In the previous article, I mentioned that roughly 70% of Series A and Series B companies measure their CAC. So we shouldn't assume they're not measuring customer lifetime value (LTV) along the CAC.
To calculate LTV, you first need to estimate the average lifetime of a customer (how long they will remain a customer) and then multiply this by the average revenue that the customer will generate during this period. For example, if a customer is expected to remain a customer for three (3) years and generate $1,000 in revenue annually, their LTV would be $3,000. Easy peasy.
I'm using the first example we used in the CAC calculation for a cybersecurity company; the Crowdstrike model could have the following calculation by segment.
Segment: Large Enterprise
Cohort: Customers acquired in Q1 2021
Total spend by cohort: $5,000,000
The average revenue per customer: $50,000
Customer lifespan: 3 years
LTV per customer: $150,000
Number of customers in cohort: 100
Total LTV for cohort: $15,000,000
Segment: Mid-Market
Cohort: Customers acquired in Q1 2021
Total spend by cohort: $2,500,000
The average revenue per customer: $20,000
Customer lifespan: 2 years
LTV per customer: $40,000
Number of customers in cohort: 125
Total LTV for cohort: $5,000,000
Segment: SMB
Cohort: Customers acquired in Q1 2021
Total spend by cohort: $1,000,000
The average revenue per customer: $5,000
Customer lifespan: 1 year
LTV per customer: $5,000
Number of customers in cohort: 200
Total LTV for cohort: $1,000,000
Another example would be in financial services. Again, using the previously used company - Charles Schwab, as a potential entity that wants to calculate LTV for a particular segment of clients, such as those who have opened a brokerage account. To do this, RevOps (or finance) would need to gather data on the following:
The average revenue per account (ARPA): The average revenue generated per account over a given period for one of the brokerage accounts is $500 per month.
Gross margin: the difference between revenue and the cost of goods sold, divided by revenue (easy). The gross margin for this segment is 70%.
Churn rate: lost clients that close their accounts over a given period. The churn rate for this segment is 2% per month.
Discount rate: This is the rate at which future cash flows are discounted to account for the time value of money. Let's say that the discount rate for Charles Schwab is 10%.
With this information, Charles Schwab can calculate the LTV of a client in this segment as follows:
LTV = (ARPA * gross margin) / (churn rate + discount rate - churn rate * discount rate)
LTV = ($500 * 0.70) / (0.02 + 0.10 - 0.02 * 0.10)
LTV = $3,500
Once these fundamentally essential measures are in place, they adjust to our industry and product or service. So how to make these decisions? First, there are better answers than the LTV or CAC separately. However, putting them together won't give you a picture that should trigger the remedy process yet. But it should allow you to action-digging in the right place.
Putting the ratio in the context of the industry and competitive benchmark will give us more confidence about the next steps. Here is a disclaimer and mention that there are more narrowed cases where conventional wisdom might not apply. For example, when a company is focusing its customer acquisition in a particular segment, learning the ropes in a new segment territory, or trying to break into a new adjacent market with extra resources required. Yes, then you will unlikely get a 3:1 ratio against your CAC. However, conventional wisdom suggests that anything below a 3:1 ratio is unhealthy. RevOps must be ready with a reasonable justification and "why" behind it but, most importantly, to elaborate on when the ratio is achieved. Again, remember that you must contextualize a broader picture before taking or recommending actions.
However, once your data and narrative story are ready, you must focus on the possible course of action. To make a recommendation, you must dig deep into the reasons behind lower ratios. Once you understand the nature of the problem, consider a few typical directions you should take your business.
Re-evaluate your pricing strategy: The company may need to reassess its pricing strategy and determine if it is too high or too low. They may need to adjust their pricing based on their customer's willingness to pay or find ways to increase the value of their product to justify their current pricing. Or you might undersell your product as well. There are many ways you can check that.
Improve customer retention: Easier said than done, but the truth is that to increase LTV, the company may need to focus on improving customer retention. They could do this by improving customer support, adding new features (pricing offers also help), or increasing customer engagement with their product. Often customers need to realize what they bought. Therefore, product adoption and increased customer engagement are the way. However, you must smartly show the usability of your customer's time. In the end, they are all busy. Be deliberate, sound, and respectful.
Increase customer acquisition efforts: Investing in marketing and sales to acquire new customers is another option. By "invest," I suggest relocating your resources to trade smarter. Perhaps your sales reps should be your solution consultant if you see higher conversion after several dive-deep demos or POC. This is one way to look at it, among many other possible trade-offs. For the same reason, you should constantly evaluate you're required CAC and underlying cost structure to find ways to reduce it while maintaining the quality of your new customers.
Target higher-value customers: The company could focus on acquiring higher-value customers with longer LTV potential, such as enterprise clients or customers with larger IT budgets. That only sometimes means more significant customers, although it might often be true. You must understand your install base before you get to this conclusion. Ultimately, ask yourself a simple question, how big is an account big enough? Well, time to dig into your data, and numbers will tell you the story.
Explore upselling and cross-selling opportunities: companies could look for opportunities to upsell and cross-sell existing customers on additional products or services to increase their LTV. This would require evaluating their customer needs and finding ways to add value to their product offerings. This one is a bit tricky for companies that don't have a very extensive list of products. Break down your existing product features to create them (see pricing bullet point above), leverage your partners to integrate better, or create additional services embedded in your support model. That might create optionality that, on the one hand, can convince your customer that price to value is beneficial to them without buying a bundle and feeling like overpaying. Nobody likes that.
Let's wrap. Here are a few practical suggestions for the RevOps teams before they get into the conversations with their finance teams.
It's important to note that LTV calculations can be even more granular when applied to cohorts of customers or clients. For example, Crowdstrike and Charles Schwab could calculate LTV for customers/ clients who joined in a particular year or quarter, allowing the company to see how client value changes over time. Sure, this could reflect the seasonality or linearity but also inconsistency in the acquisition and retention process.
By analyzing LTV segment-by-segment, companies can better understand which customer groups are most valuable to their business and tailor their marketing and sales strategies accordingly.
Finally, break LTV down to your GTM source, including marketing, sales, and channel sales. These additional dimensions connected with the cohorts and CAC will give you a good overview and ideas about where to dig first to improve your overall LTV/ CAC ratio.
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