What is a good LTV to CAC ratio?

Investing in acquiring new customers is critical for business growth. With consumers being exposed to so much advertising and branded content every day, it’s important to develop programs that capture your target customers’ attention and drive them to convert. 

Spend too little on acquisition, and consumers may do business with your competition. But spend too much, and the lifetime value (LTV) of customers may not cover the amount invested to acquire them. This is where LTV to CAC ratio comes in. 

LTV to CAC ratio is a comparative analysis of two metrics that enables you to understand the profitability of your customer acquisition model. While many sources suggest that a good LTV to CAC ratio is 3:1, the reality is that LTV to CAC ratio can vary across industries and business models. In this article, we'll break down LTV to CAC and show you how to determine a good LTV to CAC ratio for your business.

How to calculate Customer Acquisition Cost

The first step to understanding LTV to CAC ratio is to determine Customer Acquisition Cost (CAC). 

Customer Acquisition Cost (CAC) is an essential metric that enables businesses to understand how much sales and marketing budget they are spending for every new customer acquired. 

To calculate Customer Acquisition Cost, simply divide your total sales and marketing spend for a specific time period by the number of new customers acquired during that time period. 

‍Total Sales & Marketing Cost

_______________________________ = Customer Acquisition Cost

Number of New Customers Acquired

When determining Sales & Marketing Costs, it’s best to include all costs related to team member salaries, tools, and advertising fees to ensure your CAC calculation accurately represents your balance sheet.

How to calculate your Customer Lifetime Value

Next, you can determine your customer LTV. To calculate LTV, you’ll need to use historical information to make a prediction of how much customers will spend throughout their lifecycle in the future. Here's how to calculate LTV in five 5 steps:

1. Determine Average Purchase Value
   Review purchase data over a specific time period (last month, quarter, year) and determine the Average Purchase Value for this period. This can be calculated by dividing total revenue by number of purchases. 
2. Determine Average Purchase Frequency
   Next, calculate Average Purchase Frequency to determine how often customers make a purchase throughout their lifecycle. This can be calculated by dividing the number of purchases by the number of customers. 
3. Determine Customer Value
   Multiply these two figures, Average Purchase Value and Average Purchase Frequency, to determine Customer Value. 
4. Define Customer Lifespan
   Review historical data to determine the average length of time throughout which customers continue to make purchases with your brand. This is your Customer Lifespan. If this can’t be determined from your historical data, you can also reference industry benchmarks. 
5. Calculate Customer Lifetime Value
   Finally, multiply Customer Value by Customer Lifespan to determine Customer Lifetime Value. This value represents the total revenue you can expect to generate from a customer throughout their relationship with your brand.

Understanding your LTV to CAC ratio

Once you have your LTV, you’re ready to understand your LTV to CAC ratio. Analyzing CLTV alongside CAC enables you to understand the profitability of your customer acquisition model. When you’ve made an investment in acquiring a customer, by attracting them with an advertisement on Facebook, for example, that customer initially has negative value to your business. Once they make a purchase, their CLTV increases to the purchase amount and they begin to become more valuable. 

To calculate your LTV to CAC ratio, all you need to do is divide LTV by CAC. 

Customer Lifetime Value

____________________ = LTV to CAC ratio:1

Customer Acquisition Cost

LTV to CAC ratio is commonly presented as X:1, where X represents LTV divided by CAC, and 1 represents $1 spent on acquisition.

When LTV is equal to CAC, customers are generating the same amount of revenue it cost to acquire them. As LTV exceeds CAC, your acquisition model becomes more and more profitable.

What is a good LTV to CAC ratio?

While many sources suggest that a good LTV:CAC ratio is 3:1, industry research shows that average LTV:CAC does vary across industries. While eCommerce brands had an average CLTV to CAC ratio of 3:1 in 2023, Commercial Insurance brands achieved an average CLTV:CAC of 5:1. 

If your LTV:CAC ratio is lower than 3:1 (or your relevant industry benchmark), it suggests that you may be spending too much to acquire each customer. 

If your LTV:CAC ratio far exceeds your industry benchmark, it is not necessarily a good thing–you may not be investing enough in customer acquisition and therefore missing out on valuable opportunities to capture more of your target market. 

As with many marketing metrics, it’s best practice to analyze LTV:CAC ratio alongside additional metrics for greater context. While profitability is important, so is cash flow. A customer that becomes profitable to your business in 6 months is much more valuable than one that becomes profitable in 6 years. This is where CAC payback period comes in.

3 things you can do to improve LTV to CAC ratio

LTV:CAC ratio is a complex metric that encompasses several different business mechanisms. If your ratio isn’t quite where you’d like it to be, don’t fret. Here are 3 steps you can take to improve your LTV:CAC ratio. 

1. Improve retention and engagement
   Once you’ve acquired a new customer, investing in retaining them and increasing their purchases throughout the customer lifecycle is a great way to increase LTV. Customer loyalty programs, for example, reward customers for continuing to engage and make it easier for customers to repeatedly purchase their favorite products. Upsell and cross-sell experiences introduce customers to new products and services they may be interested in based on their previous purchases. Harvard Business Review reported that acquiring a new customer can cost up to 5x more than retaining an existing one – by developing programs that drive new customers to make additional purchases, you can increase LTV and optimize marketing investment. 
2. Review your pricing
   You could be doing everything well in your customer acquisition funnel, but if your pricing model is not right, your LTV to CAC ratio is going to suffer. Sure, there’s nothing wrong with offering affordable pricing compared to your competitors. But if your acquisition costs rise over time due to inflation, competitive ad bidding, and other factors, you may find that revenue generated from purchases is covering less and less of your acquisition costs, leading to a decline in LTV to CAC ratio. It’s always helpful to review your pricing to ensure that you’re maximizing the revenue generated from your share of the market.
3. Increase advertising conversion rate
   Focusing on testing and optimizing your advertising campaigns is a great way to increase the number of customers acquired for every dollar invested in acquisition. On the campaign side, you can sharpen your targeting with more nuanced audience definitions, and reduce wasted ad spend by including suppression lists and exclusion criteria in your campaign set-up. In the post-click experience, increase conversion rate by increasing landing page load speed, personalizing the landing page experience, and making the checkout experience as seamless as possible.

Key takeaways

• Investing in acquiring new customers is critical for business growth. Analyzing your LTV to CAC ratio helps you assess the profitability of your customer acquisition model, so that you can understand whether you’re investing too much or too little in acquisition.
• To calculate Customer Acquisition Cost, divide your total sales and marketing spend for a specific time period by the number of new customers acquired during that time period. 
• To calculate Lifetime Value, multiply Customer Value by Customer Lifespan. This value represents the total revenue you can expect to generate from a customer throughout their relationship with your brand.
• While many sources suggest that a good LTV:CAC ratio is 3:1, industry research shows that average LTV:CAC does vary across industries. While eCommerce brands had an average CLTV to CAC ratio of 3:1 in 2023, Commercial Insurance brands achieved an average CLTV:CAC of 5:1.
• If your LTV to CAC ratio isn’t where you’d like it to be, you can improve it by investing in customer retention and engagement programs, reviewing your pricing, sharpening your campaign targeting, and optimizing the post-click conversion experience.