Beginner’s Guide to Digital Marketing for Southeast Asia — Key Marketing Metrics (part II)
Part II: Key Marketing Metrics : Customer Acquisition Cost (CAC) and Lifetime Value (LTV)
In Part II we are introducing the two most important metrics of modern data-driven marketing: CAC and LTV.
You will learn the meaning of these two key metrics, why they are so important, how to calculate them using a real company example and the mistakes you should avoid doing when calculating it.
1 — Customer Acquisition Cost (CAC)
CAC is probably THE KING of all marketing metrics.
Given its importance for the growth and overall profitability of a company, it is surprising to see how many startups and marketers often fail to fully understand how to properly calculate it.
Our goal is to provide you with the right foundations to avoid making costly mistakes in your future career as a data-driven marketer.
1.1 — Intro to CAC
In its essence, the CAC measures the full cost of acquiring or earning a new customer. A new customer is defined as a user that purchases for the first time the goods or service produced by a company. A few examples of what a ‘new customer’ is for two familiar businesses:
- for Bukalapak, someone who buys his first product on the App / Website
- for GoJek, someone who books his first trip on the the App
CAC basic formula
CAC = (Total Cost of Marketing and Sales) / (Number of new customers acquired)
Why is CAC so important?
Assuming that any business needs to reach a point where its revenues > costs (as no business can survive for ever by only relying on external investors’ financing), its CAC is often the most impactful metric to determine whether such equation holds true.
More specifically, in order for a company to be profitable, its cost of acquiring a new customer needs to be lower than its customers’ lifetime value (LTV). The LTV is another key metric which indicates the revenue that a business can expect to generate from a single customer, over the course of the entire business-customer relationship.
We will look at the LTV metric in the next chapter.
1.2 — How to correctly calculate your CAC
CAC can be calculated in many different ways and often times this cause confusions which can then lead to mis-allocation of marketing budgets and costly business mistakes.
Below some common pitfalls to avoid, with some definition to make sure you are consistent when referring to your business CAC.
1.2.1 — Consider all of your marketing spend
The first mistake to avoid is to measure your CAC by only looking at the attributable marketing costs of acquiring a user. What does this mean?
Let’s use a simple example:
- You invest $1,000 on Facebook Ads and $1,000 on Google Ads.
- You acquire 5 customers through your Facebook Ads and no customers through your Google Ads
>> Your CAC shouldn’t be $1,000 / 5 = $200, but ($1,000 + $1,000) / 5 = $400. Don’t just consider the marketing budget that brought you a customer but all of it.
1.2.2— Consider your Fully Loaded CAC
Which costs should you include in your Marketing and Sales cost?
Unless you are explicitly referring to your Non Loaded CAC, your CAC should include all the costs and resources required to support your marketing and sales efforts. Not only your advertising costs. That is your Fully Loaded CAC.
The biggest cost to add are the salaries of all the employees who are working in both your marketing and sales teams. Not only the individual contributors but also the managers, for the part of the time they spend in marketing / sales (if they aren’t spending 100% of their time on it).
Don’t forget to also add all the cost of the marketing & sales tools used by your teams.
1.2.3 — Paid vs. Blended CAC
A Blended CAC is the CAC which includes both your paid acquisition and your organic acquisition. Organic customer acquisitions are for example the ones happening via organic word of mouth.
The problem by only looking at the blended CAC is that you are not able to isolate the cost of the users acquired through paid marketing and therefore whether your paid marketing efforts are profitable (and can be scaled.)
The Paid CAC is particularly important as a company has typically more control over its paid marketing when it comes to scaling. Organic acquisitions are harder to control and therefore to predict.
1.2.4 — Time lag between the investment in marketing & sales and when the customer is acquired
Especially in SAAS or B2B businesses, there is normally a time delay between when you acquire a lead as a result of your marketing activities to when your lead becomes an actual paying customer.
By not taking these time periods into account, you could be overestimating or underestimating your CAC and as a result making bad investment decisions.
The way to account for it properly is to know your average marketing & sales cycle (the time period from when the user first lands on your website or download your app to when he becomes an actual customer), so you can use the marketing & sales which happened X months before the month your customer truly becomes one.
B2C companies that have very short decision funnels don’t need to bother about this.
For example, for a business like Go-Jek, the user probably makes his first booking right after his first marketing touch point.
1.3 — How to improve (decrease) your CAC
Let’s assume for the sake of simplicity that your business is able to acquire its customers through marketing activities and without any sales support (which is the case for most B2C businesses).
