Customer Acquisition and Lifetime Value
Customer Acquisition
In the last five years, the cost of acquiring new customers has increased by over 50%, mainly because customers just don’t trust businesses anymore. Marketing is becoming more expensive and customers are becoming less trustworthy of brands. The solution? Companies must work smarter.
Customer acquisition is the process of bringing new customers or clients to your business. The goal of this process is to create a systematic, sustainable acquisition strategy that can evolve with new trends and changes.
Customer acquisition is important for businesses of any age and size. It allows your business to:
Make money to meet costs, pay employees, and reinvest in growth, and
Show evidence of traction for outside parties such as investors, partners, and influencers
Being able to systematically attract and convert new customers keeps companies healthy and growing — and investors happy.
Customer acquisition channels are methods, platforms, and strategies through which companies attract new fans, readers, and leads. The best channels for your business will depend on your audience, resources, and overall strategy, and include content marketing, blogging, content offers (ebooks, guides, webinars), video, social media, search engine marketing, and email marketing.
A solid customer acquisition strategy should be four things: sustainable, flexible, targeted, and diversified across acquisition methods.
At this point, you may be asking, “What’s the difference between lead generation and customer acquisition?”
In the business world, we typically visualize the customer journey with a funnel or a similar graphic that highlights the stages in the buying process and the mindset of the prospect.
As consumers move through the funnel to become buyers, they:
Gain awareness about your brand
Add your product or service to their consideration pool
Make a decision to become a paying customer of your business
To simplify the process, lead generation typically happens at the top of the funnel, lead acquisition happens in the middle, and lead conversion happens at the bottom.
And customer acquisition typically refers to the funnel as a whole.
Therefore, your Customer Acquisition Cost (CAC) is the cost associated with a new customer going through that funnel. CAC includes marketing costs, events, and advertising.
CAC is important because it assigns real value to your marketing efforts and allows you to measure your ROI — a metric inquired about by CEOs, managers, and investors alike.
How to Calculate Customer Acquisition Cost
High-level customer acquisition cost is calculated by dividing marketing costs associated with a specific campaign or effort by the number of customers acquired from said campaign.
This CAC formula is
CAC = MC / CA, where:
CAC is customer acquisition cost
MC is marketing costs
CA is customers acquired
To get a more in-depth, accurate look at CAC, you must include all costs associated with marketing spend, including everything from campaign spend to marketing salaries to the cost of the staples used to create those lengthy contracts.
This CAC formula looks like:
CAC = (MC + W + S + OS + OH) / CA, where:
CAC is customer acquisition cost
MC is marketing costs
W is wages for marketing and sales
S is marketing and sales software
OS is outsourced services
OH is overhead for marketing and sales
CA is customers acquired
Where the simple CAC metric might apply to a single campaign, the more complex CAC formula should be calculated within a given window, such as one month or fiscal year.
For example, if Company A spent $10,000 on customer acquisition in Q4 of 2017 and acquired 100 customers, the CAC would be $100.
Use this free template to calculate CAC.
CAC can be a fickle metric and shouldn’t be the only number used to evaluate marketing efforts. Why? Well, here are a few things that could throw off the value and application of your CAC:
On average, how often do your customers make purchases? There’s a major difference between the CAC of an Audi dealership and a Starbucks.
Does/did your company spend money on marketing efforts that are slated to pay off in the far future? Say you invest in a Q3 campaign but pay for it in Q1. You aren’t necessarily going to see new customers right away from that investment, and that might skew your Q1 CAC.
Regardless, CAC is a critical number to calculate (and consistently recalculate) when acquiring new customers and employing new acquisition methods.
How to Minimize Customer Acquisition Cost
If you’re looking to improve your CAC, here are a few ways to minimize the cost of acquiring new customers:
Improve your website conversion efforts. Enhance your calls-to-action, ensure your site is mobile and tablet responsive, optimize your landing pages, and clean up your copywriting. Consider A/B testing a landing page or shopping cart to see if a certain design or copywriting angle works best. These will make sure any customer acquisition methods you’re already employing are working as perfectly as possible.
Boost the value of your current customers. This may involve releasing a new product or upgrade in which your customers can also pay for. User value can also skyrocket when users refer other customers or simply act as promoters for your business.
Adjust and optimize your customer acquisition strategy. Take some time to lay out your acquisition blueprint and see what each method is costing you. Where could you cut back on extra marketing spend or manpower? Costs for specific channels can rise over time, and you can always minimize CAC by finding newer, cheaper channels to invest in. This process also ensures your strategy reflects the most recent marketing trends and remains agile
Customer Acquisition Strategy Examples
1. Freemium Product
One of the best ways to get customers interested in your product is by giving them a little taste of it through a freemium option. Lots of leading brands do this: Dropbox, Slack, Spotify, etc.
2. Email
Email marketing is a valuable way to routinely engage with leads and keep your brand and product top-of-mind. This applies whether you’re a Fortune 500 company or individual freelance writer.
3. Referral Program
Word-of-mouth marketing is one of the most effective ways to attract new customers. Truth is, people trust other people more than they do advertising and salespeople.
The good news is that you can equip your customers — especially your most loyal ones — to market on your behalf. By running a referral program, you incentivize your users to share your business with new customers, typically in exchange for a discount or coupon for both parties.
4. Gated Content
Consider producing various new content offers every year, such as e-books, templates, worksheets, guides, and more. This type of content is also called “gated content,” as leads have to enter their emails in exchange for access to the content.
5. Event Attendance
Events, like conferences, webinars, and trade shows, are a great way to connect with interested prospects and acquire new leads. Today most events are online, which can actually make customer acquisition easier as attendees have to register with their email addresses to attend (whether they pay or not). This information isn’t always easy or natural to capture when meeting prospects in person.
