Why a Small Business Needs to Know Customer Acquisition Cost and Lifetime Value

by Craig Anthony

2 min read

Although a company is much more than two calculated figures, there are two equations that can help determine if a company will be successful. These two calculations, customer acquisition cost and customer lifetime value, can help a business determine its long-term outlook. Determining these values helps guide advertising endeavors, expansion efforts, and overall company health.

Customer Acquisition Cost

Customer acquisition cost (CAC) is the average expense needed to attract a new customer. It is calculated by dividing the total expenses relating to sales and marketing programs by the number of new customers attracted during the related period. If total expenses for the period were $25,000 and 100 new customers were obtained, the CAC is $250. The total expenses for marketing and sales should include salaries. In addition, the costs should encompass all activity, including accrued amounts.

Customer Lifetime Value

The customer lifetime value (CLV) is the amount of revenue expected to be earned from any given customer. It is a measurement that spans the customer’s entire purchasing relationship with a company. In addition to product purchases, CLV incorporates ongoing services provided. The formula attempts to gauge the average amount of business generated due to a customer repeating business. Although there are several complex formulas to calculate the CLV, the easiest way to get a rough estimate is to divide your net profit over a period of time by the number of customers served over the same period of time. For example, if you report a net profit of $75,000 with 100 customers, the CLV is $750.

Relationship Between CAC and CLV

There is a direct relationship between the CAC and CLV that can easily signify the prospective future of a company. In general, it is most advantageous for the CAC to be low and CLV to be high. If this is not the case, the business will not be profitable in the long term. For example, if it costs $100 to obtain a customer that will produce a CLV of $500, your company will experience a long-term benefit. However, if the CAC is greater than the total value to be received, it is not worthwhile embarking on the opportunity to pursue the new customer and growth is not an option under the current situation.

Conservatism

Not all elements required for the calculations of CAC and CLV may be presently known. For this reason, it is important to take a conservative approach when performing the calculations. Although it may be advantageous to omit future costs, all calculations should project reasonable figures to give an accurate representation of where your business stands. It is imperative to incorporate all associated variables including estimates, accruals, forecasts, projections, and contingencies.

Incorporating CAC and CLV Into Marketing

These two figures are directly correlated to how much is spent on marketing campaigns and the success of the outcomes. Therefore, the general premise behind CAC and CLV is that these advertising endeavors should pursue the greatest value per dollar. For example, a project costing $20,000 could return 200 new customers. Even if the project was cut in half and 100 new customers were brought in, the same CAC would exist. A company should seek not only to manage marketing spending but target areas where the CAC is minimized.

References & Resources

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