Customer Lifetime Value (LTV) is the average revenue generated from a customer over the life of their account. In simple terms, it is the total money you would make off a customer before churning.
LTV is an important metric as it gives you a sense of how much you should spend to acquire new customers. If this number is significantly higher than your CAC (the cost to acquire a customer) it means that you’re making a profit. Else it means you are burning money in the long run.
LTV = Average monthly recurring revenue per user X customer lifetime (in months)
LTV can also be calculated from Churn Rate.
LTV = ARPU/Churn Rate
The CAC LTV ratio is calculated to help you determine how much you should be spending on acquiring customers. Ideally, LTV/CAC should be greater than 3, which means you should make 3x of what you would spend in acquiring them.
If your LTV/CAC is lesser than 3, it's your business sending out a smoke signal! It's an indicator to try and reduce your marketing spend.
How to optimize for CAC/LTV?
Before optimizing your spend, make sure you've calculated the CAC accurately. If everything is in place, here are a few pointers to help you out.
Focus on the right channels. The channels that bring in a number of customers aren't necessarily the ones that work. If those customers churn out quickly, there's no point in crying over spent costs. So invest in channels like Inbound marketing that give you a good quality of customers but still involve less spending.
Experiment with pricing If you have a freemium model, try experimenting with your pricing to figure out the factors which could lead to converting more paying customers. It could be an increased pricing tier, a feature-based pricing model, seat-based pricing, etc. The more easily you are able to convert freemium users to a paid plan, the lower your CAC would be. But don't compromise on customer happiness.
Reduce sales complexity A tough sales process or a longer sales cycle will lead to a higher CAC. Keeping your prospects engaged with an effective handholding process and proper onboarding is key. Ensure you invest in setting up a tight funnel and make each step easily navigable.