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Managing a startup and not knowing your customer acquisition cost (CAC) or customer lifetime value (LTV) metrics is a recipe for incomprehensible disaster.
If you haven’t already calculated your CAC and LTV, you won’t be able to accurately measure if your business model is profitable, how much you must put aside for marketing, and potentially sabotage your chances of funding.
Startups who ignore these two key metrics often struggle and die of a slow, painful death.
1. What is CAC and LTV and why you should care
- Customer acquisition cost – is simply the price you pay to acquire a new customer.
- Customer lifetime value – the amount a customer spends during their relationship with your business.
Your startup’s CAC and LTV is not only of use to you, but also critical for future investment.
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Investors who pump capital into startups factor a big part of their decision based on how much money a startup can extract from its customers, and the price they pay to acquire them.
For example, if gold was believed to found in a certain mountain in an extremely remote location, but the cost to extract the gold was more than the cost of the gold itself, this is clearly not a profitable investment and investors would shy away.
Venture capitalists view startups in the exact same way, they must be shown data that your startup is profitable before they invest.
CAC and LTV metrics are also detrimental to your marketing team as they will know the parameters they have to work with and what is realistically possible. Once they have accurate data to work with, they are able to run targeted campaigns and start to plan ways to further reduce CAC and uplift LTV, increasing your startup’s growth and the likelihood of investment.
2. How to calculate CAC (and why it matters)
Calculating CAC is very easy, you simply add up all the money spent on acquiring customers (the cost of marketing), then divide that number by the total amount of customers acquired.
For example, if you spent $10,000 on marketing in a year and acquired 150 new customers, your CAC is $66.60.
Do keep in mind that not all marketing strategies offer an instant ROI. For example, running a Facebook dynamic product Ad will bring immediate traffic to your website, whereas investing in SEO can take months or even years before you convert a single customer.
This can sometimes misrepresent your true CAC during calculation.
To avoid misleading metrics, you should further segment your CAC calculation by assigning a CAC metric to each marketing channel. For example, Facebook, Twitter, Bing Ads and YouTube could all be measured independently for their CAC. This way your marketing team will know which areas to allocate funding and which mediums to drop all together.
If you’re working with a small marketing budget, it makes sense to double down on your best performing CAC marketing medium to acquire the most about of capital from marketing spend. Later you can think about reinvesting the money into other channels that provide a positive CAC to further stimulate growth.
How to lower your CAC
Once you calculate your CAC, the first question you’ll ask your marketing team is:
How can we lower our customer acquisition cost?
The good news is that marketing campaigns can always be improved, landing pages can be further optimized, better offers created and much more.
Test everything – A good portion of your customer acquisition strategy is going to direct prospects to landing pages. You can A/B test landing pages to increase conversions, test ad copy to increase click-through rates, vary your email marketing content, further optimize your website for mobile users and improve overall website performance.
There’s several steps a prospect takes from starting their search to eventually becoming a customer, every step along the way can be tested and improved to increase CTR. Increased clicks lead to a better conversion rate lowering your CAC.
ComScore increased their lead generation by 69% after testing a number of variations of their landing page. An increase of 69% would have seen their CAC drop dramatically.
Increase value – Value can be increased in a number of different ways. It ranges from offering 24/7 support 7 days a week, new functions to your product/service that customers were demanding, or changing your marketing message to better resonate with customer’s problems.
Increasing value isn’t only about offering the lowest price, but adding extras on top or positioning your product to enhance it’s value via branding.
Apple are the greatest example of this, they never run sales or offers on any of their flagship products but are the world’s biggest brand.
Why? Because they’ve done an extremely successful job of branding their business as the leader in consumer electronics, adding tons of perceived value to their brand and products.
Customer relationship management – Better nurturing prospects via informative blog posts, refining email marketing strategies and other lead generation initiatives such as social media posting or offering lead magnets can dramatically reduce CAC.
Neil Patel revealed that for every blog post he wrote generated his business $20,000 in sales. Don’t underestimate the power of giving your prospects content for free. Once they view you as an authority in your niche, they are more likely to spend their money with you.