Customer Lifetime Value
In addition to knowing the cost of acquiring a new customer, you should know how much value a retained customer provides your business. Both of these are important metrics to calculate and compare when reviewing marketing and sales efforts.
Customer lifetime value (LTV) is the estimated net profit that an individual or business will provide over their lifetime as a paying customer.
Customer LTV is a helpful factor to consider when getting to know your customers and how they interact with your business. It also provides a clear valuation of your marketing and support efforts and helps influence business decisions across the board.
The longer a customer continues to purchase from a company, the greater their lifetime value becomes.
Customers with high LTV are more expensive to acquire, but they provide the greatest value—in terms of revenue, feedback, and referrals—than other customers.
How to Calculate Customer Lifetime Value (LTV or CLV or CLTV)
Calculating customer LTV isn’t difficult, but it does require defining a few metrics, such as average purchase value and frequency. Even if you have to estimate these numbers, having a solid customer LTV can help you predict how much revenue you can roughly expect a customer to provide throughout their relationship with your business.
Calculate average purchase value: Calculate this number by dividing your company’s total revenue in a time period (usually one year) by the number of purchases over the course of that same time period.
Calculate average purchase frequency rate: Calculate this number by dividing the number of purchases by the number of unique customers who made purchases during that time period.
Calculate customer value: Calculate this number by multiplying the average purchase value by the average purchase frequency rate.
Calculate average customer lifespan: Calculate this number by averaging the number of years a customer continues purchasing from your company.
Calculate CLTV: multiply customer value by the average customer lifespan. This will give you the revenue you can reasonably expect an average customer to generate for your company over the course of their relationship with you.
Use the same free template as above to calculate LTV
Customer Lifetime Value EXAMPLE
According to data from a Kissmetrics report, we can take Starbucks as an example for determining CLTV. Their report measures the weekly purchasing habits of five customers, then averages their total values together.
By following the steps listed above, we can use this information to calculate the average lifetime value of a Starbucks customer.
1. Calculate average purchase value: Using the report above — per visit to Starbucks:
Customer
Amount spent
Customer 1
$3.50
Customer 2
$8.50
Customer 3
$5.00
Customer 4
$6.50
Customer 5
$6.00
Therefore, the average purchase value across 5 customers is $5.90 each visit.
2. Calculate average purchase frequency rate: Number of visits per week:
Customer
# visits per week
Customer 1
4
Customer 2
3
Customer 3
5
Customer 4
6
Customer 5
3
Therefore, the average observed across the five customers is 4.2 visits.
3. Calculate customer value: Multiply amount spent x number of visits
Customer
Avg. customer value per week
Customer 1
$14.00
Customer 2
$25.50
Customer 3
$25.00
Customer 4
$39.00
Customer 5
$18.00
Average their values together to get the average customer’s value of $24.30.
4. Calculate average customer lifespan: While it’s not specifically stated how Kissmetrics measured Starbucks’ average customer lifetime span, it does list this value as 20 years. If we were to calculate Starbucks’ average customer lifespan we would have to look at the number of years that each customer frequented Starbucks. Then we could average the values together to get 20 years. If you don’t have 20 years to wait and verify that, one way to estimate customer lifespan is to divide 1 by your churn rate percentage:
To figure out your churn rate, you need to track how many customers purchased in two sequential periods and divide that by the total number of customers who bought in the first period.
To determine your annual customer churn rate, you can use this formula:
Using this churn rate, your average customer lifespan will be measured in years.
5. Calculate LTV: Once we have determined the average customer value as well as the average customer lifespan, we can use this data to calculate LTV. In the Starbucks example, we first need to multiply the average customer value by 52. Since we were measuring customers on their weekly habits, we need to multiply their customer value by 52 to reflect an annual average. After that, multiply this number by the customer lifespan value (20) to get LTV.
LTV = $24.30 x 52 x 20 = $25,272
Improving Customer Lifetime Value
Customer Satisfaction: Making your customers happier will usually result in them spending more money at your company. Companies that are actively geared towards their customer’s success are experiencing more revenue because of increased customer satisfaction.
Customer Retention: As we’ve discussed, acquiring a new customer can be a costly affair. In fact, an article published by Harvard Business Review, found that gaining a customer can cost anywhere between five and 25 times more than retaining an existing one. Additionally, a study conducted by Bain & Company found that a 5% increase in retention rate can lead to an increase in profit between 25% to 95%. This makes it imperative that your business identifies and nurtures the most valuable customers that interact with your company. By doing so, you’ll gain more total revenue resulting in an increase in customer lifetime value.
Use the same free template as above to calculate customer retention rate
Using LTV in Conjunction with CAC
By defining customer LTV alongside CAC, companies can measure how long it takes to recoup the investment required to earn a new customer—such as the cost of sales and marketing.
The Ideal LTV:CAC Ratio
An ideal LTV:CAC ratio should be 3:1.The value of a customer should be three times more than the cost of acquiring them. If the ratio is close, i.e.1:1, you are spending too much. If it’s 5:1, you are spending too little. In fact, you are probably missing out on business by under-spending and giving your competition an advantage
Assignment
(1) It’s probably too early to calculate CAC and LTV with real numbers. However, can you come up with estimates? For CAC, can you estimate how much a marketing campaign would cost (social media campaign, email campaign, etc.), and how many customers you’d expect to receive from the campaign? For LTV, can you envision 5 customers (similar to the Kissmetrics report on Starbucks) and work through the 5 steps with these figures?
Similarly, can you find industry standards? About how much are companies in your industry spending on acquiring customers? And how long are those customers sticking around?