When using paid advertising, there are two metrics that can help you ensure your paid marketing campaigns are bringing in a ROI for your business. Despite what many people think, these metrics are not Click-Through-Rate, Conversion Rate or Impressions. The two metrics you should use are Customer Acquisition Cost (CAC) and Lifetime Value of a Customer (LTV).
What is Customer Acquisition Cost (CAC)
Customer Acquisition Cost is the cost of acquiring a customer throughout the whole buyer’s journey. This means what you spend taking a person from being a cold lead (someone who does not know your brand), to a warm lead (someone who has interacted with your brand), up until they actually buy from your company (a customer).
How to Measure CAC
Measuring CAC varies in different industries, but we will provide a few examples below.
- Small Business – Lead Generation:
Let’s say we have a membership gym that is advertising on Facebook, we can call it Blue Gym. Blue gym is selling a paid trial for $10, and it costs $6, on average, for someone to make the purchase through their advertising strategy. One would think the CAC is $6 and therefore the ROI is $4 for each special sold. However, this is not the case, as people who purchase the special are not actually members; these individuals are actually qualified leads.
We would need to take a closer look at closing rates for the trials to determine what percentage of these individuals actually become members. Let’s say this gym converts 33.33% of their trial members into full memberships. This would mean that you would need three people to buy a trial in order to get a full member, making your CAC $18 ($6/.3333). For this example, the CAC can be calculated by the average cost of a trial or ACT divided by Trial Conversion Rate or TCR. The formula you would need in this case to calculate CAC is ACT/TCR.
Now let’s calculate the ROI for the gym’s advertising. We can do this by finding the Lifetime Value or LTV (we will go into more detail about Lifetime Value below) of a customer. If the average length of a membership is 8 months and the membership is $100 per month, the LTV of a member $800. This means that for every $18 of ad spend on this campaign, the gym will make – on average – $800 back in revenue.
- Small Business – Sales
Now let’s say this same gym implements a new way to buy memberships online and tries to use the same strategy to sell full memberships directly online instead of paid trials. The marketing team tries it out and finds out that it costs the gym on average $60 of ad spend to get someone to sign up for a membership.
This CAC is pretty simple. Since this is a direct sale, the gym’s CAC is $40. The gym owner thought that even though the CAC was higher, it was a good exchange in order to get members at a faster rate. However, the gym owner quickly realized that the average membership length for people who bought memberships directly online decreased from 8 months to 3, greatly decreasing their ROI on this campaign and eventually making him decide to go back to the drawing board for a new strategy.
How to Use CAC in Marketing
The examples we’ve used here were focused on paid advertising. However, CAC can also be applied to Influencer Marketing or the later stages of a SEO campaign. By using CAC, you can evaluate the results of your efforts across different marketing channels and increase your ad spend in the channels that bring the greatest ROI for your business.
What is Lifetime Value (LTV)?
The lifetime value of a customer is the average amount of revenue that a customer generates during their lifetime. Lifetime value is an important metric to every business, yet it is often overlooked by SMBs. Knowing the average lifetime value of your customers is crucial in order to measure the success of marketing campaigns. Having a better idea of this metric can also provide additional insight about your marketing efforts that you previously thought were bringing in revenue, but which in reality are not.
This scenario tends to happen to many businesses when they run a marketing campaign and fail to calculate the average lifetime value of a customer from a specific channel. Calculating the lifetime value of a customer by marketing channel and campaign can also give you insight into the quality of leads or customers that you are generating from a specific channel and campaign.
How to Use LTV in Marketing
Let’s take a look at two different marketing campaigns and how we can use LTV to measure the effectiveness of the campaigns.
Going back to the membership gym example, let’s pretend that a competitor gym, Red Gym wants to run a flash sale for $1 for three trial classes. The owner runs a marketing campaign for this flash sale and spends $1,000 on advertising. By the end of the campaign, he sees that 200 people took advantage of the $1 sale. Since this cost him about $5 for a lead to come try out his gym, he deems the campaign a success.
However, looking more closely at the campaign’s analytics, he noticed that only 100 of the 200 flash sale buyers actually came to the gym for their trial classes, and that of those 100, only 40 people completed all three trial classes, and 8 purchased a membership. Thinking his average customer has a lifetime value of $800, the gym owner still thinks his campaign generated a good ROI with a CAC of $125.
Digging deeper into the data tells a different story. The gym staff kept track of these new members. Of the 8 individuals who became members, six canceled their memberships after one month and the other two new members quit after two months. Calculating the revenue from the $1 trials – $200 – and the memberships of the customers that converted at $100 per month each – $1,000 – the owner only made $200 in this marketing campaign.
Although the owner did make a profit, let’s look at the CAC and average LTV of this marketing campaign. The CAC for a new member was $125. However, for the members of this campaign, the LTV was not $800 but $125, meaning that the only money he made was from the return on ad spend from the ad itself.
This may seem profitable on paper, but if you take into account the cost of running your business and paying your staff, this campaign is probably not sustainable. On average, you would want to aim for a CAC that is at least three to five times less than the LTV of your customer (from that channel) for your campaign to be profitable and sustainable.
- Cost Per Lead: $5
- CAC: $125
- LTV: $125
- CAC:LTV Ratio 1:1
- ROI: $200
Blue Gym also ran a slightly different promotion at the same time. This promotion was $10 for three trial classes and training gloves, which cost the gym $10. The owner also spends $1,000 on a marketing campaign and ends up selling 33 trials. Out of those 33 leads, 20 show up, 12 finish their trials, and 6 become members.
One of these members quits after two months ($200), another two quit after 6 months ($1200), another two stay for 10 months ($2,000), and one of them stays for a year ($1,200) bringing in an average lifetime value of $766 per customer. This campaign generated $4,600 in revenue on a $1,000 ad spend.
- Cost per Lead: $30.30
- CAC: $166.66
- LTV: $766.66
- CAC:LTV Ratio 1:4.7
- ROI: $3600
If none of these metrics had been calculated except the Cost per Lead and CAC then you would have probably assumed Campaign 1 was more successful and viable then Campaign 2 but when you add in the rest of the information the picture becomes much clearer and it is easy to see that Campaign 2 was much more successful.
Why was one campaign far more successful than the other?
You may be wondering why in Campaign 1, the members didn’t stay around for long like they did in Campaign 2 or why a smaller percentage actually showed up and finished their trial.
It all came down to one thing: pricing.
When a customer pays for a service, they are expecting the quality to match the price. When the offer was $1, many people didn’t show up, because their investment of $1 was so low they didn’t really care if they lost it. The individuals who paid $10 have more to lose. Another issue with Campaign 1 is that getting people to jump from paying $1 to paying $100 per month is a much harder task than getting them to increase their monthly expenditure from $10 to $100.
People who pay the $10 are closer to your target market and current customer base (think demographics), making them more qualified leads than the leads from Campaign 1. So although the leads from Campaign 1 cost less, they were not nearly as qualified as the leads in Campaign 2, so they were much less likely to convert to a full membership and stay members for a longer period of time. This may be due to various factors like commitment to fitness, income levels, lifestyle choices, etc.
We hope that this post was helpful to you and that we have given you some things to consider when you craft your next marketing campaign.
Click here to view a spreadsheet that helps you calculate your Customer Acquisition Cost and Average Lifetime Value – Make the most out of your next marketing campaign!