15 Aug Customer Acquisition Cost vs Customer Lifetime Value
I know, I get it! I understand how frustrating it is when a marketing salesperson cold calls you. They spout out these random statements of how big their distribution (“print run”) is or their “expected potential” viewer or listener base might be and then proceed to tell you that if you do not advertise using what they are selling you the sky will fall down, your dog will hate you and inevitably you are going to be a failure at business.
But…I want to tell you my story and the thoughts and questions that went through my head every time a marketing salesperson called me offering their service and telling me how the product they were trying to sell me was going to revolutionise my business and bring in customers.
My first venture into business was owning a local car interior restoration business. I literally started by working out of the back of my old Holden Commodore and knocking on the doors of local car dealerships. My first focus was primarily B2B sales and service and after a couple of years of hard work, I had secured quite a sizable client base. My next focus was then growing the B2C side of my business.
So I started looking into different types of advertising, trying to discern what would be the best fit for my ideal target market and which would deliver the best results in sales for my business.
I asked lots of questions of these salespeople as well as myself. Questions like “how can you prove that is the size of your readership/listener base/viewer base?” “What percentage of those people are likely to translate and convert into actual customers and therefore sales that I can attribute against the cost of marketing?” “ What is my expected return on investment for advertising?”
The ultimate question that it must always boil down to is this…
“What is my Customer Acquisition Cost and how does it measure against my Customers Lifetime Value?”
Surprisingly there is a large number of business owners who do not properly understand what this means and how it affects profitability, so let me explain.
Customer lifetime value (LTV)
This metric is pretty straightforward, it simply means what is the total value that each customer/client is worth to your business over their lifetime. That is the combined total of all sales that a customer makes.
An example of this might be a car mechanic.
A customer brings in their family car for its regular service. This service costs $350. However, it needs to be serviced every 10,000 km or 6 months whichever is sooner. So at the least every 6 months, this customer will be back in for another service.
$350 x 2 services per year = $750 per year.
If they have two cars, then they are worth $1500 per year to your business, and if they remain as your customer for the next 5 years their customer lifetime value is then $1500 x 5 years. A total of $7500.
Another example might be a novelty T-shirt company. The average price of a shirt is $25 and historically customers have only ever purchased 1 or maybe 2 shirts (let’s say 2).
So, in this case, the lifetime value would simply be…
$25 x 2 = Customer lifetime value of $50
Depending on your business and the word of mouth referral growth that you see, you may also decide to include these referrals into your lifetime customer value. If your mechanical business customers refer you to 2 family members or friends, then the LTV suddenly balloons.
Customer acquisition cost (CAC)
Simply put is how much does it cost to acquire a customer. Therefore how much money (this includes time) does it cost to get each customer. Think marketing budget, staff wages, phone and emails and agency retainer costs etc. All of this contributes to the cost to acquire customers.
What does it all mean?
As I am sure you can start to see, it is crucial to ensure that your CAC is less than your Customer LTV. How much less really depends on your profit margins. If acquiring customers is costing you more than they are worth to your business, it is a losing game that is costing you in money, resources and energy and ultimately sending your business into bankruptcy.
If however, you are prepared to absorb your upfront costs knowing that the lifetime value will outweigh the initial cost for acquisition (think recurring monthly packages etc), then you can factor in a higher CAC initially.
However….the exciting thing is that by knowing these metrics you have the ability to monitor its health, make further improvements and even revolutionise your business.
Back then when I started my business, it was extremely hard to get real data that could tell me the success of each marketing campaign. It was before digital marketing was really a thing, and it required me asking everyone I spoke to “how did they hear about us?” There was no real way to quantify how successful a campaign was.
Digital marketing has changed all that.
Digital marketing allows you to not only see exactly how many people saw your ad but also the conversions attributed to it. It is now possible to see that exactly 55,986 people saw your ad and then out of that 55,986 people, 632 people clicked through and purchased a product, or looked at your website or filled in a Lead Generation form etc.
You can know exactly in extreme detail the results of your campaigns, and get amazing detail on its performance. It is a complete game changer.
Our platforms of choice are Facebook and Instagram.
Yeah, we know there are other ways to target your audience online, but we are fans of Facebook’s network as the CAC’s are the lowest and the audience building potential is second to none (think 273,000 touch points to use in your targeting).
We just do Facebook and Instagram…and we do them well.
If you are interested in how we can help you with digital marketing via Facebook and Instagram as well as helping you to lower your CAC get in touch with us here at BidPixel. We would love to hear from you.