Understanding and Optimizing the LTV to CAC Ratio

Running a successful SaaS business is all about optimizing for profitability. There are multiple metrics that can help you do this. Calculating your Customer Acquisition Cost (CAC) lets you understand how much you’re spending to bring in new customers while knowing their Lifetime Value (LTV) tells you how much revenue they will bring.

But when you compare these two metrics against each other, something else happens. You get a simple ratio that can reveal a whole lot about your brand’s short- and long-term profitability, growth potential, and overall value.

What Is LTV:CAC Ratio?

LTV:CAC Ratio (also sometimes written as CLV:CAC Ratio) is a measure of your company’s Customer Lifetime Value (LTV) against your Customer Acquisition Costs (CAC). It helps you determine whether the total value a customer brings in is greater than the total costs it took to acquire them in the first place.

Regularly measuring your LTV:CAC Ratio is a good way to assess whether your company is optimizing its sales and marketing efforts and positioning itself for long-term profitability. For this reason, it is a common metric many investors look at when measuring the health of a company.

How to Calculate LTV:CAC?

Figuring out your LTV:CAC Ratio is relatively simple. You just take your LTV and divide it by your CAC. Here is that formula:

LTV ÷ CAC = LTV:CAC Ratio

For example, if your LTV was $90,000 and your CAC was $30,000, then your LTV:CAC Ratio will be 3:1:

$90,000 ÷ $30,000 = 3

Of course, being able to calculate this properly requires you to have previously worked out your LTV and CAC. Let’s break down these underlying metrics some more.

Customer Acquisition Cost (CAC)

CAC is the average cost of acquiring a single customer. You can calculate this by adding up your total sales and marketing costs (such as program and ad spend, marketing campaigns, bonuses and sales commissions, employee salaries, and so forth) and dividing this sum by the total number of new customers acquired within the period you’re measuring.

Here is the formula for CAC:

Total sales and marketing costs ÷ Total # of new customers = CAC

Note that you should only be using sales and marketing costs dedicated to new customer acquisition, as opposed to existing customer retention. Likewise, you should only be counting new customers acquired, rather than customer upgrades or upsells.

Check out our full article on CAC to learn more.

Customer Lifetime Value (LTV)

LTV is the total amount you can expect to earn from a customer from their first purchase to their last. This is a point-in-time calculation, meaning that you will have to recalculate this number regularly. In order to measure LTV, you multiply the Average Customer Value by the Average Customer Lifespan.

Here is the formula for LTV:

Average Customer Value (CV) x Average Customer Lifespan (CL) = LTV

Of course, in order to use this formula, you’ll have to have your CV and CL metrics already calculated. To learn how to do this, read our full article on LTV.

An alternative method is to multiply your Average Order Value (AOV), Number of Repeat Sales (RS), Average Retention Time (ART), and Gross Margin together:

AOV ($) x RS (#) x ART (# in months) x Gross Margin (%) = LTV

What Different LTV:CAC Ratios Mean

So how are you supposed to read your LTV:CAC Ratio? Generally speaking, a ratio of about 3:1 is considered the “sweet spot” you want to aim for. Anything lower or higher than this may mean you are losing money or leaving money on the table. Let’s look closer at what different LTV:CAC Ratios mean.

LTV And CAC Are The Same (1:1)

This means that the costs of acquiring a customer are the same as the lifetime value of a customer.

On the surface, this may seem like an adequate result. It looks like you’re breaking even.

However, the problem with this is that CAC only accounts for marketing and sales expenses related to acquisition. There are also other expenses associated with the day-to-day operation of a business. These include taxes, shipping, and returns, as well as customer service costs and any related employee expenses. After factoring these in, you’ll more than likely be at a net loss.

LTV Is Lower Than CAC (1:>1)

This means that you’re spending more to acquire customers than they are bringing into your business. Even when measured over the course of their entire lifetime, you will still be at a net loss. When you factor in any additional expenses, the amount of money you’re losing could be significant.

If your business has a LTV:CAC Ratio like this, then you will likely need to make some major adjustments to both how you acquire customers and how you sell to them. Start by looking for and eliminating any costly acquisition efforts, especially those that aren’t performing well. Also consider ways you can increase LTV, such as by raising prices or encouraging customers to remain with your business longer.

LTV Is Higher Than CAC (2:1 to 4:1)

This means you are earning anywhere from two to four times as much per customer as it costs to acquire them.

This is commonly considered the ideal for most businesses because it means you are making enough to recoup both sales and marketing expenses, as well as additional business costs, but not so much that you are potentially leaving profits on the table. Venture capitalists and other investors typically look for a LTV:CAC Ratio in this range.

LTV Is Much Higher Than CAC (>5:1)

This means that your sales and marketing efforts are likely not going far enough. You could afford to acquire new customers at a faster rate, but aren’t for some reason. That results in unrealized growth.

If this is the case, you should reinvest your earnings back into your acquisition efforts. Search out new opportunities to market your company and expand any efforts that are already successful.

With such a strong LTV, it’s obvious that existing customers find your product useful. Take advantage of this by enlisting them to market for you (e.g., through a loyalty program). You may be surprised by the additional growth.

5 Ways to Optimize LTV:CAC Ratio

If your LTV:CAC Ratio isn’t where you want it to be, don’t panic. Here are a few optimization strategies you can employ to start getting it to the golden 3:1 ratio.

• Leverage the right channels and segments. Try to invest your acquisition efforts in only the most successful places. Look for channels and customer segments that produce long-term and/or more lucrative relationships. Skip any channels or segments that lead to customers more likely to churn. And if you can identify any marketing efforts with low acquisitions costs (e.g., inbound marketing), all the better.

• Introduce new (and more nuanced) pricing. Experimenting with different pricing models can be an effective way to attract and retain new types of customers. Maybe a lower price can bring in customers that will be more likely to upsell later on. Or maybe introducing a higher-priced tier can help produce a more lucrative income stream.

• Keep prospects engaged and customers happy. If your sales process is too long or your onboarding is too complex, you may be losing leads and new customers. Try to simplify the sales and onboarding process so that it is as effortless as possible. And once you’ve converted a customer, increase your retention rate by investing in customer success initiatives.

• Improve your value proposition. Enhance your product's features, customer support, and the overall experience offered by your product to retain customers and increase their lifetime value.