You have 3 main levers you can play with:
- Increase your ratio of (customers acquired) to (marketing employee)
- Increase your proportion of (organic acquisition) to (paid acquisition)
- Decrease your Paid CAC, by decreasing your CPC (cost per click) or increasing your CR (conversion rate)
1.3.1 — Increase your ratio of customers acquired to marketing employee
Another reason why you should prioritise marketing channels which are highly scalable in nature, such as SEO, Google Ads or FB ads, is the efficiency you can achieve on these channels in terms of number of employees needed to manage an increasingly large budget.
Typically you won’t need to increase your # of employees proportionally to the size of the budget allocated to a specific channel. A proficient SEM marketer should be able to manage equally well a budget of $1,000 / month or $10,000 / month. Which means acquiring 10x the number of customers without adding any headcount cost.
The more scalable a channel, the higher your ratio of customers acquired to marketing employee will be.
1.3.2— Increase your proportion of organic acquisition to paid acquisition
The higher your percentage of organic acquisitions vs. paid acquisitions and the lower your overall blended CAC.
As we have seen in the previous chapter, it is hard to control and predict how to scale your organic acquisitions, but it is nonetheless important for your blended CAC to not entirely driven by paid sources of acquisition.
Relying entirely on paid acquisitions can be risky, especially if you rely only on one channel, as you might saturate the channel and therefore stop growing.
1.3.3— Decrease your Paid CAC
Paid CAC = (Cost per Click) : (Conversion Rate)
In its essence your Paid CAC is the result of (1)how much it costs you to bring a new visitor to your website / app and (2)the percentage of visitors who convert into customers.
Let’s use a simple example for an e-commerce company, with some realistic numbers:
- (1) Average CPC = $0.2
- (2) Conversion Rate = 2% (2 out of 100 visitors)
>> Paid CAC = ($0.2) / (2%) = $10
Cost per click
On Ads platform like Google Ads, you typically pay each time a user clicks on any of your Ads.
Decreasing your average CPC is primarily a function of how relevant your ads are for the market you are targeting. To know more about it we suggest you to have a read on how the Google Ads auction works.
How the Google Ads auction works
Google Ads determines which ads should show with a lightning-fast ad auction, which takes place every time someone…
Facebook adopts a similar auction-based logic
About Ad Auctions | Facebook Ads Help Center
We use an ad auction to determine the best ad to show to a person at a given point in time. The winning ad maximizes…
Improving your conversion rate means to make your app or website more efficient in driving visitors toward your business goal (ie. conversion).
The upside in terms of improvement on the conversion rate is typically higher than the one you can have in decreasing your CPC, although most businesses focus on the latter instead of the former.
The art and science of improving the conversion rate of a business is called Conversion Rate Optimization (CRO).
There are lots of guides providing you ideas on what to test to improve your CR. Below one of the best one.
13 Ways to Increase Your Conversion Rate Right Now | CXL
When I review websites, I ask people about their #1 business goal - the main action they want people to take on their…
Guides such as the one above are very useful, especially if you are new to the field. But the more sophisticated you become, the more your experiments should be driven by your own hypothesis, which should be based on your customers feedback instead of someone’s else “best practices”.
2 — Lifetime Value (LTV)
As we wrote previously, in order for a company to be profitable its CAC needs to be lower than its customer’s average lifetime value (LTV).
The LTV of a customer indicates the total net profit a business can expect from a single customer over the predicted customer lifespan.
Let’s look at how to calculate it, the major mistakes to avoid and what are the main drivers to improve this metric.
2.1 — How to calculate your LTV
LTV = (Contribution margin from customer ) x (Average lifespan of customer)
How to calculate it (an ecommerce example):
- Start by calculating the average purchase value per order per customer. To calculate it, divide your company’s total Gross Merchandise Value (GMV) in a time period by the number of orders made over the course of that time period. Let’s take Shopee as an example and their latest financial results (Q2 2019).
>> (1) GMV per order = 3,828 / 246 = $16
After this, you would need to calculate the revenue per order, which is a very different number than the GMV. The revenue per order depends of the so called take rate of the marketplace. That is, the fees and commissions that the marketplace collects on the sales (GMV) of their third-party sellers. This number is around 5% for players like Shopee, Lazada or T-Mall in China.
