What Are CAC and LTV?

Customer Acquisition Cost (CAC)

CAC represents the amount you spend on advertising to acquire a new customer. The formula for CAC is:

Total Customer Acquisition Cost / Number of New Customers Acquired.

For instance, if a company spends £10,000 on marketing and gains 200 customers, the CAC is £50 per customer.

Customer Lifetime Value (LTV)

LTV measures the total revenue a business can expect from a customer over the duration of their lifetime. It is calculated the following way:

Average Purchase Value × Purchase Frequency × Customer Lifespan

If a customer spends £100 per transaction, purchases twice a year, and their lifespan as a customer is 5 years, their LTV is £1,000.

Why Are CAC and LTV Linked?

The LTV-CAC Ratio: A Core Metric

So how do we get to a point where we begin to understand how much we should be paying for a new customer? This begins with your LTV-to-CAC ratio, which tells you how much revenue you earn for every pound spent acquiring new customers. The ideal ratio varies by industry but is generally considered healthy when it’s a 3:1 ratio, this means you will be earning three pounds for every pound you spend.

If your LTV is high due to either a high purchase repeat rate or AOV then you can afford to achieve a higher CAC. This will mean you can:

• Acquire a Larger Volume of New Customers: Test spending more on ASC+ or Pmax/Generic search to see if you gain incremental customers until you reach your CaC target.

• Invest in Higher-Quality Leads: Target customers with a higher propensity to make repeat purchases who may cost more to acquire due to more competition and in platform costs.

On the other hand, a low LTV will limit how much you are able to spend on acquiring new customers, which can stunt growth.

Setting Your CAC Target

Determining your ideal CAC requires more than just a look at your LTV. It involves aligning your CAC with your gross margin and profitability goals. Here’s how I recommend business to go about this calculation:

1. Start with Your Gross Margin: Calculate how much profit you make after accounting for the costs of goods sold (COGS). For example, if your gross margin is 70%, you’re left with £70 on every £100 of revenue to cover your CAC and other expenses.
   
   

2. Determine your profitability goals: I mentioned earlier the rule of thumb is to aim for an LTV-to-CAC ratio of 3:1 for long-term sustainability. The beauty of this model is we can look at short-term profitability too. For example, if you decide that you want to achieve £x profit or x% profitability on every new customer you acquire after 3 months then you can look at your average 3 month LTV data and implement this instead. Of course you will need to aim for a lower CaC but you will have adapted to your businesses profit targets. The table below visualises this data LTV breakdown data for you.

   
   

   

   
   
   

3. Factor in Profitability Goals: Subtract fixed net costs from your gross margin to ensure your CAC target still allows for net profitability.
   
   So as an example, if your LTV is £1,000 and your gross margin is 70%, your sustainable CAC might be around £233 to achieve the 3:1 ratio.

   Another example is a smaller brand who cannot afford to wait 12 months+ to achieve this level of profit so they need to look at their 3 month LTV profit per customer. So let's say 3 month LTV is £250 and gross margin remains at 70%, the 3:1 ratio CAC here would be £58.

Why CAC and LTV Outperform ROAS as Metrics

While Return on Ad Spend (ROAS) is often a go-to performance metric in paid media channels, it offers an incomplete, narrow and short-term view. ROAS measures how much revenue is generated for every pound you spend. While useful, it doesn’t account for the total new customers your channels could be driving, the long-term value of acquired customers and this KPI is usually skewed by returning customers through ASC and brand search/pmax.

Why CAC and LTV Are Better Indicators

• Holistic Perspective: CAC and LTV consider both acquisition costs and the extended revenue potential of customers.

• Profitability Focus: These metrics align with your profitability goals, unlike ROAS, which can tempt businesses into prioritising low-cost, low-value customers.

• Growth Enablement: By tracking LTV and CAC, you can make informed decisions about scaling your business sustainably.

How to Increase LTV and Justify Higher CAC

If your goal is to scale, increasing your LTV allows you to spend more on acquiring new customers. Here’s how you can boost LTV:

1. Enhance Customer Retention: Develop loyalty programs, provide stellar customer support, and engage with customers through personalised email campaigns.

2. Up-sell and Cross-Sell: Offer complementary products or services to increase purchase frequency and AOV.

3. Focus on Customer Experience: Improve the overall buying journey to encourage repeat business and long-term loyalty.

By increasing LTV, you create a buffer to increase CAC while maintaining a healthy LTV-to-CAC ratio. For example, raising LTV from £1,000 to £1,500 means you can now spend up to £500 on CAC while preserving the 3:1 ratio.

Conclusion

Balancing CAC and LTV is essential for achieving sustainable growth and profitability. By understanding the dynamics between these two metrics, you can:

• Scale effectively by targeting high-value customers.

• Optimise your advertising spend to focus on long-term success rather than short-term wins.

• Build a profitable business model that aligns with your financial goals.

Shift your focus from in platform-specific metrics like ROAS and start leveraging the power of CAC and LTV. Doing so will provide a clearer, more actionable roadmap to scale your business successfully.

Interested in implementing this model for your business but still unsure where to begin? Get in touch with us at contact@icatcha.agency or fill in this form here.