3. How to measure LTV (and why it matters)
The simplest way to measure your LTV is to find the following figures:
- Your average order value
- Repeat purchase rate
For example, if your average order is $55, 25% of all customer buy again and it costs $10 to acquire a new customer, your LTV is $56.67:
You can find your own customer LTV by visiting customerlifetimevalue.co.
You’ve most likely heard the saying:
80% of your sales come from 20% of your customers.
And it’s true.
For every 100 customers you convert, 80 of them will most likely never use you again. And if you’re not doing everything in your power to maximize the LTV of your loyal customers, you’re going to have trouble staying afloat.
Econsultancy revealed that it’s much easier to retain a customer than to acquire a new one:
Another valuable infographic created by Nelsen shows us what encourages customers to switch to a new brand:
If only 20% of customers make the bulk of your revenue, how do you keep them for the longest period of time and ensure they keep spending money with you?
How to increase your LTV
Increasing your LTV is a much greater task than lowering your CAC.
As you noticed from the infographic above, customers jump from brand to brand based on price.
Devaluing your product may lead to customers staying with your longer, but that doesn’t necessary increase your revenue or help you position your startup the way you want.
Here’s a few proven ways you can increase your LTV:
Make customers feel special – Offering a better price is not always an option. If you’re selling a premium SaaS tool or are a luxury brand (Think Apple or Gucci), lowering your price can be counter-productive. Instead, what you should do is make your loyal customers feel special and valued.
This can be achieved by personalizing their content or offering them something for free on special occasions like birthdays.
Starbucks gives every customer a free coffee for their birthday, what better way to make a customer feel special than to offer them a gift and be part of their special day? Running fan of the week contests or creating exclusive promotions for customers only are other options to make them feel more valued.
Always be selling – Whether your startup is an online store, offers a SaaS service or mobile app, always be selling. The easiest way to increase your LTV is to offer customers more things to buy.
This is done by cross- and up-selling.
Amazon are the perfect example of this, when searching for any product they always combine other products that go along with the item you’re looking at:
If can you offer more services or products at the buying level, do it. If your startup only has a single product with no cross- or up-sell options, see where you can increase value by offering further products/services to maximize the LTV of every customer.
Reactivate old customers – Instead of continually focusing on customer acquisition, you will always have a database of customer who haven’t used bought from you in long time. Maybe they forgot about you, your emails for some reason started landing in their junk folder or life just got in the way.
Whatever the reason was, reaching out and incentivizing them with an offer can bring them back from the dead and increase your LTV. That’s what Winner Poker did to get old customers playing again at their casino, offering them free cash credit if they made a deposit.
Past customers need less convincing to start using you again, and a single email or phone call can reactivate a huge amount of forgotten customers.
4. CAC and LTV ensure startups make the right decisions
Every startup benefits from understanding and increasing their LTV and lowering their CAC. Startups don’t become successful by acquiring thousands of customers each month who make a single order, they do so by acquiring thousands of customers who keep on using their product or service.
Only the latter is a sustainable business model.
Focus on the bigger picture and the long-term approach to generating revenue, once a customer has been acquired most of the hard work is done. You no longer need to convince them of your product or why your mobile app or SaaS is right for them.
Fewer resources need to be allocated to get them to keep on spending. Simply keep up the value-based interactions, create loyalty programs and email often enough to ensure your brand is always on their mind.
5. Actionable steps to take once you have your metrics
Once you’ve calculated or received estimates of your CAC and LTV, you’re going to want to lower your CAC and increase your LTV, and here’s how you should approach it:
CAC – Everything involved with customer acquisition is at the top of your funnel. Blog posts, adverts, landing pages, lead magnets, email inquires, branding and so forth.
Start by focusing on the biggest action points for prospects:
- Ad platforms (all will vary in CAC)
- Ad copies (the first interaction a prospect has with your startup)
- Landing pages (Where they make a big action like subscribing or buying)
Most startups acquire new customers through advertising, this will also be where the lion’s share of your CAC.
