2 Key Acronyms to Measure In Your Business
In the marketing world, we deal with a lot of acronyms. Sometimes there are so many letters flying about that it becomes difficult to assign meaning to them. If you struggle with this, you’re not alone. CAC (Customer Acquisition Cost) and CLV (Customer Lifetime Value) are two especially challenging ones that many businesspeople have a hard time with. They’re important to understand though, so do take the time to learn the difference. You also should understand what each means for your overall marketing strategy.
One important thing to realize about CAC and CLV is that both are directly related to ROI. ROI, or return on investment, is a term that most businesspeople are familiar with. According to Investopedia, ROI measures the amount of return on an investment relative to the investment’s cost. In other words, if you’re going to put money into something (advertising, content marketing, consulting), your ROI is a measure of how much money you’ll make from that investment.
ROI is normally measured as a percentage. For example, let’s say you manage a bookstore. You spend $500 to get a famous author to come to a book signing at your store. The sales that result from the author’s visit are $700 more than you’d expect under normal conditions. So your ROI for this particular investment is approximately 29 percent. ($700 – $500 = $200 / $700 = 28.5%)
So why are we talking about ROI when you’re here to find out about CAC and CLV? Both CAC and CLV are directly related to ROI, and it’s important to understand ROI if you want to get to know what these terms mean for your business and your marketing strategy.
CAC – Customer Acquisition Cost
CAC stands for customer acquisition cost. It refers to the investment it takes to gain a customer. Investment costs in this realm may include advertising, content marketing, employing salespeople, software, and other miscellaneous costs.
You arrive at the CAC number by dividing costs spent on acquiring customers by number of customers acquired. So if you spent $10,000 in a given period and acquired 100 customers, your CAC for that period is $100.
CAC is an important metric because it is directly tied to your overall return on investment. If you’re spending too little, you won’t gain enough customers to sustain your business. If you’re spending too much, you won’t regain your investment with sales.
Ideally, you want to fall into the goldilocks zone of CAC. You should be spending enough to attract a significant amount of new customers, but not so much that you investment exceeds your return.
Of course, you also need to consider your specific industry when you think of customer acquisition. Are you selling low-value, high-volume goods, or high-value, low-volume ones? If each new customer is expected to spend a substantial amount, then the CAC can and should be higher.
CLV – Customer Lifetime Value
CLV is a measure of how much money you can expect to make from an average customer for the entire duration of their relationship with your brand.
The actual calculations are often more complex, but here’s a simplified idea of what goes into calculating CLV. You multiply the average spend per purchase by the number of repeat sales and the average retention time.
For an expanded view of CLV, along with some examples, check out this helpful infographic from Kissmetrics. It goes deeper into exploring some of the different variables that go into CLV, including profit margin per customer, gross margin per customer lifespan, and rate of discount.
CLV is really one of the most important metrics of all because successful businesses are those that cultivate long-term relationships with their customers. Think about it this way: there are only so many new customers out there. Even if you are successfully able to attract every single potential customer, your business won’t be sustainable if each makes just one or two purchases and never returns.
The Secret to Maximizing CLV
If you’re going to foster those customer relationships that will result in a high CLV, your main focus has to be on customer satisfaction. As the Kissmetrics infographic shows, it costs 6 to 8 times more to gain a new customer than to keep one you already have. It’s clearly unsustainable to keep churning through customers. What you need to do is keep existing customers coming back.
And why do customers return? The main reason is that they are satisfied with their overall experience. Many factors go into customer satisfaction, but some of the most important are customer service, prices, perceived value, and convenience. A customer that is consistently satisfied will develop an attachment to your brand and will be less likely to shop with your competitors.
What CLV means for CAC – and vice versa
The length and profitability of your customer relationships will determine the amount you can reasonably spend to acquire new customers. Therefore, if you have a high CLV, you can justify relatively high spending in the pursuit of gaining new customers. Your CAC will be higher, but you know that you’ll ultimately make that money back over the lifetime of your customer relationships.
Likewise, if you have a high CAC, then your CLV must be high enough to make the costs of customer acquisition sustainable. If you spend more to attract a customer than that customer will spend with you, your business will fail. Of course we’re talking about averages here. If you have a CAC of $100, you might still have some new customers that spend $5 and never come back. It’s not ideal but it happens. The important thing is that the average customer spends enough long-term to justify your CAC.
And that brings us back to ROI. You can look at it this way – the CAC is the investment and the CLV is the return on that investment. But don’t forget that there’s another key ingredient along the way – customer satisfaction. So a simple formula might look like this: CAC + customer satisfaction = CLV (ROI).
This is, of course, a major oversimplification. Calculating CAC and CLV is more complex, and it takes time and effort to learn how to arrive at these numbers. But understanding the concepts is a basic first step.