You’ve got to spend money to make money — or so says every professed marketing guru out there.
This advice isn’t inherently wrong, but more marketing spend doesn't always mean better results. Profitable strategies are about more than the number of eyeballs you reach — or even what revenue you generate from an individual campaign.
Better marketing means figuring out what processes and techniques drive sustainable growth for your ecommerce business.
After all, your day-to-day key performance indicators (KPIs) might show that you’re bringing in business left, right, and center. But if you’re overspending on acquiring each individual customer, these sales aren’t worth much to your bottom line.
Or a promotion’s total value may grow outside of its campaign context. If you aren’t tracking trickle-down effects like repeat purchases, you miss opportunities to scale up what’s working well.
Here’s the good news: The keys to ongoing growth already lie in your store’s data. It comes down to three key data metrics:
- Your customers’ lifetime value (LTV)
- Your customer acquisition cost (CAC)
- The relationship between these two metrics, calculating your LTV-to-CAC ratio
What is LTV to CAC Ratio?
LTV, or Lifetime Value, is a metric that measures a customer's spending, buying frequency, and purchasing behavior to identify the total value they bring to your business over the entirety of their lifespan with your company. This is a key metric for understanding how much value your new and existing customers are bringing in, provides opportunities to optimize the shopping experience and get more value out of your customer base.
CAC, or Customer Acquisition Cost, is a metric that measures the average amount of marketing spend that it takes to acquire a single customer. This is critical information as you want your CAC running as lean as possible in relation to the lifetime value of a customer.
This is where LTV/CAC ratio comes in. This metric directly compares your Customer Lifetime Value and your acquisition cost for those same customers. As a general rule of thumb, you want your CAC to be as low as possible in relation to your LTV. The less you are spending on acquiring valuable customers, the more money is going in your business's pocket.
This also informs you on which groups of customers are most valuable and warrant a higher CAC budget to acquire them. It's all about refining your acquisition process to reduce marketing expenses and increasing your customer LTV accordingly. Okay, there's your high-level view of LTV/CAC ratio. Let's jump into some examples and carve out the finer details.
Why Calculate LTV-to-CAC Ratio?
Not all customers are created equal. Understanding each buyer’s profit potential is the first step to managing them — and determining what efforts are worth taking to engage them.
Here's how to calculate LTV:
Let's dive into an example to better understand customer LTV.
If Joe makes a one-time purchase for $100, but Sara buys one $25 item each month of the year, she’s your higher-LTV customer.
You want to attract — and retain — more Saras. Research shows that prioritizing your high-LTV customers is far cheaper than grabbing for new ones. Reducing customer churn rate by just 5% can increase profits by up to 25 percent.
On their own, LTVs can guide retention-based marketing decisions like:
- Focusing on the channels that bring in high-LTV customers
- Segmenting your customers to make customer retention strategies more effective
- Leveraging high-LTV customers’ buying patterns to trigger product recommendations and promotional discounts
But the LTV metric becomes even more powerful compared against your customer acquisition costs (CAC). This relationship shows you not only how profitable your customers are, but also at what cost to you. At its core, the LTV:CAC ratio is a measure of sales and marketing efficiency.
Your LTV:CAC Ratio — a Cost-Benefit Analysis
Your current strategy may be reaching customers with greater LTV potential. However, your LTV:CAC ratio will reveal if it’s actually cost-effective.
Let’s say your e-commerce business spends a total of $10,000 on a Google Ads campaign. Your analytics show that:
- You acquire 100 new customers.
- The average monthly revenue your store nets per customer is $25.
- On average, your store’s customer life span — the number of months a person keeps buying from you — is 24 months.
In this scenario, your store can measure its campaign’s:
- LTV: [average monthly revenue per customer in dollars] x [customer life span in months] = $600
- CAC: [total campaign expenses] / [number of new customers acquired from the campaign] = $100
This makes your LTV:CAC ratio 6:1. Throw your team a party — experts generally consider a 3:1 within 12 months ratio a sign of a healthy, growing company. Numbers are multipliers so, for example, 6 means that LTV is 6 times the CAC value. 1.00 would mean the cost = the return.
Ratios lower than this benchmark spell trouble — the marketing costs you're incurring aren’t sustainable. But this knowledge is crucial to making the right strategy changes, especially if surface-level KPIs like click-through rates illustrate a promising but potentially incomplete picture.
A higher ratio affirms that your customer acquisition methods are working — and they’re bringing in longer-term, higher-value buyers. You're making more money than the cost to bring them in. That is the end game.
This isn’t just good news for your bottom line. Businesses with greater LTV-to-CAC ratios tend to have higher valuations poised for faster, more predictable growth — making them attractive to investors and venture capitalists.
Optimizing Your Profitability Ratio
The example above is a basic measure of a software as a service (saas company) or e-commerce company’s profit generation.
Regardless of your business activity, a CAC calculation will always be your total expenses divided by the number of new customers acquired.
But there are many different ways to measure an LTV metric, with formulas adaptable to the type of business you run and what your goals include, like:
- Measuring the value of a specific campaign
- Performing a month-to-month cohort analysis to spot trends like purchasing drop-offs
- Taking a predictive approach modeled on past customers’ purchases and behavior
For example, an e-commerce company could enhance this basic LTV formula by measuring for customers’ repeat activity, with a calculation like: [average revenue per customer] x [average number of repeat sales per customer] x [average customer life span in months].
In general, the more data you include, the more personalized, precise, and usable a metric you get. For example, you could add in elements like:
- Accounting for gross profit margin: [average order value] x [number of repeat transactions] x [customer life span in months] x [gross margin percentage]
- Analyzing different time periods or cohorts: [Average monthly or annual recurring revenue per account] x [1/monthly or annual churn] x [gross margin percentage]
- Predicting behavior: [Average transactions per month] x [average order value] x [average gross margin] x [average customer life span in months] / [number of customers expected for your measurement period]
- Factoring in discounts: [Gross margin percentage x average revenue per customer] x [monthly retention rate / (1 + monthly discount rate - monthly retention rate)]
Once you have the LTV, all you have to do is divide it by your CAC to find the ratio. From there, you have the fuel to drive your marketing efforts and major revenue growth.
Make Business Growth Simpler
Monitoring your business’s LTV-to-CAC ratio gives you more control over your sales performance. From resource allocation to marketing strategies, it’s one of the most important metrics to measure how well your efforts attract — and retain — high-value customers.
But as with most data, your business gets the most value if you track this metric over time. Customer behaviors and trends change constantly. Your ratio may indicate sustainable growth one month, only to have the same calculations signal a need for adjustments in the next.
This number-crunching cycle can get complicated fast.
Automate it all with Peel’s analytics platform. Just connect your e-commerce store and voila — more than 35 of your business’s data metrics get monitored, analyzed, and reported back to you.
That means you spend less time translating metrics and more time making data-driven decisions to lean into your drive up your total . Start a 17-day free trial to spot what opportunities you might be missing to power sustainable growth.