The LTV/CAC ratio, the key indicator for your profitability
Every investment counts, and to assess whether you'll be truly profitable in the future, the LTV/CAC ratio is your best ally.
This essential indicator measures how profitable a customer is by comparing the value they bring over the long term (LTV) with the cost of acquiring them (CAC).
By balancing these two elements, you can not only optimize your budget, but also fine-tune your strategies.
LTV/CAC ratio: what are we talking about?
To fully understand the LTV/CAC ratio, it's crucial to define its two main components: LTV (Lifetime Value) and CAC (Customer Acquisition Cost).
Taken together, these indicators enable us to assess whether acquired customers are bringing in enough revenue to cover acquisition costs and generate sustainable income.
LTV
LTV, or lifetime value, represents the amount of revenue a customer generates for a brand over the entire duration of their relationship with it.
This indicator takes several factors into account: average purchase amount, frequency of purchase, and average customer lifetime.
CAC
The CAC, or customer acquisition cost, measures the amount invested to acquire a new customer.
It includes all marketing and sales expenses incurred to attract, convince and convert a prospect into a customer.
This includes advertising costs, sales force costs, promotions, and even some technology costs.
6 reasons to calculate it
LTV/CAC is much more than a simple financial indicator: it informs your strategic decisions in terms of acquisition and customer retention.
1. Assess the relationship between acquisition and loyalty
LTV/CAC highlights the balance between acquiring new customers and retaining existing ones.
By calculating this ratio, you get a clear picture of the value each buyer generates over time compared to what was spent to acquire them.
This calculation helps you understand whether efforts are profitable and how they translate into lasting customer relationships, reinforcing loyalty.
2. Calculating the profitability of an acquisition strategy
A favorable LTV/CAC indicates that your new customers are earning more than they're costing.
This means that the acquisition strategy is profitable and supports the company's development.
This calculation helps to identify the acquisition channels and campaigns that generate the best results, enabling the budget to be allocated where it will have the greatest impact to achieve optimum ROI.
3. Optimize your budget
LTV/CAC enables the budget to be allocated efficiently between acquisition and retention, according to expected profitability.
This helps companies to invest where the return is greatest, maximizing profits while minimizing costs.
4. Make informed strategic decisions
By analyzing the ratio, brands can make more informed marketing choices, focusing on the most profitable segments and adjusting their strategies accordingly.
This becomes a valuable guide for prioritizing investments.
5. View of profitability per customer
This ratio offers a clear perspective on the value generated by each customer, enabling companies to make more precise decisions on investment and the definition of growth objectives.
6. Solid support for fund-raising and investment strategy
An optimal LTV/CAC attracts investors by offering concrete evidence of the company's profitability and long-term viability.
A balanced ratio demonstrates that the brand is controlling its acquisition costs while maximizing the value of each customer, which is essential for sustainable revenues.
For investors, a favorable ratio is an indicator of financial stability, showing a solid acquisition and retention strategy.
4 limitations of the LTV/CAC ratio
LTV/CAC is a very powerful tool for assessing whether acquisition and retention strategies are profitable, but it also has limitations that must be taken into account to avoid simplified or incomplete interpretations.
1. Exclusion of indirect costs
LTV/CAC focuses solely on what is directly spent on customer acquisition and value generation, but omits some of what is spent indirectly, such as after-sales service, customer support and operations.
These elements can reduce actual revenue and should be integrated for a more complete picture.
2. Adapting to variable customer life cycles
LTV depends on the average lifespan of customers, which can be difficult to estimate accurately, especially for companies with highly variable lifecycles.
For example, sectors with irregular purchasing patterns may not have very stable LTVs, which complicates the interpretation of the indicator.
3. Risk of excessive focus on acquisitions
The use of LTV/CAC can encourage an excessive focus on reducing acquisition costs to the detriment of other aspects, such as customer experience and product innovation.
This approach can compromise the quality of the overall experience, which is essential for maximizing LTV.
