Acquiring and retaining customers is the key to growing a startup.
But each customer also costs money to acquire.
Is the value of each customer worth the price it costs to acquire them?
You can find that out using your customer lifetime value to customer acquisition cost ratio (LTV:CAC ratio). Let’s discover why this metric matters and how you can work to improve it for your startup.
Table of contents:
- What is LTV:CAC ratio?
- How to calculate your LTV:CAC ratio
- Why LTV:CAC ratio is important for startups
- 7 ways to improve your LTV:CAC ratio
What is LTV:CAC Ratio?
Your LTV:CAC ratio is a way to measure the relationship between how much a customer spends on your products/services over their lifetime (i.e. before they churn) and how much it costs to acquire them.
This metric is primarily used by subscription-based businesses because they depend on customer retention rather than a series of one-time sales to grow.
How to Calculate LTV:CAC Ratio
LTV:CAC Ratio Formula
Customer Lifetime Value / Customer Acquisition Cost = LTV to (1) CAC Ratio
For example, if you have an LTV of $1000 and a CAC of $500:
1000 / 500 = 2
This means you have an LTV:CAC ratio of 2:1. In other words, you earn 2X more from your average customer over their lifetime than it costs you to acquire them.
Why LTV:CAC Ratio is Important for Startups
It’s impossible to know if your LTV is too low or your CAC is too high without knowing your ratio first.
For example, a high LTV may not be high enough if the customer acquisition cost is also high.
The opposite can also be true. You can have an LTV that doesn’t seem very high at first glance. But if your CAC is low and your CAC payback period is shorter than your LTV, then you may still be profitable.
When you know your LTV: CAC ratio, you can get a pulse on the health of your startup. A low ratio means that something needs to change if you want your startup to grow efficiently.
If the cost of customer acquisition is too expensive for the value of your customers, then it will be impossible to generate a profit in the long run.
What’s a Good LTV:CAC Ratio?
If you have a ratio of 1:1, it means that it costs as much to bring on a new customer as they are worth during their lifetime.
This isn’t ideal. Not only can you not generate a profit like this, but you’ll most likely incur a loss, since your startup most likely has other expenses.
So you need your ratio to be above 1:1. The widely accepted “goal” is a ratio of 3:1. This means that a customer is worth three times as much as it costs to acquire them, which gives you more wiggle room for your other startup costs.
Why not higher? While an LTV:CAC ratio of 5:1 can mean you’re profiting more from each customer, it also means that you might not be growing as quickly as you could be. A larger ratio like this means you can potentially spend more on customer acquisition to drive growth.
How to Improve Your LTV:CAC Ratio
There are only two ways you can improve your LTV:CAC ratio. You can either increase your customer lifetime value, or decrease your customer acquisition cost. Ideally, you should do a bit of both.
Here are some tips to improve your LTV:CAC ratio.
1. Improve Your Lead Conversion Rate
How many of your leads turn into paying customers?
That’s your lead conversion rate. The more leads turn into paying customers, the cheaper it will be to acquire each one.
There’s no shortage of ways to improve your lead conversion rate. Some of these methods can even help you increase your LTV at the same time.
For example, start improving your lead nurturing process. You can nurture your leads by:
- Creating valuable content for your customers (tutorials, blog posts, case studies, etc)
- Segmenting your leads to send them relevant, targeted emails at the right time
- Using multiple touchpoints throughout the buyer’s journey
- Adding multi-channel strategies to reach out to your leads on several platforms (email, retargeting ads, social media, direct outreach, etc)
But when you nurture your leads, you’ll also help them get acquainted with your product. As a result, they’ll be better educated and know their way around your product. This will help them achieve the goals they have with your product, which will help them stick around for longer (hello customer retention!).
Other ways you can improve your lead conversion rate include:
- Using lead scoring to keep track of which leads are more qualified
- A/B testing your campaigns to see which ones get you the best results
- Optimizing your calls-to-action
- Making sure your sales team has the right information on each lead to follow up with them
- Offering discounts for first-time buyers
If you keep improving your lead conversion rate, you can slowly but consistently improve your LTV:CAC ratio.
2. Decrease Your Cost Per Lead (CPL)
If each lead costs you less to acquire, it makes sense that each customer will cost less, too. That’s why you should prioritize decreasing your cost per lead if you want to improve your LTV:CAC ratio.
