What it means:

The CAC to LTV ratio (customer acquisition cost to lifetime value) is a critical metric that reveals the balance between the cost of acquiring customers and the value they bring over their lifetime. It's calculated by dividing CAC by LTV, providing insights into the efficiency and sustainability of your business model.

To break it down, CAC represents the cost incurred to acquire a new customer, while LTV represents the total revenue expected from that customer throughout their relationship with your business.

Why it matters:

The CAC to LTV ratio is a fundamental metric because it helps you determine the health and viability of your business. Here's why it's important:

• Profitability Indicator: A CAC to LTV ratio greater than 1 indicates that you are acquiring customers cost-effectively. In other words, the value a customer brings exceeds the cost of acquiring them, resulting in a profitable customer acquisition strategy.

• Sustainability: If the ratio is significantly lower than 1, it suggests that you might be spending too much to acquire customers relative to their long-term value. This can be unsustainable and negatively impact your business's financial health.

• Strategic Decision-Making: Understanding this ratio helps in making informed decisions about marketing budgets, pricing strategies, and customer retention efforts. It guides you in allocating resources where they are most effective.

Places it is used:

The CAC to LTV ratio is widely used across various industries, especially in businesses with recurring revenue models, subscription-based services, and e-commerce. It's a core metric for determining the viability of customer acquisition strategies.

For example, in the SaaS industry, companies rely heavily on this ratio to assess the return on investment for marketing campaigns and to set pricing strategies. It's also valuable for evaluating the performance of different customer acquisition channels, such as advertising, referrals, or content marketing.

Where it gets tricky:

Interpreting the CAC to LTV ratio can be tricky, and there is no one-size-fits-all benchmark. The ideal ratio varies by industry, business model, and stage of growth. What's considered a good ratio for a SaaS startup may differ from that of an established e-commerce business.

Additionally, it's important to keep in mind that both CAC and LTV can change over time. For example, as your business grows, you might invest more in marketing, which can impact your CAC. Similarly, customer behaviors and preferences may evolve, affecting LTV.

An example:

In the below situation, I’ve crafted up a particularly extreme example of the different outcomes we can see. In one scenario we are acquiring customers for cheap (Cohort 1), acquiring customers expensively but with immediate return (Cohort 2), and at a medium cost with good returns, but over a long period of time (Cohort 3). These are each individually great Cohorts to have, but in scaling startups, where capital is limited, it’s important to acquire clients in an affordable way.