4. Lack of information on immediate profitability
The LTV/CAC ratio focuses on the long term, but does not take the immediate into account.
A company may have a favorable ratio but not be sufficiently profitable to support future operations, which can be a problem, especially for companies in a rapid growth phase.
How to calculate LTV and CAC?
To measure the ratio, we first need to calculate the two essential components: LTV (Lifetime Value) and CAC (Customer Acquisition Cost).
These calculations provide a clear picture of profitability per customer and the efficiency of acquisition investments.
LTV calculation
LTV, or Customer Lifetime Value, represents the revenue a customer is expected to generate for the company over the lifetime of the relationship. Several factors come into play:
- Average amount per purchase: the average amount each customer spends on a transaction.
- Purchase frequency: the average number of transactions carried out over a defined period (e.g. per year).
- Average customer lifetime: an estimate of the length of time a customer remains active with the company, often calculated from the retention rate.
LTV = (Average amount per purchase) x (Purchase frequency) x (Customer lifetime)
This formula helps to evaluate what each customer can contribute over the long term, offering a broader vision than that given by a single transaction.
Note that this calculation can be optimized with a CRM, which centralizes purchase and customer interaction data.
With a CRM, it is possible to better estimate the lifespan of customers by tracking their purchase history, commitment and loyalty.
Calculating CAC
The CAC, or customer acquisition cost, represents the amount invested to acquire a new customer. It includes all expenses linked to marketing campaigns, promotions, sales teams and the technologies used to attract new customers.
- Total acquisition cost: Includes advertising investments, sales-related personnel costs, and all resources used to attract prospects.
- Number of new customers: The total number of customers acquired over a specific period.
CAC = (Total cost of acquisition) / (Number of new customers)
Knowing your CAC is essential for evaluating the effectiveness of acquisition campaigns and optimizing marketing budget allocation.
Calculating the LTV/CAC ratio
Once the LTV and CAC have been calculated, the LTV/CAC ratio can be obtained. This ratio indicates whether each euro invested in acquisition generates sufficient value for the company.
LTV/CAC ratio = LTV / CAC
A ratio greater than 1 indicates that each customer will bring in more than the cost of acquiring it, which is favorable.
2 examples of LTV/CAC calculation
High ratio example
Let's imagine an e-commerce company with the following data:
- Average amount per purchase: €50
- Purchase frequency: 3 times a year
- Customer lifetime: 2 years
- Total acquisition cost over a period: €10,000
- Number of new customers acquired over the same period: 100
- LTV calculation
LTV = €50 x 3 x 2 = €300
- Calculation of CAC
CAC = €10,000 / 100 = €100
- Calculation of LTV/CAC ratio
LTV/CAC ratio = €300 / €100 = 3
This ratio of 3 means that for every €1 spent, the company generates €3 in revenue per customer, which corresponds to a good level of profitability.
Low ratio example
Let's take another example where an e-commerce company presents the following data:
- Average amount per purchase: €30
- Purchase frequency: 2 times a year
- Customer lifetime: 1.5 years
- Total acquisition cost over one period: €15,000
- Number of new customers acquired over the same period: 100
- LTV calculation
LTV = €30 x 2 x 1.5 = €90
- Calculation of CAC
CAC = €15,000 / 100 = €150
- Calculation of LTV/CAC ratio
LTV/CAC ratio = €90 / €150 = 0.6
In this scenario, the LTV/CAC ratio is 0.6, which means that for every euro spent to acquire a customer, the company generates only €0.60 in revenues.
In other words, it loses €0.40 for every €1 invested in a buyer.
Interpreting the LTV/CAC ratio to better assess performance
What is the right LTV/CAC ratio?
An LTV/CAC ratio of 3:1 is considered a good balance.
This ratio means that for every 1 euro invested in customer acquisition, you generate 3 euros in revenue.
Such a ratio indicates healthy profitability: your customer base provides far more value than it costs to acquire, ensuring a comfortable margin.
Ratio too high or too low: what are the consequences for your business?
