Calculating average customer value (Customer Lifetime Value) and average acquisition cost (Customer Acquisiton Cost) is perhaps the most important step in data-driven marketing. Many Dutch people are reluctant when it comes to spending money on marketing. But it doesn’t have to be a bad thing to increase your marketing costs, as long as you get enough revenue in return. Using the Customer Lifetime Value (CLTV) and Customer Acquisition Cost (CAC), you can easily calculate whether you should reduce or increase your marketing budget. Moreover, you can easily convince the management team that your marketing department delivers value when you have these metrics listed.
Why is the CLTV so important?
Well, think of a company that sells toothbrushes at a price of 2 euros. And imagine this company using an entire sales force to call their customers and sell the toothbrushes. You can imagine that you have to sell a lot of these toothbrushes per customer to break even: the training of the sales staff, the salaries of the sales staff and then your own salary. It is quite easy to see that this is not feasible.
To put it simply:
If you don’t know what you can spend on one customer, it’s hard to judge whether marketing campaigns are working or not, and you can’t scale up effectively. For this reason, it is important to know the Customer Lifetime Value (CLTV) of your business and thus how much you can spend on your marketing strategies to turn a profit.
Depending on the CLTV, you need to choose your marketing strategies
How do you calculate the CLTV?
You can calculate the CLTV by adding up the revenue you receive on average from a customer over the entire period he or she remains a customer.
Your organisation sells a software package with a licence value of €200 per month. On average, customers continue to use your software for 40 months. CLTV is therefore 40 x €200. So a new customer generates €8,000.
Do you find it difficult to calculate how long a customer remains a customer on average? Then look at the churn rate. How big is your customer database and how many customers cancel each month? By calculating this back, you arrive at the average number of months the contract with a customer runs.
How do you calculate the average acquisition cost per customer (CAC)?
The Customer Acquisition Cost (CAC) is the average cost you pay for acquiring one additional customer. You calculate the CAC by adding up the total acquisition costs for a given period. Acquisition costs include all costs you incurred to acquire new customers, such as marketing costs and the salaries of your sales staff. Include all costs to give the most reliable picture. Think about: salaries, hiring, sales training, etc. To calculate the CAC, divide the recruitment costs by the number of new customers you have won in a given period.
You spent €10,000 on LinkedIn ads in May, spent €3,000 on two ads in a magazine, spent €5,000 to be at a trade show and spent €100 per hour on one sales staff working 40 hours a week. Through all these marketing efforts, you brought in a total of 100 new customers. This means your Customer Acquisition Cost is:
€10,000 + €4,000 + €5,000 + (€100 x 40 hours x 4 weeks = €16,000) = €35,000 acquisition cost
€35,000 / 100 clients = €350 CAC
What share does marketing have in the total CAC?
M%-CAC: M%-CAC is the share that marketing has in the total Customer Acquisition Cost. For a company that focuses mainly on field sales and has a long and complicated sales process, the M%-CAC may only be 10-20%. Companies that also use inside sales or have a less complicated sales process often have an M%-CAC of around 20-50%.
Finally, there are also companies that incur low sales costs and have a simpler sales process. Here, the M%-CAC could go as high as 60-90%. Think for instance of webshops.
Ratio between CLTV & CAC
An important metric to keep an eye on is the ratio between CLTV and CAC. The higher the ratio, the higher the ROI of marketing and sales. Mind you, higher is not always better! You might be making it too easy for your competitors right now. If the ratio is too high, it may actually be a good idea to invest more to grow faster. A good target ratio is 3:1.
One step deeper: splitting by channel
Imagine this; what if you had not one, but two acquisition channels? For example, content marketing and Facebook ads. Because content marketing is cheaper, more efficient and, unlike conventional ads, is often not seen as a disruptive factor, these channels differ in quality of customers and therefore value.
So the standard CLTV does not fit well in this situation; a customer brought in through the content channel may be worth 90 euros. But because customers brought in through Facebook ads are worth much less ‘value’, this means you can’t spend the 90 euros on Facebook ads and still even break even.
The leads you bring in through different channels are almost certainly of different quality and therefore of different value. That’s why it’s good to break down by channel.
Another possible step deeper: the value per funnel step
So what if you know what a customer is really worth (CLTV) and how much it actually costs to bring in a customer (CAC) per channel? You can now go one more step deeper and calculate back how much each of the funnel steps is worth to you.
Say the average CLTV of your customers is €8,000. And when you make an offer, it has a 50% success rate. The value of an offer is then €4,000. You can calculate this further and further, higher and higher into the funnel.
Between each phase in the funnel there is a conversion rate. The more relevant you are, the higher your conversion rates. Make sure you know the conversion rates. You can find the conversion from MQL to SQL, from SQL to Customer in a Customer Relationship Management (CRM) system. The conversion from Visitor to Lead and from Lead to MQL can often be found in your Marketing Automation Platform (MAP).
You can now calculate back exactly how much a Customer, an SQL, an MQL, a lead and even a visitor on your website is worth. Perhaps after this calculation, it turns out that a visitor on your website is ‘only’ worth €2.50, while you pay Google €5.00 per visitor every day. That’s a waste of investment. Or maybe you generate leads through a publisher, for €25 per lead, while a lead is actually worth €45 to you. So you know exactly what you can optimise to increase ROI.
Key insights from today:
- You should always put the average customer value of 1 customer (CLTV) next to the average cost of bringing in 1 customer (CAC)
- A business needs to make money, so your CLTV should be higher than the CAC, preferably 3 times higher
- With the CLTV and CAC, your marketing team can make much smarter decisions and work more efficiently
- Knowing the CLTV and CAC per channel (or other relevant variable such as funnel steps) is an excellent way to make your business more data-driven