There is a near-endless list of metrics you can look at to evaluate your business’s health, but few offer as much insight as your LTV:CAC ratio. LTV:CAC folds several critical metrics into one broad ratio, making it a valuable tool for analyzing your company from multiple angles.
In this article, you’ll learn:
- What LTV:CAC measures, and why it’s important
- When you should start tracking LTV:CAC
- How to calculate LTV:CAC
- Tips for benchmarking your LTV:CAC against peers
- Some cases that may add complexity to LTV:CAC calculations
What Does LTV: CAC Measure?
Customer Lifetime Value, or LTV, is a measure of the total gross margin you earn from a customer over the duration of your relationship with them.
Customer Acquisition Cost, or CAC, measures the average sales and marketing spend it takes to acquire a customer.
Therefore, LTV:CAC essentially measures your total return on sales and marketing spend over the lifetime of a customer relationship.
For example, say you spend $5,000 to acquire the average customer. Your CAC is $5,000. That customer earns you $20,000 in revenue over their lifetime with 80% gross margins, making your LTV $16,000.
Dividing your $16,000 LTV by your $5,000 CAC brings you an LTV:CAC of 3.2.
LTV:CAC Monitoring by Startup Stage
Any company that has found product/market fit and has predictable, scalable sales and marketing processes should monitor LTV:CAC.
If you have yet to find product/market fit, LTV:CAC won’t provide you with much value. You should focus on finding that fit and developing your sales and marketing processes before turning your attention to LTV:CAC.
As your company scales, you’ll want to start calculating LTV:CAC by channel, so you can measure the relative effectiveness of your various marketing efforts and allocate resources to the ones providing the best return on your investment.
Calculating LTV: CAC
Both LTV and CAC require some calculations.
CAC is much simpler, though. Here is the formula:
$ Spent on Sales & Marketing / # of Customers Acquired
The formula for calculating LTV is as follows:
This formula looks complicated, but it’s overkill for the needs of most startups because calculating a weighted-average cost of capital (WACC) is difficult in the early stages. Instead, we can use this simplified formula:
LTV = [ARPU * GM%] * CL (in Months)
Let’s break down each component of this formula:
| Metric | Description | Formula |
| ARPU: Average Revenue Per User | Revenue generated per user or customer on average. | Monthly Revenue / Total # of Customers |
| GM%: Gross Margin Percentage | Percentage of revenue that is left after all expenses. | [Gross Profit / Revenue] * 100 |
| CL: Customer Lifetime | The average amount of time a customer stays with your brand in months. | 1 / Monthly Churn |
With these in mind, let’s expand the formula so you can see where everything fits in:
LTV = {[Monthly Revenue / Total # of Customers] * [(Gross Profit / Revenue) * 100]} / Monthly Churn
Finally, you’d divide the result of this formula by your CAC (using the formula mentioned earlier) to arrive at your LTV:CAC ratio expressed as a number instead of a percentage.
Why is LTV:CAC Important?
LTV:CAC is primarily helpful for determining if your overall go-to-market motion is working effectively.
Additionally, since LTV:CAC folds several vital metrics into one ratio, management can use it to identify opportunities for improvement. If your LTV:CAC isn’t where you want it to be, you can decompose LTV:CAC and evaluate each individual metric for improvement opportunities. For example, you could look for ways to increase LTV (increase ARPU, expand gross margins, reduce churn) or you could work with your marketing team to decrease CAC.
A Word of Caution on LTV:CAC & Unintended Consequences
The variables that roll up into LTV:CAC are interrelated; Tren Griffin describes them as five horsemen connected by a rope in this great piece by Bill Gurley:
Tren Griffin, a close friend that has worked for both Craig McCaw and Bill Gates refers to the five variables of the LTV formula as the five horsemen. What he envisions is that a rope connects them all, and they are all facing different directions. When one horse pulls one way, it makes it more difficult for the other horse to go his direction.
For example, if you raise prices to bolster ARPU, you might price a proportionate number of customers (the ARPU denominator) out of your product. In theory, you’ll end up with the same ARPU.
Instead, you may consider adding value by building new features into the product or enhancing the customer experience. Doing so helps to justify the higher price, which should help you keep customers and increase ARPU.
Other Instances Where LTV:CAC is Important
At Series A/B stage and beyond, investors will expect founders to speak intelligently on these numbers and hopefully show that unit economics trend in a positive direction.
LTV:CAC will likely be a talking point in your board meetings, too. When you’re preparing the financial section of your board meeting presentation, you should be able to talk about your LTV:CAC and what direction it’s going.
In either case, calculating your LTV:CAC per customer cohort is a great way to demonstrate that you’re optimizing your firm over time. You’ll hopefully demonstrate that CAC is decreasing alongside an LTV that’s increasing.
A quick note: if your company has multiple customer segments, one broad LTV:CAC across your entire customer base won’t tell you much. Instead, calculate LTV:CAC within each customer segment or acquisition channel.
In doing so, you can see which customers provide your firm with the highest returns. You can then shift your focus to these customers while brainstorming ways to bring LTV up among your less lucrative segments.
LTC:CAC Benchmarks
There’s no correct answer to “what is a good CAC?” Some businesses can thrive with a high CAC, while others need to be more scrappy.
For example, if you sell a low-priced, one-off product, you can’t support as high of a CAC as a firm selling a high-ticket SaaS product.
Ultimately, the LTV you shoot for depends on your CAC and vice versa. That said, a high-level rule of thumb is to aim for an LTV:CAC of 3. For more exact benchmarking & analysis, feel free to reach out and we’ll connect you with a member of our Finance team.
Cases That Add Complexity
Certain instances add complexity to figure your LTV:CAC. Covering these in-depth is beyond this article’s scope, but let’s look broadly at a few cases.
One of the most prominent is a business with an ARPU that changes month-to-month. Companies with per-seat or usage-based products, such as email service providers, often fall into this category.
You’ll have to adjust the LTV:CAC formula to account for your remaining customer growth and the cost of expanding your revenue.
Key Takeaways
- Put necessary infrastructure in place to monitor LTV:CAC the moment your sales engine is ready to scale. For example, you should have the ability to attribute customer acquisition by channel and efficiently pull user analyses. This way, you’ll be prepared to track your metrics over time and seek out ways to improve.
- Once things get going, measure your LTV:CAC regularly — preferably monthly. As you do so, communicate LTV:CAC performance with all key stakeholders to keep them in the know.
- One last thing: LTV:CAC is not the definitive way to see your business’s health. You want to assess it alongside other broad metrics. Payback period is a great one. If you have a high LTV:CAC, but it takes 10 years to recoup your investment, you won’t be able to grow.
At AirCFO, we help startups like yours understand crucial financial metrics like LTV:CAC and identify ways you can improve them. Contact us for a free 30-minute discovery conversation to learn how we can help
Author Note: Alex Wittenberg is COO of airCFO and has a background in management consulting, startup finance and as founder of a social enterprise startup called CoffeeQ