excellent customer service.
Personalise your marketing and sales efforts: You may contact your customers with the appropriate message at the appropriate moment by tailoring your marketing and sales activities.
Use data to influence your decisions: You may invest in client acquisition and retention more profitably by using data to guide your decisions.
Why Payback-Time may outperform CLV/CAC
Customer lifetime value divided by customer acquisition cost (ratio) is a common statistic for analysing marketing spending, however payback time may provide a more accurate picture.
Payback time measures the efficiency and profitability of an investment by calculating the months needed to earn returns equivalent to the initial outlay. Payback time in marketing budgets is the time it takes for customer income to offset acquisition costs.
Payback time is important since it accounts the time value of money. Businesses have continuing expenses like staff and office space, so the faster they can return their marketing spend, the better their cash flow. Companies may optimise their marketing strategy to maximise payback time, allowing them to better manage resources and stay financially healthy.
Considering marketing investment payback time is beneficial due to the high IRR of fast payback times. IRR estimates investment profitability, and a higher IRR implies a better investment. Businesses recover their marketing expenditure faster and have a greater IRR with a fast payback period. This larger IRR means the marketing spend creates a higher return on investment faster, making it more profitable and efficient.
The world's finest companies have fast payback times and high CLV:CAC, allowing them to hypergrow by reinvesting marketing profits. First-order payback usually indicates an unlimited IRR, which is rare and suggests your organisation can print money.
Payback time helps explain how quickly money may be reinvested to create compound effects. A shorter payback period means the organisation can invest more in business expansion sooner. In contrast, a longer payback period increases uncertainty, market volatility, and incapacity to reinvest in quick corporate growth. Businesses can reduce risk and make better marketing expenditure decisions by considering payback time.
Payback time is simpler and easier to explain to stakeholders. CLV and CAC need sophisticated calculations and customer behaviour assumptions, whereas payback time is a simpler, more practical way to evaluate marketing strategies. Managers and investors can allocate marketing resources more quickly and accurately by concentrating on investment recovery time.
Formula for CAC payback period:
Payback Period = CAC / (Monthly Contribution Margin)
This formula divides the Customer Acquisition Cost (CAC) by the monthly Contribution Margin, which is the ARPU multiplied by the contribution margin ratio. This will provide you the time (typically months) to recoup the marketing expense used to recruit new clients, based on their monthly revenue and actual profit after variable costs.
The Contribution Margin is more accurate than Gross Margin since it accounts for the product or service's variable costs, revealing how much each client contributes to your profit.
Instead of only the lifetime worth of a customer, the calculation additionally incorporates the speed at which the investment in gaining that customer is recouped.
A lower payback period means the corporation recoups its investment faster. A lower payback time implies more effective resource utilisation and enhances cash flow, hence it is preferable.
In conclusion, payback time is a more practical and complete marketing investment evaluation method than CLV/CAC. Payback time helps firms make smarter marketing budget decisions by considering the time worth of money, allowing for risks, and offering a simpler statistic.
You may be calculating CLV and CAC incorrectly. Companies often underestimate the complexity of these measures and give overstated estimates. I recommend analysing your marketing data to fully grasp the value a customer provides to your business and plan your marketing approach accordingly.
Businesses can better estimate product profitability by considering variable expenses (including COGS) before marketing. Businesses that sell physical products, where manufacture and delivery might account for a large chunk of sales, should take note. Businesses can better price and sell products and services by considering these costs.
Businesses can increase profitability and sustainability by examining the intricacies of CLV and CAC calculation instead of using the standard method. This allows them to make more educated pricing, product, and marketing decisions.
Payback-Time may be better than CLV/CAC. The time value of money is considered when calculating the speed at which a customer acquisition investment is recouped. Communication is easier and more accurate. This focus on cash flow efficiency can help organisations reinvest profits faster, develop faster, optimise marketing, better deploy resources, and stay financially sound.
This analysis's unique blend of corporate finance and performance marketing is crucial to note as we conclude. Previously considered different areas, this study showed how a transdisciplinary approach might improve business metrics knowledge. We used corporate finance principles to improve performance marketing KPIs by understanding Customer Lifetime Value, Customer Acquisition Cost, and Payback Time.