Improving your CPL involves lots of testing and optimization, especially if you’re using paid ads. Here are some ways you can optimize your campaigns:
- Consistently test new ad creatives and disable the ones that don’t perform as well
- Test new audiences
- Use retargeting ads
- Create lookalike audiences
- Use negative keywords in your PPC campaigns
- Test new keywords and remove those with bad performance
However, there are other ways you can decrease your CPL in the long term. Some methods will cost you more upfront, but will help you acquire more leads without only relying on paid media.
For example, you can start investing in search engine optimization (SEO) and creating high-quality content that will rank on the first page of search results. On top of a lower CPL, it can also improve your LTV by attracting more qualified leads.
The more you invest in SEO and content marketing in a consistent way, the more leads you will generate from this channel. Even if you stop running ads, your old content will still help you generate leads.
You can also start an affiliate program. Just like content marketing, this won’t automatically reduce your CPL. But over time, as your existing customers start generating more leads for you, your CPL will go down.
3. Improve Your Onboarding Process
Once you finally acquire a customer, make sure that they have the necessary tools to succeed with your product.
Even if you create a huge library of valuable content, you should still invest in creating a tailored onboarding experience for every new customer.
In fact, a large library of content can be overwhelming for your customers! So make sure that you guide them in the right direction.
If your product has several use cases, find a way to segment your new customers. You can survey them once they sign up for your product to find out which use case is most relevant to them.
Using this information, you can add your customers to the right automated email sequence to guide them through the onboarding process. You can send them tutorials, provide them with the contact information for their dedicated account manager, drip relevant content that can help them make the most of your product, and send them invitations to relevant webinars if applicable.
When your customers have the right information to succeed, they’re also more likely to get value from your product. This will help them remain a paying customer for a longer period of time, which increases your LTV.
4. Improve Your Existing Customer Experience
What happens once your customers are onboarded?
If you want to keep customers around for longer periods of time and increase your LTV—which will simultaneously improve your LTV:CAC ratio—you need to provide a stellar customer experience across the entire customer lifecycle.
When a customer struggles with an aspect of your product, they should easily be able to reach a customer service rep and troubleshoot their issues. Make sure you train and upkeep a talented customer service team that knows how to adapt to any situation your customers can come across.
However, a positive customer experience goes far beyond customer service. Your product should also be built in a way that provides a good experience.
Is it easy to perform actions your customers are looking for? Does the product adapt well to customers, or is it the other way around?
Make sure you invest to improve your product’s UX if this isn’t the case. Find ways to make the experience smoother and easier for not just you, but your customers.
You can find people to test out your features and improvements before they roll out to every customer. Email your customers to ask if anyone would like to participate in beta tests and provide feedback.
5. Identify Your Ideal Customer
You created an awesome product—but that doesn’t mean it’s the right fit for everyone.
Even if your startup was created to target everyone, doing so isn’t the best strategy to lower your CAC and increase your LTV. Instead of casting a wide net and appealing to everyone at once, try to focus on a specific customer persona.
When you know who your ideal customer is, you’ll be able to tailor your sales funnel and your entire customer experience to fit this persona. Not only will it help you reduce your CAC, but it will also help you keep customers for longer, which will improve your LTV.
On the other hand, if you try to please everyone, you’ll end up pleasing no one.
6. Find Ways to Upsell or Cross-Sell Your Customers
Did you know that you have a 60-70% chance of closing a sale with an existing customer compared to a 5-20% chance with someone who has never bought from your startup before?
Because of this, you can increase your revenue without dramatically spending to acquire a new customer—just by upselling or cross-selling your existing customer base.
Plus, your existing customers are 50% more likely to try new products compared to new customers. They’ll also spend 31% more, which will help you increase your LTV without increasing your CAC.
7. Train Your Sales Team
Investing in sales training will increase your CAC at first. But, like the other methods to reduce your CAC, it’ll pay off in the long run.
You can expect an average of $4.53 in return for every dollar you invest in sales training. That’s because a better-educated sales team will be able to perform tasks more efficiently, convert more leads into customers, and build better relationships with these new customers, which can help increase customer loyalty.
If your startup can build a powerful, cost-effective sales team that knows how to get customers efficiently and keep them around, you’ll have a valuable tool for efficient growth.
Keep Track of Your LTV:CAC Ratio
It’s important to be aware of your LTV:CAC ratio at all times. A sudden increase in CAC or decrease in LTV can be a red flag for issues that need to be addressed as quickly as possible.
Finmark simplifies keeping track of your financial metrics, all without complicated spreadsheets. Schedule a demo today to see how you can make financial modeling easier for your startup.