A Beginner’s Guide on Customer Acquisition Cost and Customer Lifetime Value
If you’re running a business, one of the first things you’ll consider is how to acquire new customers. Marketing and advertising are key tools for this. But here’s the catch: if you don’t know which marketing channels are creating better customers, you might just be burning some of your money. This is where understanding ECAC and CLTV comes into play. Don’t worry if these sound complicated — we’re going to break them down in the simplest way possible.
Effective Customer Acquisition Cost (ECAC)
One ultimate thing that I learned as Marketing Data Analyst is:
You can’t target everyone.
Trying to target everybody is not just costly but also ineffective. Different people want different things, and your product might not appeal to everybody.
Imagine you just opened a coffee shop. Now you have to think how to promote your product.
Let’s say you have $20 marketing cost to advertise your coffee shop. You split the money into 2 marketing channels:
1. $10 to generate campaign on social media
2. $10 to pay local partner to spread flyer about your shop
A week has passed. Now you want to evaluate the performance of each marketing channels:
- Social media: 5 visitors, 2 purchases
- Local partner: 4 visitors, 1 purchase
Congrats your marketing attracts people to visit! now you are ready to calculate the customer acquisition cost and effective customer acquisition cost.
Customer Acquisition Cost (CAC) is a measure of how much a company spend to acquire new customer. The lower cost the better.
CAC = Marketing Cost / Visitor
At first, let’s set aside whether or not the visitor buy your product. Based on CAC definition we can calculate:
1. Social Media: $10 (marketing cost) / 5 (visitor) = $2 per visitor
2. Local Partner: $10 (marketing cost) / 4 (visitor) = $2.5 per visitor
Next let’s calculate how much money is needed to actually acquire transacting customer.
Effective Customer Acquisition Cost (ECAC) is a measure of how much a company spend to acquire new transacting customer. The lower cost the better.
ECAC = Marketing Cost / transacting customer
Based on ECAC definition we can calculate:
1. Social Media: $10 (marketing cost) / 2 (customer) = $5 per customer
2. Local Partner: $10 (marketing cost) / 1 (customer) = $10 per customer
Nicely done. Now your marketing report looks like this:
CAC and ECAC is a good indicator of evaluating acquisition cost. From the previous example, it costs $2 to attract a customer to your shop through social media and $2.50 through a local partner. While to make an actual buyer, it costs $5 through social media and $10 for local partner.
So far promoting your product on social media seems effectively generate customers. Next, let’s see how marketing channel impact on the revenue. To do this, we need to calculate Customer Lifetime Value.
CUSTOMER LIFETIME VALUE (CLTV)
Measuring users is hard. Lifetimes makes it easy.
GREAT! You already have transacting customers. But how do you know the investment on marketing cost will give a return?
One way to analyze acquisition strategy is to calculate CLTV of a customer. Roughly defined, LTV is the projected revenue that a customer will generate during their lifetime.
Let’s assume you only sell 1 type of coffee with price $5 per cup. Let’s see how each transacting customer generate value in the first week.
Ok. Now you have records of user transaction. From the report you know the CLTV 7 days of user A, B and C are $10, $5, $10 respectively. From this given time, you know your marketing cost is already reaching a break even point (ECAC $5 for social media and $10 for local partner).
What about their CLTV after 30 days?
DANG! even though the ECAC of customer who came from local partner is more expensive than those who came from social media, it turns out they are also more loyal in the long run.
Lesson learned: The short-term revenue turned out to be a poor parameter to define customers value. This is the reason why a lot of companies try to predict their customer value in the future to see the long-term impact.
In general the longer the CLTV you have the better. However, predicting too far ahead might be bad for the prediction accuracy. A business must quickly generate a “good enough” prediction to optimize the acquisition strategy.
If you can figure out who the best customers are early on, you can make more money from those loyal customers. At the same time you also avoid wasting time and money on customers who have low chance to be profitable in the long run.
CLTV / ECAC Ratio
Alright, let’s put these two together in a scale balance. If your ECAC is too high compared to your CLTV, you’re spending too much to acquire a customer. Imagine paying $10 to attract a user worth only $5 throughout their life — that’s not a good investment right?
However, if your CLTV is way higher than your CAC, you’re in for a treat! you are spending less to get a valuable customer who keeps coming for a longer time. It’s like spending $10 to get $30 worth of customer — now that’s a profitable investment!
Common benchmark for CLTV to CAC ratio is 3:1. The higher the ratio the better.
Suppose you are able to predict Customer Lifetime Value (pCLTV) for 360 days:
1. Social media: $15
2. Local partner: $50
From the predicted result we can calculate the ratio pCLTV360d to ECAC for each marketing channel:
1. Social media = $15 (pCLTV360d) / $5 (ECAC) = 3.0
2. Local partner = $50 (pCLTV360d) / $10 (ECAC) = 5.0
Great, now your marketing report looks like this:
Another way to look at the relationship of ECAC and CLTV is to plot the revenue after substracted by ECAC. This way, you can see the acquisition performance from time to time.
Summary
Knowing your ECAC and CLTV helps you work smarter, not harder. It helps you decide where to invest your marketing budget. If your ECAC is too high compared to your CLTV, you might need to find other customer segment. If your CLTV outweighs ECAC than perhaps its time to scale up the marketing budget.
So there you have it — Effective Customer Acquisition Cost (ECAC) and Customer Lifetime Value (CLTV) in a nutshell. Remember, you can’t target everyone. Trying to get everyone will drain your money on customers that don’t bring value. Instead, focus on the marketing channel that brings the right customers. This way, you’ll ensure a sustainable and profitable business.
Lesson learned in Evermos
Sometimes, analyzing CLTV by marketing channel alone isn’t enough. It’s also crucial to distinguish CLTV based on post-acquisition treatment. Some customers might evolve into your Business to Business (B2B) partners.
While sales process of Business to Customer (B2C) is straightforward, B2B relies heavily on relationship management, where the quality and depth of these relationships can greatly influence future business prospects. By separating CLTV of B2C and B2B customer, you can clearly assess marketing performance without getting bias of your post-acquisition treatment.
