Comparing Customer Acquisition Costs (CAC) and Customer Lifetime Value (CLV)
In the last two blogs, we discussed the methodology to calculate CLV and to apply it to different segments of your customers. In this blog, we will close the loop by discussing Customer Acquisition Costs (CAC) and how it should compare to CLV in a typical B2C business like ecommerce.
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CAC is estimated as:
(Total Marketing costs associated with customer acquisitions in a period) / (Number of new customers acquired in the period)
The costs include the following components:
- Click-based advertising (Google, Facebook, …)
- Display and brand advertising
- Coupons or discounts offered for acquisition
- Headcount costs associated with acquisition
Calculation of some of these components may get tedious. Our recommendation is to make your best estimate. Note: If you are doing these calculations in the first place, you are already way ahead of the pack!
The industry suggested optimal ratio for CLV/CAC is 3 (Reference)
Of the cost components listed above, click-based advertising costs are the most important because it has the highest flexibility for adjustments. This is the component you can control for acquiring specific types of customers that fall into segments as we discussed in the previous blog.
Let us illustrate the above concepts with an example:
Let us say the overall CLV is $50
Assume the acquisition costs in a period were:
Click-based advertising (Google, Facebook, …): $60,000
Display and brand advertising: $15,000
Coupons or discounts offered for acquisition: $5,000
Headcount costs associated with acquisition: $30,000
TOTAL ACQUISITION COSTS: $110,000
Suppose 5,500 new customers were acquired during this period. That means the CAC is $110,000/5,500 = $20
CLV/CAC = $50 / $20 = 2.5, which is slightly below the ideal ratio of 3
Now let us take an example of a segment-based CLV. Using the simple segmentation plan outlined in the previous blog, let us say women over 35 is the highest CLV group for the business with a CLV of $75, which is 50% higher than the overall CLV of $50.
On a per-customer basis, average click-based advertising costs was
= $60,000/5,500 = $10.91
With a segmentation strategy, we can afford to spend 50% more costs to acquire this segment (women over 35 years). This comes to $10.91 * 1.5 = $16.36
(This calculation assumes we stick to the CLV/CAC ratio of 2.5 of this business, even though it is not the ideal ratio).
This is an example of making the CLV, CAC, and Segmentation insights actionable in acquisition marketing.