Why LTV to CAC Ratio Is One Of The Best eCommerce Metrics

There are many metrics available to you in an eCommerce business. Some metrics tell a lot about the health of your business, while others are little more than vanity metrics.

LTV and CAC are two figures that are certainly worth tracking. Yet the powerful part of LTV and CAC comes when you measure them in relation to one another.

Keep reading for all you need to know about LTV to CAC ratio, what a good ratio is, and how to optimize LTV and CAC in your business.

What Are LTV and CAC?

LTV (sometimes referred to as CLV or CLTV), refers to customer lifetime value.

This means the total amount of money the average customer spends with you over their lifetime as a customer.

CAC refers to customer acquisition cost.

Customer acquisition cost is the average amount your business spends to get a new customer. Think marketing costs, advertising, sales reps, and anything else that goes into convincing someone to come to your site and buy your products.

Calculating Lifetime Value

To calculate lifetime value, you take your average order value and multiply it by the average number of times a customer buys from you.

Let’s say, for example, your average order value is $50. With great customer service, a magical unboxing experience and attention to detail in your product design, the average customer makes seven separate purchases from your store.

This makes your customer lifetime value $350 ($50 average order value x 7 orders on average).

For a deeper understanding of LTV, check out this excellent infographic from Kissmetrics analyzing the customer lifetime value of Starbucks.

Calculating Customer Acquisition Cost

To calculate customer acquisition cost, you take the money spent on marketing and sales expenses, and divide this figure by the number of new customers acquired.

These expenses can include:

• Ad spend
• Salary for marketing/sales team members
• Outsourcing fees for marketing campaigns
• Software costs for marketing/sales tools

So, for example, let’s say you spent a total of $100,000 on customer acquisition in one month.

For that month, you got 1,000 new customers.

Your CAC would therefore be $100 (100,000 / 1,000).

Learn more: the average customer acquisition cost (CAC) for eCommerce 

Breaking Down LTV to CAC Ratio

LTV to CAC ratio is, as you’d expect, the relationship between lifetime value and customer acquisition cost in your business.

It means how much money you’re getting from each customer for each dollar you spend acquiring them.

If we use the figures from our two earlier examples, the LTV to CAC ratio would be 3.5:1.

Why LTV to CAC is a Powerful Metric

LTV to CAC is a great way to judge the health of your business and the effectiveness of your marketing.

At its core, it’s a very simple metric – how much return you’re getting on your investment into marketing and sales.

LTV to CAC ratio tells you a lot. If you have a negative ratio (CAC higher than LTV), it means you’re spending more on marketing than you’re making in revenue, and therefore your current path is unsustainable.

If you have an even ratio (such as 1:1, or slightly more, such as 1.5:1), it means you’re still likely losing money when you take into account operational costs, cost of goods sold, etc.

Yet a significantly positive ratio is a strong signal that you’re doing things the right way, and that the current path you’re on is sustainable for building a profitable business.

Drawbacks of LTV:CAC

Like any metric, you should always judge LTV:CAC ratio in context, and not in a vacuum.

You could have a healthy LTV:CAC ratio, but a low volume of sales, for example, which would mean you’re not making any real money (despite being profitable).

You could have a marketing strategy that’s not scalable at the same cost, meaning you couldn’t maintain the same LTV:CAC ratio at higher volume.

It can also be difficult to get an accurate idea of LTV:CAC in your company’s early years, as you don’t have a clear understanding yet of the typical lifespan of a customer.

Another issue with LTV to CAC ratio is that, if it takes you a long time to recoup your LTV, you may face short-term cashflow issues despite projecting long-term profitability.

For example, if your LTV is $350, but over a typical lifespan of 10 years, it will take you longer to recoup the $100 you spend acquiring a customer than if the average customer lifespan is only 2-3 years.

Make sure you take these into account when making decisions based on LTV and CAC in your business.

What’s a Good LTV:CAC Ratio?

Most experts say that the ideal LTV:CAC ratio for eCommerce businesses is approximately 3:1.

A 3:1 ratio means that for every $1 you spent, you generate $3 in revenue.

Anything lower than this, and you’re unlikely to be making much (if any) profit, after taking other expenses into account. You’re also more likely to have cashflow problems as you wait to recoup the full LTV from each customer.

