Gauging your business's performance is not new--income statements and balance sheets are as old as capitalism, after all. But today’s businesses have a few new measurement tools at their fingertips: CAC (customer acquisition cost) and LTV (lifetime value).
Bear with me; I know your eyes are probably glazing over. But if you're a startup founder, the following is both relevant and vital.
Back to CAC (pronounced "kack") and LTV. By design, each metric puts the customer first. No matter how much you think your product is the be all and end all, it's nothing without customers.
At a minimum, learn what these key performance indicators are and how to calculate them for your business. Further, integrate them into your business early on. Make sure everyone in your company becomes fluent in CAC and LTV.
Getting to Know CAC
In its simplest form, your CAC should represent all of the costs you incurred to acquire a customer divided by the number of customers you acquired for the same time period, typically monthly.
Are you running paid campaigns through Facebook or Google AdWords? Those costs are part of CAC. Do you have telemarketing people involved in the sales process? Their salaries are also part of CAC. For most companies, a number of line items would blend together to form your overall customer acquisition cost.
Rooting Out Value
Calculating a customer's lifetime value will be different for every company. For example, consumer-focused applications such as Hostel Rocket, CareLuLu, and BringMeThat (all investments in our portfolio) receive commission revenue from transactions. Over time, each tracks how much revenue each customer generated, as well as the number of times that customer returned.
If Hostel Rocket generates a $4 commission from the booking of a hostel and the typical customer books 30 nights over a 36-month period, the LTV of that customer is $120.
The hard part is that the LTV literally takes time to calculate. However, you can look to industry benchmarks as a starting point and measure against those until time becomes your friend.
How to Apply CAC and LTV Metrics:
Once you calculate both of these figures for your company, you need to apply them in your decision making. Here are four steps:
1. Establish a baseline. To know how you're doing and what, if anything, you can do to adjust, you have to know where you are. If, for example, your CAC is $150 and your LTV is $100, you have a problem.
2. Adjust your strategy. In the aforementioned example, your costs outweigh the value your customers bring in. To bring your costs down, you might roll out a few new CAC campaigns, perhaps. Similarly, you'll want to extract more value from customers. You might consider upgrading your product offerings, and introducing retention campaigns and discount offers. At this point, you are trying to optimize your CAC and LTV so you have a scalable business.
3. Bake the strategy in. The best situation is when the company's leadership and employees keep these CAC and LTV strategies top of mind. Keep these stats current, and regularly discuss your progress at meetings.
4. Track your progress. As an investor, this is always a plus. I love it when my business updates are around the results of new campaigns that decreased CAC and increased LTV. Then I have an investment that is going somewhere. To make me really happy, be able to show that your LTV is at least 3x your CAC.
These two metrics are critical for your business as the basic foundation of your operations and priorities. If you are a customer-driven organization, then your metrics should reflect that.