Looking into your ad copy, the message you’re using (fear, motivation, urgency, problem/solution) and see which copy is gaining the most traction.
Is Facebook offering you a much lower CAC than AdWords or Twitter? If yes, then allocate 90% of your marketing budget to Facebook and the other 10% to test other mediums to find better ad channels to reduce overall CAC.
Once you build a customer list that keeps on spending, allocate more to marketing and test other channels for their profitability.
Spy on your competitors and see which messages and mediums they are using and how successful they are. This takes a lot of trial and error out of your marketing process if you have the ability to audit businesses with a sharp eye.
Segment your customer database based on spend, and focus on targeting new prospects who match the profile of your top spenders. Allocating more resources to a particular target market may reduce your start-up’s reach in the short-term, but will increase its ROI resulting in faster growth.
Landing pages are another huge point in a prospect’s buying journey.
Is your value proposition clear enough, does it resonate with the prospect? Create bespoke landing pages for each customer type to better address their needs.
Increasing the amount of leads generated or conversions by even a few percent from a landing page can decrease your CAC substantially. There’s dozens of variables you can investigate to reduce your CAC, start by focusing on the biggest points that will have the greatest impact on your business (points where prospects are expected to make an action).
LTV – The simplest ways to increase your LTV is to ask your customers what they want.
Send a survey asking for suggestions on ways you can improve their experience as a customer, a poll listing new features you’re thinking about adding, or straight up ask what they would like next is a superb way to understand their needs.
You can guess what they want, or you can ask.
It’s usually wise to add multiple choice questions as they are less daunting and easier for customers to fill out. Some won’t have the time to answer several questions, but filling in 4-5 multiple choice questions with an optional box with extra suggestions is a lot more inviting.
Offer some sort of prize-draw for customer store fill out a survey, as you’ll receive more data than if you didn’t.
How does your current loyalty program work? Are customers encouraged to use it, are the requirements easy to obtain and easy to understand? Do you even have a loyalty program?
Look at each of your products in detail and see where you can offer up-sells or cross-sells. Can you create products or services that compliment your current line of products?
Increasing LTV is all about adding value and pitching offers, you must get this frequency right to not annoy customers. Every startup is unique with it’s own products and customers, only after testing and gaining information will you know your frequency.
Know your CAC and LTV or prepare to fail
You don’t want to invest time and money into a startup that isn’t feasible. Startups fail today because they have an imbalanced CAC to LTV ratio:
Calculating CAC and LTV from the start gives you insights and the ability to restructure your startup model before you lose everything.
If your ratios look like the picture above because you offer a standalone product, you may want to think about increasing your product range or price. Or it may also look like that because you’re using the wrong ad platforms or don’t fully understand your target market.
The good thing is there’s a number of levers you can pull which I’ve talked about today that can flip the ratios around:
If you’re an investor, which of the two models above pump money into?
As CEO you’ll be able to retain more ownership of your business with a favorable CAC to LTV ratio, you’ll have more working capital to allocate into your business rather than solely relying on investors.
If you’ve yet to launch your startup, you can still get CAC and LTV estimates based on secondary data, or gain first hand metrics by running micro strategies to test the waters.
For example, allocate a small amount of ad spend and use the results as a baseline for CAC and LTV. Consider driving 10,000 targeted prospects to your website and measure the conversion rates, CAC of each ad platform and forecast a LTV. Take these results with a pinch of salt as once data has been collected, you can start to optimize every part of your sales funnel which will lower CAC and increase LTV.
But this will give you a rough idea on what you have to work with and what is possible.
Calculating CAC and LTV makes everything else easy. Once you know how much it costs to acquire a customer and how much they will spend, knowing which ad mediums to scale, tactics to implement and how much everything will cost takes a lot of guesswork out of decision making.
When you make decisions based on data and not guesswork, your actions lead to much better results.
Not sure how much your startup pays for every customer or how much they spend lifetime? Get in touch with us today and we’ll help you on your way.
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