There are two major metrics that measure how much revenue (and profit) a single customer nets for your local business: Lifetime Value (LTV) and Customer Acquisition Cost (CAC). LTV measures how much, in total, a customer spends with your brand over the course of your relationship and CAC calculates how much it was to attract them in the first place.
Comparing these two figures—in essence, calculating your LTV:CAC ratio—gives you a solid sense of your customers’ real monetary value to your company. It also allows you to assess your marketing spend and sales costs against the revenue they create, enabling you to make informed decisions.
So, let’s explore how to measure, assess, and improve your LTV:CAC ratio to help ensure maximum profit per customer.
What is LTV (Customer Lifetime Value)?
LTV (Customer Lifetime Value) keeps tabs on the total amount of goods and services a customer purchases from your small local business over the course of your operations. It’s a key metric that allows you to:
- Predict potential revenue from future customers
- Get a sense of the average amount each client spends per visit, financial period, or across your relationship
- Forecast sales and profit margins for upcoming periods
To calculate LTV for a singular customer, you can simply tally up the total they’ve spent at your local business over the years. Your average LTV across customers, however, gives you a more robust understanding of your profitability.
To calculate it, multiply the average purchase value per visit to your local business by the average number of visits a customer makes in total. The resulting figure will be your general customer’s LTV, in dollars. If you have a low LTV, you may want to invest more in customer retention strategies to build loyal customers. On the other hand, a high LTV indicates high customer satisfaction, purchase frequency, and customer success.
What is CAC (Customer Acquisition Cost)?
Customers don’t just start patronizing brands out of the blue. They need to discover them, learn about them, and trust them before purchasing—and that takes marketing efforts, acquisition channels, customer outreach, sales departments, and more.
All these factors used to attract new customers require money, and their average price per person is called your customer acquisition cost (CAC). CAC is essential for finding your real profit per client because it subtracts from the overall amount you net per sale.
To calculate CAC, first choose a period—whether it’s a month, fiscal year, or another preferred amount of time. Then, add up all your marketing spend and sales expenses. Finally, divide this figure by the total number of new customers you acquired over the period to find your average CAC.
UpNest, a rising home-selling platform, increased its revenue by lowering acquisition costs with Nextdoor. Through a targeted marketing campaign focused on attracting neighbors in their local area, they were able to meet acquisition goals for roughly 50% of the cost they originally projected.
Understanding the LTV:CAC ratio
LTV:CAC ratio compares how much money a customer brings into your small local business against how much it costs you to attract them. It allows you to get a quick understanding of each customer’s potential profitability at a glance. It also allows you to balance acquisition spending with revenue to achieve maximum profitability.
Ultimately, finding your LTV:CAC ratio is essential to success for your small business because:
- It lets you know if you’re spending too much to connect with customers
- You can better decide if your customer acquisition efforts are paying off and, if necessary, focus more effort, resources, and budget on improving your strategies
- You’ll know if you’re keeping pace with competitive companies by measuring your LTV:CAC ratio against theirs and industry standards
How to calculate the LTV:CAC ratio
The LTV:CAC ratio formula has multiple steps. To begin:
- Find your average LTV
- Calculate your average CAC
- Divide your LTV by your CAC
Let’s assume you have an average LTV of $900 and your acquisition costs work out to $300 per client. Your LTV:CAC ratio calculation would look like:
- LTV:CAC Ratio = LTV/CAC
- LTV:CAC Ratio = 900/300
- LTV:CAC Ratio = 3
In this case, your LTV:CAC ratio would be 3—or, expressed as a proper ratio, 3:1. As per HubSpot, marketing and sales professionals often cite this benchmark as the standard for a positive LTV:CAC ratio across all industries.
So, if you’re attaining 3:1 or above, you’re on course for profitability.
Why the LTV:CAC ratio matters
LTV:CAC ratio is one of your most valuable insights into profitability. On a base level, it compares expenditure and revenue in a singular, neat, and easy-to-understand figure that can be applied across your customer base.
Beyond letting you know if you're earning more than you spend, however, LTV:CAC ratio can also help you steer and improve your local business. In the short term, it can help you make informed decisions about developing business relationships by giving you an idea of potential profitability before entering into any customer agreements.
In the long term, it can refine your approach to settling deals by allowing you to budget your marketing strategy and sales resources in relation to revenue. If, for instance, a deal is worth about $90,000 and you want to maintain that golden LTV:CAC ratio of 3:1, the maximum you can spend on acquisition would be $30,000.
Optimizing LTV and CAC for better business outcomes
Cross-selling and up-selling are two effective strategies for improving LTV without raising CAC. Since customers are already in your base, selling them on more (or better) products and services doesn’t generally cost any extra.
Plus, 72% of upsellers and 74% of cross-sellers say up to 30% of their revenue comes from these techniques—so, you may be missing out on a third of your potential profits if you don’t leverage them in your sales strategies.
When it comes to reducing CAC, market research is your best tool. Understanding your base allows you to create a marketing campaign that connects with them and avoids excess spending on poorly targeted advertising and sales efforts.
Home Chef, a weekly meal delivery service, significantly reduced CAC with local ads on Nextdoor. By targeting cooking enthusiasts and recent movers, they got their services in front of more interested eyes, reducing missed connections and overall acquisition costs by 25%.
Common mistakes to avoid
One major issue to note before calculating LTV is data reliability. Over the course of a business’s lifespan, they may use several databases, customer relationship management solutions (CRMs), and other tech solutions. To calculate true LTV, all the data from each of these platforms must be complete, accurate, and reliable.
Likewise, when measuring CAC, be sure to account for every facet of a customer acquisition strategy to ensure you’re not underestimating expenses. Some of the primary costs associated with attracting customers include:
- Ad spending
- Employee salaries
- Technical expenses
- Creative costs
- Inventory upkeep
- Production
LTV:CAC ratio gives key insight into profitability, business health, and more. What it doesn’t provide, however, is information about customer satisfaction. While some small local businesses may take a solid LTV:CAC ratio as proof of happy clientele, you should still conduct surveys and studies into your clients’ feelings about your brand to foster long-term positive relationships.
Reach local clientele and boost your LTV:CAC ratio with Nextdoor Ads Manager
Choose Nextdoor Ads Manager to optimize your LTV:CAC ratio, understand your audience, cross- and upsell them on more products and services, and target nearby neighbors.
Nextdoor Ads Manager connects local businesses with engaged decision-makers in their local neighborhoods. These high-intent customers have low acquisition costs as they’re already they're already in an action-mindset when they're on the platform. And, with the chance to foster enduring, positive relationships, they hold a strong potential for high LTVs as well.
Leverage Nextdoor Ads Manager to optimize your LTV:CAC ratio and, in turn, your profitability.
Sources:
- HubSpot. How to Calculate Customer Lifetime Value (CLV) & Why It Matters. https://blog.hubspot.com/
- HubSpot. Confused about Customer Acquisition Cost? I Asked Experts About CAC to Help [+Benchmarks and Formulas]. https://blog.hubspot.com/
- HubSpot. What is a Good LTV to CAC Ratio?. https://blog.hubspot.com/
- HubSpot. Most Sales Reps are Upselling or Cross-Selling in 2022 [Data]. https://blog.hubspot.com/.
