The Customer Lifetime Value to Customer Acquisition Cost (LTV:CAC) ratio measures the relationship between the lifetime value of a customer and the cost of acquiring that customer. The LTV:CAC ratio is calculated by dividing your LTV by CAC.
LTV:CAC is a signal of profitability. This metric tells you if the lifetime value of a customer is higher or lower than the marketing and sales costs to acquire that customer.
What is the formula for LTV:CAC Ratio?
If you are a scaling SaaS business your LTV:CAC ratio should be more between 3-5. A lower ratio means that you may not have product-market fit. A higher ratio (above 5) is an opportunity to invest more in sales and marketing. A ratio of less than 1 means lost revenue on every customer.
Measuring and optimizing the CAC metric can be challenging, especially if you’re attempting to attribute acquisition costs to individual accounts or customer segments - how much of your monthly ad spend or sales budget should be attributed to a specific win?
Even at the aggregate level, adding up marketing and sales costs over a given period can be misleading from a CAC perspective; in most cases marketing and sales resources are not solely focused on new customer acquisition.
LTV:CAC Best Practices
According to Jordan McBride, to reduce your CAC and optimize profit, SaaS companies need to optimize their funnel by quantifying each step of the process and understanding how many visits to leads, how many leads move to opportunities, and how many opportunities become customers. It’s also important to optimize your pricing because a huge portion of CAC feeds into the recovery period, as well as CAC ratio. McBride points out that if you optimize your pricing to gain cash up front to recover your CAC, in the form of mandatory training, integration costs, you can ensure you start making a profit as a soon as possible.