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Both lifetime value and customer acquisition cost metrics are key metrics to keep improving
A lot of the startups that have quickly reached millions in monthly revenue rely on the arbitrage of being able to acquire customers through paid marketing for less than the lifetime value of that customer.
CAC < LTV
As a reminder, lifetime value, or lifetime contribution as it should perhaps more accurately be named, is given by the formula:
LTV = Expected Life x ARPU x Gross Margin
Where Arpu = average revenue per user in each time period. This equation can hold whether you are in a subscription business or an ecommerce business with repeat purchase behavior. Although you need to be a bit more nuanced with non-subscription businesses, the same cohort analysis techniques still allow you to approximate LTV in this manner. I’ll post more about this later.
Both LTV and CAC are key metrics that the management teams should be focused on improving.
Usually CAC is a blended average of several customer acquisition costs from several different channels. Each of these channels typically can be optimized by better targeting, better copy and creative on the advertising, better landing pages,optimization ofthe flow through to checkout, more and better payment options, and increased viral pass along.
Some of the tools that can be used to improve LTV include retention programs to extend life, cross sell and upsell campaigns to increase ARPU, and improving gross margin.
Both metrics are very important. However, if resource constraints force a choice between focusing on one or the other (it can be hard enough to do one thing at a time at a startup!), I would choose to focus on lifetime value. There are two reasons for this. Firstly, most of the improvements that can be made to LTV will improve LTV for all users, both current and future, and regardless of channel of acquisition. In contrast, many of the improvements that can be made to CAC are channel specific (e.g. copy of a particular ad) and none of them improve the economics of existing customers, only new customers. You get more leverage out of your efforts on LTV.
Secondly, because LTV is typically already higher than CAC, an x% increase in LTV has more impact to the company than an x% reduction in CAC.
I’d love to hear what others think about this choice, and about other ways to improve both CAC and LTV
(For more from Jeremy, visit his blog)
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