A high ratio (over 3:1) reflects high profitability. However, it can also signal under-utilization of acquisition opportunities.
The company could invest more to increase its customer base while remaining profitable.
A high ratio is often an incentive to increase acquisition spending, optimizing campaigns and channels for maximum impact.
A low ratio (below 1) means that the CAC is too high in relation to the value generated by each customer.
This may indicate a need for optimization, whether by reviewing advertising campaigns, diversifying acquisition channels, or improving loyalty strategies to increase CLTV.
A low ratio calls for in-depth analysis to identify and correct sources of excessive cash loss or weaknesses in retention.
Why improve the LTV/CAC ratio to support growth?
Optimizing the LTV/CAC ratio is essential to ensure sustainable, profitable growth. A balanced ratio means that the company maximizes the value generated by each customer while controlling acquisition costs.
Optimizing return on investment (ROI)
An optimized LTV/CAC ratio maximizes the return on every euro invested.
By increasing customer lifetime value and reducing acquisition expenses, you achieve a higher ROI, enabling the company to generate more comfortable margins and invest more in other initiatives, such as product development or expansion into new markets.
Attracting investors with an optimal LTV/CAC ratio
A solid LTV/CAC ratio is a powerful argument for attracting investors.
A good ratio proves that the company is capable of generating long-term revenues and maintaining a profitable acquisition strategy.
Investors are looking for companies that control their acquisition costs and know how to maximize customer value.
Demonstrate the ability to generate long-term value
An optimized LTV/CAC ratio shows that the company not only acquires customers, but is also able to retain them and maintain a lasting relationship.
This reflects a long-term strategy focused on customer retention and satisfaction, which are crucial to sustainable growth.
By improving this ratio, the company proves that it can not only attract customers, but also keep them and make them an ongoing source of revenue.
Strengthening the company's resilience to market fluctuations
A good LTV/CAC ratio helps the company to be less vulnerable to variations in acquisition costs or changes in purchasing behavior.
If spending temporarily increases, a company with a high LTV is better positioned to absorb these fluctuations.
By optimizing this ratio, the company strengthens its ability to grow even in a competitive or unstable environment.
The 3 keys to balancing CAC and LTV?
Striking the right balance between CAC and LTV is essential to maximizing profitability and sustaining your company's growth. However, this balance can vary depending on the company's stage of maturity.
1. Keeping CAC low by optimizing acquisition channels
For young companies, maintaining a low CAC is essential to maximize short-term ROI.
By focusing on the most profitable acquisition channels and keeping costs down, these companies can achieve a more immediate ROI.
Identifying the channels that generate quality conversions at the lowest cost, such as SEO, social network marketing or strategic partnerships, helps keep CAC under control.
This helps build a customer base while minimizing unnecessary investment.
2. Prioritize loyalty and retention to increase LTV
As a company evolves and reaches a stable stage of growth, it can afford to dedicate more resources to retaining existing customers.
In the scale-up phase, the aim is to increase LTV to generate more revenue per customer, which requires loyalty efforts.
Loyalty programs, personalized experiences and high-quality customer service are effective levers for keeping customers coming back and reducing churn.
With a referral program, you can also increase your LTV: referred customers have a 16% higher Lifetime Value.
To know more about referral checkout our Loyoly's Ultimate Guide to Referrals.
By increasing the average lifespan of customers, you maximize the value of each initial acquisition, which becomes essential for sustainable growth.
3. Adjust marketing strategy to balance acquisition and retention.
Once the company has achieved a certain stability, it can adopt a more balanced approach between acquisition and retention, adjusting investments according to the needs and objectives of each growth phase.
For a more mature company, this “game” between CAC and LTV allows for flexibility and adaptability.
Allocating a significant proportion of the marketing budget to retention, while maintaining a constant flow of new customers through acquisition, offers an optimal LTV/CAC ratio.
By adapting marketing strategy to the company's stage of development, it is possible to ensure stable growth and long-term profitability.
