CAC, LTV, CHURN and the health of your business

Conquering new customers is the desire of any company, as it is directly related to the increase in revenue. However, keeping these customers is not always the company’s focus.

A company’s true success lies in its ability to build a relationship with the customer that lasts for as long as possible. To ensure customer retention in a more assertive way, it is necessary to have a process for analyzing customer purchase data and a methodology to analyze and understand this data.

According to a study carried out by McKinsey, companies that use customer analysis methodologies achieve a 115% higher ROI and 93% higher profits.

If you want to have a healthy company that is capable of acquiring and retaining high value customers, then it is essential that you keep track of the CAC, LTV and Churn indicators and learn how to calculate them.

To calculate said indicators, we will use records of transactions carried out (represented in the table below). The calculations will be structured in Power BI — with it, you can streamline the process of creating and updating reports to focus on what really matters: data analysis.

Definition of CAC

Customer Acquisition Cost (CAC) is the amount of money invested to acquire a new customer. CAC includes the sum of marketing costs (such as paid ads and staff maintenance) and sales costs (such as commissions).

The total costs must be divided by the number of new customers acquired during a certain period so to obtain the indicator.

Let’s use a fictitious example to make this process clearer. A business that invests R$ 5.000,00 in media, which pays R$ 5.000,00 in sales commissions and acquired a total of 500 new customers in the analyzed period, obtained an average CAC of R$ 20,00.

However, this value by itself does not present all the information necessary to assess whether this investment is worth it. For example, the CAC of a given customer segment or a given client acquisition channel may be greater than the average value of the customer’s first purchase, but this can be offset by the recurrence of purchases.

Therefore, it is necessary to know how much these customers will buy during their relationship with your company and thus identify which acquisition channels are bringing better results. That takes us to the next indicator.

Definition of LTV

Lifetime Value (LTV) indicates the average value that each customer brings to your business during the entire span of their relationship with your company.

Acquiring new customers is a process that demands a great deal of effort and investment. So, if your business is not able to retain customers, any effort to grow will be more expensive and complex. Research data by Bain & Company shows that retaining a customer is on average 5 to 25 times cheaper than acquiring a new customer.

In addition to being cheaper, retaining a customer is also more profitable, even with low retention rates. This article published by Harvard Business School shows that with 5% retention it is possible to increase your profitability from 25% to 95%.

With LTV tracking, you can understand which campaigns and customer acquisition channels attract the most loyal customers and increase your overall revenue. That’s why this indicator is essential for the health of your business.

To calculate this indicator, it is necessary to multiply the average revenue per customer in the period by the contribution margin.

Following our previous example: in this business, each new customer spends an average of R$ 50,00 per transaction and buys again twice during the entire relationship. In that case, the average LTV is R$ 100,00.

Definition of CHURN

Another metric that shows customer retention capacity is CHURN. This indicator calculates customer turnover in the given period and allows your business to see the number of customers who abandoned your services. In other words, the lower your churn, the better. It’s an essential metric, primarily for businesses with recurrence or subscription models.

If your business model is different, you should establish a period to consider as churn. For example, a transportation app — such as Uber — may establish that if a particular customer doesn’t use their services for 30 days, it will be considered a churn (this customer is probably using the competitor’s services).

The calculation is defined by:

Let’s resume the example of our fictional business. We’ll consider that, in the first month, this company acquired 50 customers. As this is a monthly recurring product, we need to assess how many customers renewed the service in the second month. In this example, 45 customers renewed the service.

In addition to acquiring more customers in the second month, the company was also able to maintain high retention. Regardless of the number of customers acquired, we are performing the analysis by cohorts, that is, customers who renewed must be compared to their original crop. Thus, we have that the churn of customers acquired in the first month was 10%.

This analysis becomes clearer when we look at the resulting matrix.

From this result, we calculated the retention percentage by dividing the number of customers retained by the number of customers who entered the month of the analyzed cohort.

Finally, we have the following result:

The last step is to calculate the remainder of the retention percentage to obtain the churn percentage:

The end result is the percentage of lost customers over the months per cohort.

We can analyze the result in two ways: vertically and horizontally. Vertically, we can see the progress of the indicator in the same month as the customer’s life cycle. Horizontally, we see this indicator’s progress for the same cohort.

Newer cohorts tend to have better retention because the company will understand why some cohorts perform better and will invest more in them. According to data from Recurly Research, the average churn rate per segment is as follows:

• SaaS: 4,79%
• Media and entertainment: 5,23%
• Education: 9,61%
• Box of the Month: 10,54%
• OTT (Over-the-top) / SVOD (Subscription Video on Demand): 10,01%
• Consumer Goods: 9,62%
• Consumer Services: 7,49%
• Business Services: 6,25%
• Healthcare: 7,55%
• Internet of Things: 5,88%

In addition to analyzing customer churn, it is possible to analyze revenue churn. Ideally, a business’ revenue churn should be zero. Thus, the loss of customers is compensated by the increase in revenue from retained customers through strategies such as price adjustments and new products.

The LTV and CAC relationship

By analyzing the combined CAC and LTV indicators, it is possible to identify not only the channels that have the lowest acquisition costs, but also those that bring in the most revenue. When using different sales channels, we may come across platforms that have low acquisition costs but do not retain customers and where the amount spent by the acquired customer is also lower than in channels with higher acquisition costs. Therefore, your focus must be on the net result and not just on costs.

To identify which channel has the best relationship, it is necessary to calculate the return on investment (ROI).

For the business example that we have been following, the calculated ROI was 5. Thus, for every real (R$) invested to acquire a customer, the company earns five reais. How to identify if this is a healthy value for the business?

LTV and CAC:

>5:1 — Supergrowth

>3:1, <5:1 — Sustainable Growth

< 3:1, >1:1 — Growth

<1:1 — No Growth, unsustainable

With a ROI value above 1, the company makes a profit. A ROI of 3 is already considered an excellent ROI. If the ROI is above 5, it is possible to assess whether the company has room to invest more in customer acquisition. This may decrease the ROI, but it will be offset by the upscale on sales and increase in net income.

Integrating and analyzing data from multiple sources to drive your company’s growth can be a challenge. If you want to structure your analyses and discover opportunities to improve your retention and become more profitable, get in touch.