The Battle for Customer: Fundamental of CAC and CLV (First Part)

Gaining ‘mind share’ remains one of the best strategies for company to position its products and services. This mind share works for both Customer Acquisition (in case of potential customer) and Customer Retention (in case of existing customer). In the age of heightened customer expectations and widespread sharing via social media, positive customer experiences have witnessed the significance like never before. Companies are bleeding beyond capacity to acquire and retain customer, which question its survival in such a high-stakes struggle.

The modern business implies acquisition of customer is all about convincing people to buy or use your products or service. And customer retention means, making the customer continue do business with you. But it’s not that simple as the definition.  As a marketer, you need to make a reasonable program that legitimate the spending for acquiring or retaining a customer. In this part of the article, my discussion will focus the Customer Acquisition Cost (CAC) and Customer Lifetime Value (CLV) comparison. The value of CAC and CLV with correspondent balancing model fundamentally determines the legitimacy of the fight for the customer.

Customer Acquisition Cost (CAC)

As defined previously, the customer acquisition means convincing people to buy or use your product or services. The process of convince actually starts with identifying a prospect who is a stranger to your offerings. The consumer journey with your product/brand starts with getting awareness and ends with making a decision to buy or not-buy.

Consumer Journey Funnel | Source: HubSpot

As per the funnel above, HubSpot explain that as consumers move through the funnel (as part of their journey as a buyer), they:

• Gain awareness of your brand
• Add your product or service to their consideration pool, and
• Make a decision to become a paying customer of your business.

The consumer journey through out the funnel produces certain cost for the company. The sales and marketing cost required to earn a new customer over a specific time period is ideally defined as Customer Acquisition Cost (CAC). The market study indicates that, marketers consider customer acquisition cost as an important business metric which helps organizations to determine the amount of resources that can be profitably spent on a specific customer.

Now let us have a look on “How to Calculate CAC?”

The determination formula to calculate CAC may vary from industry to industry based on the product/service nature and the behavior of the consumer toward the type of product. The high-level customer acquisition cost can be found by dividing marketing costs associated with a customer acquisition campaign by the number of customers acquired from said campaign.

So, the above listed variables are required to determine for the calculation of CAC. CAC is a critical number to calculate (and constantly recalculate) when acquiring new customers and employing new acquisition methods.

Customer Lifetime Value (CLV)

For overall acquisition decision making, CAC seems to be stand alone number without any specific implication. In order to make the value meaningful and material in decision making, another metric to calculate and analyze in relation to customer acquisition cost is a customer’s lifetime value (LTV).

Defined roughly, CLV is the projected total economic value a customer brings to your business over their “lifetime” (i.e. the duration of time they will spend with your company, from first interaction to final purchase). It indicates the projected revenue one customer will generate over the course of their relationship with a company.

A simplified formula to calculate CLV can be presented as below:

This calculation may bring the marketer into a position to determine the customer acquisition decision. The CLV to CAC ratio works as an indicator of a customer’s value relative to the costs to earn them.

The Balancing Act

Now the two standalone value provides a meaningful ground to analyze the customer value proposition in number. For a business point of view, if the CAC is higher than the CLV (or even equal), that’s a serious problem. Ideally, it should take roughly one year to recoup the cost of customer acquisition, and the CLV:CAC should be 3:1, which means the value of the customers should be three times the cost of acquiring them. A higher ratio than 3x means you could actually be growing faster if you invested in the right channels.

The above figures explain the difference between Well-Balanced and Out-of-Balance Model for customer acquisition. The balancing act is a highly sought after issue for marketers. However, a proper balance in the CAC:CLV ration means a very well planned program for sustainable business.

Read the Second Part of the Article: The Battle for Customer: Fundamental of Share of Wallet (Second Part)

Read the Final Part of the Article: The Battle for Customer: Implication of CLV & SOW in Strategic Marketing (Final Part)