>> (2) Revenue per order = (1) x (take rate) = $16 x 4.6% = $0.7
Next you need to calculate the contribution margin per order, which is the revenue you get from each order minus any variable costs associated with it. These costs are typically shipping costs, transaction fees & other costs associated with each order fulfilled. We can assume these costs to account for up to 60% of the revenue per order. Based on this assumption, the operative margin will be equal to (1–60%) = 40%
>> (3) Contribution margin per order = (2) x (operative margin) = $0.7 x 40% = $0.3
- Next step is to multiply the (3)contribution margin per order for the order frequency per month per customer so to get our (4)Contribution margin per customer per month
- In the case of Shopee let’s assume that number to be 4x, which means 4 orders per month on average.
>> (4) Contribution margin per customer per month = (3) x (order frequency per month) = $0.3 x 4x = $1.2
- Finally, we need to assume the average lifespan of customer. That is, for how many months will the average customer shop on Shopee before churning (abandoning the platform). Let’s assume an average of 12 months.
>> (5) Average lifespan of customer = 12 months
LTV = $ 1.2 x 12 = $14.4
>> Here we are with our final LTV number: $14.4
(!) Important: Calculate the profit per customer, not the revenue (!)
The whole point of calculating your customers’ LTV is to understand whether you are acquiring your customers in a cost effective way. Which means that you need to calculate the profits generated by your customer, and not the revenue.
In the case of Shopee, you shouldn’t use neither the GMV ($16) nor the revenue ($0.7), but the contribution margin per order per customer ($0.3).
As you can see, the numbers look very very different and so is the margin you can play with, in terms of your CAC.
2.2 — How to improve your LTV
How to increase your LTV
Coherently with the LTV formula, to increase the lifetime value of their customers, a company can either:
- increase the average revenue per order/transaction
- increase the profit margin
- increase the purchase frequency or
- have longer active customers.
Let’s keep using as an example Shopee
2.2.1 — Increase the average revenue per order
There are two ways to increase your average revenue per order:
- increase your average order value (AOV)
- increase the take rate
1) For an ecommerce business, its AOV doesn’t typically fluctuate as much, unless the catalogue of the products they sell change drastically. You should therefore assume your AOV to remain relatively stable.
Let’s look again at Shopee’s financials to further validate our statement:
Let’s now calculate how their AOV evolved in the past 5 quarters
As you can see, the AOV fluctuated just slightly between $16–17 for the past 5 quarters.
2) On the other hand, its take rate almost doubled in the past year alone (from 2.6% to 4.6%).
As a result of this, their average revenue per order increased substiantially from $17 x 2.6% = $0.4 to $16 x 4.6% = $0.7.
In the specific case of Shopee, this has been achieved by the positive development of their different revenue streams such as their transaction-based fees, value-added services and sellers advertising.
The take rate of an e-commerce marketplace doesn’t normally increase past a certain point, so we shouldn’t expect such number to increase at the same speed in the coming months / years.
2.2.2 — Increase the profit margin
If you remember, in the case of Shopee we assumed the operative margin to be at 40%. This number could be further improved by decreasing costs such as for example the logistic costs or transaction costs.
You could decrease your shipping costs by start charging your sellers for example for the shipping cost instead of subsidizing the fees. For the transaction costs, the more transactions a company processes on its platform and the better rate they are typically able to negotiate with the payment providers.
2.2.3 — Increase the purchase frequency with 4) Longer active customers
Both tactics fall under what is commonly referred as retention strategies.
Once acquired, you want to make sure that your customers shop as often as possible on your platform and remain active shoppers for many years.
Increasing your customers’ retention is usually the most important and impactful factor to increase your LTV. Yet the most underestimated by most companies.
Aside from simply offering a better product to your customers, below a few example of strategies which are typically implemented to make your customers shop more often on your platform:
- keep a fresh and updated product catalogue so to always give your customers a reason to come back to your platform and buy the latest product
- promotional periods and seasonal campaigns — ever wondered why most e-commerce companies always have a seemingly endless series of new seasonal campaigns (9/9, 11/11, 12/12, company anniversary, etc)? It’s a way for them to keep their customers engaged and active
- re-activation emails and vouchers — once a customer stop being active, most ecommerce companies will reach out to them via targeted App notifications or Email to convince to get back on the platform. Typically by offering them a special voucher / discount
For a deeper look at the topic of retention and repurchase rate for e-commerce you can take a look at the reading below:
You now went through our all beginner’s guide to digital marketing! Hope you enjoy learning about some of the most important online marketing fundamentals.
…but there is much much more to learn in the ever-evolving field of Digital Marketing. We teach this and much more in RevoU’s 12-weeks Digital Marketing Program.