Financial planning is a dreaded part of being an eCommerce leader, but if done right, it could be the difference between succeeding and understanding your customers… or not. That’s why it’s essential to understand your customers' value and how much it costs you to acquire them.
Two key metrics can help you do both: Customer Lifetime Value (CLV) and Customer Acquisition Cost (CAC). And we’re going to tell you all about them today.
Customer Lifetime Value and How it’s Calculated
Customer Lifetime Value (CLV) is the total value a customer brings to your business over their lifetime. It considers both the revenue they generate and the cost of retaining them.
Here is your formula for calculating CLV:
Let’s say, for example, that your average sale price (or average order value) is £50, and a customer purchases five times a year. If your average retention time is three years, your CLV would be £750. What does that mean? Over three years, each customer is worth £750 to your business.
Calculating this formula is handy to relate your customers to something you can visualise. It allows you to see how valuable your customers are to your business and determine whether this is something you need to focus on.
However, the metric alone won’t get you far when determining the health of your eCommerce store. CLV together with Customer Acquisition Cost will tell you whether you’re wasting money.
Customer Acquisition Cost & How to Calculate it
Customer Acquisition Cost (CAC) is exactly what it says — what it costs you to acquire a new customer. It considers all the expenses that come with acquiring new customers, including advertising costs, marketing salaries, etc.
Here is your formula for calculating CAC:
We’ll give you another example. If your sales and marketing costs for a specific period are £10,000 and you acquired 100 new customers during that period, your CAC would be £100. This means it costs you £100 to acquire a new customer.
This formula will help you understand all that goes into acquiring customers, but not really in keeping them around. If you had £10,000 and a workforce to put towards CAC, but not actively focusing on the growth of your CLV, your cost of acquisition could be equal to or even more than your CLV — leading to customers costing you more money than they bring in.
How CLV and CAC Work Together
Understanding CLV and CAC will help you make informed decisions when narrowing your eCommerce strategy. If your CAC is higher than your CLV, your customers are costing you more to acquire than they are worth.
If this happens, you’ll likely need to re-evaluate your acquisition strategy and find ways to lower your costs. Taking another look at your sales and marketing strategy, exploring new acquisition channels, or reducing the cost of your sales and marketing efforts are all ways you can do this.
On the other hand, if your CLV is higher than your CAC, you are making a profit from each customer, in which case, you should focus on acquiring more customers to increase your revenue. Increasing your marketing efforts or improving your product or service offerings are effective ways of bringing in more business.
Typically, an excellent CLV:CAC ratio is 3.1, but if yours is below this, it’s not the end of the world. The key is to find where the problem lies and take action to address it.
What You Should Focus on with CLV and CAC
One of the most important things to remember when calculating and deciphering your CLV and CAC is that they should be used in conjunction with each other. While CAC helps you understand the cost of acquiring new customers, CLV will help you understand how valuable your customers are and whether there is a problem underlying your Conversion Rate.
Combining the two will help you make data-driven decisions regarding your strategy and optimise your investment. You’ll also be able to identify patterns and trends in your customer base.
If you notice that your CLV is higher for specific customer segments or product lines, you can focus your customer acquisition efforts on those segments or promote those product lines. Additionally, you’ll also be able to narrow down your pricing strategy by determining what’s missing and implementing changes that will increase your ratio.
Blend & CLV/CAC
As always, we want you to have all the important information at your fingertips when building your eCommerce legacy. That’s why another essential aspect to consider is the Return on Investment (ROI) of your acquisition and retention efforts.
You will be able to determine the ROI of your investment by comparing your CLV to your CAC. If your ROI is high, you’ll be happy to know your business is growing. But if it’s low, your efforts may not be as effective as you’d like, and it may be time to re-evaluate your strategy.
If you want to find the best way to even out your ratio, get in touch with the team at Blend today.