Is a High LTV:CAC Good?

If a 3:1 LTV:CAC ratio is good, surely even higher than this (e.g. 4:1, 5:1, 8:1) is even better, right?

Not necessarily.

While a higher ratio means a higher return on your marketing investment, it generally means you’re missing opportunities for growth.

For example, if you have a ratio of 8:1, there’s a lot of room to spend more on marketing to scale your total revenue and grow your business.

Take these two situations as examples.

• Example one, each month you spend $1,000 on acquisition which generates $8,000 in lifetime value (8:1 LTV:CAC)
• Example two, each month you spend $8,000 on acquisition and generate $24,000 in lifetime value (3:1 LTV:CAC)

Though the LTV:CAC is much higher in the first example, you’re making more money in the second example, which is ultimately the point of doing business.

A high LTV:CAC ratio is not always a bad thing, however, and in many cases it’s fine to sit on an LTV:CAC of 8:1 or 9:1 and just enjoy high profits and financial stability.

How to Optimize LTV & CAC

Now we know what LTV and CAC are, what LTV:CAC ratio is, and what the ideal benchmark is, let’s look at how to make your LTV:CAC ratio as healthy as possible.

The most likely situation you’ll find yourself in is a low LTV:CAC ratio (less than 3:1). In this case, you can improve it by either increasing LTV or lowering CAC.

If you find yourself on the other end of the scale, with a LTV:CAC ratio significantly higher than 3:1, you may also want to take action to balance it out.

Let’s run through a few ways to go about doing this now.

5 Ways to Reduce CAC

You’ll often find a poor LTV:CAC ratio is caused by inefficient marketing – spending too much on customer acquisition.

If you’re in this situation, here are five ways to remedy it.

Improve Your Conversion Rate

If you’ve got a poor conversion rate, you’ll probably have a high CAC.

It generally costs a lot to get someone to come to your site, so it’s essential that your site does a good job of converting these people into buyers, in order to keep CAC down.

Look for any opportunities you have to improve user experience on your website (e.g. improving site speed, simplifying site structure, making your website mobile-friendly) and streamline your checkout process to minimize the number of people who drop off in the purchase flow.

Recover Abandoned Carts

A low-hanging fruit for reducing CAC is to recapture lost revenue from abandoned carts.

On average, 70% of online shopping carts are left abandoned. That’s a huge opportunity for additional revenue, from shoppers who have already signaled their interest in your products.

There are numerous ways to go about recovering abandoned carts, including reaching out to these people with emails or push notifications. Abandoned cart notifications come with very little cost, so even recovering a small percentage of these carts will make a big difference to CAC.

Start a Referral Program

Referrals are a powerful, low-cost way to drive more customers to your store.

A referral program typically takes very little upkeep, referrals cost you less than most other marketing channels, and customers coming from referrals tend to have a higher lifetime value as well.

All that adds up to reduce CAC, working more or less on autopilot once you get the program set up.

Find More Affordable Marketing Channels

High CAC usually means you’re spending a lot on expensive paid advertising channels.

Try finding more affordable ways to get customers, such as email marketing, content marketing/SEO and influencer marketing.

You don’t need to pivot your marketing strategy completely to these channels (as more affordable channels tend to be harder to scale), but generating some low-cost sales from other channels can offset your ad spend and reduce overall CAC.

Narrow Your Target Audience

Spending a lot on CAC (especially via paid ads) might mean you’re trying to market to a much too broad audience.

For most businesses it will be more efficient and more profitable to target a narrower audience. Look at your ideal buyer persona, and see how you can make this persona more targeted, based on the type of people who have bought from you and converted at a higher rate in the past.

5 Ways to Increase LTV

To increase customer lifetime value, you’ve got two options: get people to spend more in each order, or get them to buy from you more often.

Here are five ways to achieve this.

Provide an Amazing Post-Purchase Experience

It’s important to understand that once a customer completes their purchase, your job is not done.

You want to make the customer feel great after they hit the “buy” button, so they’re more likely to remember your brand and come back to buy from you again.

Prompt, automatic order updates, speedy and helpful customer service, and a great unboxing experience all contribute to a great post-purchase experience, making it more likely that the customer will bring you return business.

Push Up-Sells and Cross-Sells

Once a customer makes a purchase, use this opportunity to recommend complementary products to increase their basket size (or get them to come back and make another purchase soon after).

If someone buys a pair of shoes, recommend a pair of socks to go with it. If they buy a bike, recommend a helmet.

You don’t need to be too pushy about it, and a simple addition to your checkout flow or an automated post-purchase email/push notification could add a small but significant amount to your LTV.

Offer a Loyalty Program

Loyalty programs are a powerful tool to get customers to spend more and shop more often.

Giving people a clear incentive to spend money works, and it’s why just about all major brands, from H&M to Starbucks, have their own loyalty program in place.

Run Email Marketing, Push Notification Campaigns to Existing Customers

Acquiring a new customer is typically five times more expensive than selling to an existing customer.

Pair that with the extremely low cost of channels like email marketing and push notifications, and you have an excellent, low-cost way to increase lifetime value.

If you’ve been in business for a while, you’ll almost certainly have a sizable customer list, which you should be messaging regularly to stimulate higher loyalty, retention and LTV.

Launch a Mobile App

Finally, one of the best things you can do to increase lifetime value is to launch a mobile app.

The world is getting more mobile-centric, and mobile commerce is now worth more than $500 billion in the US, and more than $2 trillion worldwide (over 50% of total global eCommerce sales).

A mobile app lets you offer the best user experience to the growing share of mobile shoppers.

It’s also a perfect tool for boosting retention and long-term revenue from your customers. An app keeps your brand top-of-mind, incentivizes repeat purchases, and lets you use mobile push notifications to consistently re-engage your customers.

To launch a mobile app for a manageable cost, minimal effort, and without adding any complexity or hassle to your existing workflow, check out MobiLoud.

You can go live with an app in less than a month, simply by converting what already works for you on your website.

To learn more, check out our website or book a free demo today.

3 Ways to Balance LTV:CAC Ratio (Increase CAC)

So how about if your LTV:CAC ratio is too high?

In most cases, this means you want to spend more on CAC, to increase revenue and grow your business.

(Don’t take this to mean you need to reduce LTV in order to get your LTV:CAC closer to 3:1).

If you’re in this situation, and you’re riding high with an extremely high LTV:CAC and feel like you want to reinvest that into growth, here are a few options to consider.

Increase Ad Spend

The simplest solution to this is to spend more on advertising.

Earlier we said that you may be targeting too broad an audience, but it can also be the case you’re targeting an audience that’s too narrow.

A wider audience may be less profitable, but if your LTV:CAC ratio is already very high, it may be worth the higher CAC to increase revenue as well.

Reduce Prices or Run More Promotions

You may find success scaling revenue by selling your products at a lower price, or running more discounted promotions, to increase total number of purchases.

This is something you could experiment with. Remember, the goal is not to decrease revenue; it’s to increase revenue, by sacrificing profit to generate higher volume.

Increase Team Size

If you’re generating revenue efficiently with a small team, you might be able to scale higher and faster with a larger team.

Consider hiring more people for your marketing/sales teams, or additional team members like graphic designers and content creators, in order to improve your marketing efforts, reach more customers and generate more revenue.

Final Thoughts

LTV to CAC is an effective way to measure the health and sustainability of your business.

Like with almost any metric, only looking at this on its own, without context, can get you into trouble. But as long as you consider the broader scope of your business, LTV and CAC tell you a lot about where your business is going and what needs to change.

One of the best ways you can get your LTV:CAC ratio to a healthy level is by launching a mobile app.

Mobile apps help you generate more LTV by increasing customer loyalty and retention, as well as boosting AOV and conversion rate for mobile shoppers.

And apps also help reduce CAC, giving you a cheap and powerful way to sell to your existing customers.

More than 2,000 businesses, including high-revenue eCommerce brands including Rainbow Shops, Jack & Jones and John Varvatos, used MobiLoud to build their apps, with none of the effort and overhead of custom development, and without the limitations of app builders.

MobiLoud let them take what already worked for them on their website, and turn it into an amazing app experience that elevated their brand.

You can do the same – just get in touch with us today and book a free demo to learn how, and see if MobiLoud is the right fit to help you grow your business.