LTV, CAC, CRR: what do they mean, how to count and what are really useful
Business is about calculations and exact numbers that underlie any action. What numbers are important for almost any company and what they give – in this article.
LTV is lifetime value. That is, the profit that you will receive from the client for the entire time of working with them. Other names: CLV or CLTV (customer lifetime value).
This metric is very important in marketing, advertising, sales, especially for e-commerce. And that’s why:
- One way to calculate ROI (return on investment) involves LTV. ROI is one of the few ways to assess whether your advertising is paying off or taking your business into the red;
- LTV helps you identify targeting audiences in marketing and better understand how your business works;
- knowing the real lifetime value of the customer for the business, you can build a more effective advertising strategy and modify the customer retention strategy;
- helps in customer segmentation, as it shows which part of the audience is most profitable for the business.
There are several ways to calculate LTV. The more complex the formula, the more realistic the result is, because less error.
Formula for calculating LTV #1
LTV = (customer revenue) – (customer acquisition and retention costs)
Formula for calculating LTV #2
LTV = (average sales value) * (average sales per month) * (how many months the customer is held)
Formula for calculating LTV #3
LTV = ((T * AOV) * AGM) * ALT,
where T is the average number of sales (orders) per month
AOV – Average Check
AGM – profit share in revenue
ALT – the average duration of the client’s interaction with the company (in months)
We recommend calculating the LTV for each of the formulas and deriving the average from all results.
CAC stands for customer acquisition cost. This is the amount of how much one new client costs the business. Another name: user acquisition cost – the cost of a new user.
Why we need to know the cost of attracting a customer (besides the obvious benefit in understanding the financial situation in marketing):
- To calculate and be able to improve the LTV / CAC metric, that is, the ratio of profit from one client to the amount of funds spent on attracting him/her (about it below).
- To be sure that the cost of attracting a customer is not more than the company can afford economically, i.e. that attracting a client does not cost more than the profit received.
- Knowing the CAC, you can think of ways to optimize this metric in order to spend less on acquisition and, accordingly, leave more money in the company.
Formula for calculating CAC #1
САС = (the sum of the cost of attracting a customer for the period t) / (the number of new customers for the same period t)
Important! For the result to be reliable, it is important to include all components in the cost of attracting clients: salaries for specialists who are engaged in advertising, the cost of pictures for advertising posts from a designer, payment for the work of an author who writes advertising posts, communication costs, and so on.
Based on this:
Formula for calculating САС #2
where MCC is the total cost of advertising campaigns to attract new customers
W – salary for specialists who are engaged in setting up customer acquisition channels
S – software costs
PS – costs for additional services (design, copywriting, etc)
O – marketing and sales spending
CA – the number of customers attracted by the specified funds (not all the customers who came, since they can also be brought by free promotion methods, but specifically customers from the considered advertising sources)
We spent $ 250 (MCC) on advertising campaigns, specialists were paid $ 150 (W), software costs $ 15 (S), additional services – $ 30 (PS), overhead costs were about $ 15 (O). In total, 65 clients were attracted (CA).
Total: (250 + 150 + 15 + 30 + 15) / 65 = $ 7.07. That is, it took us $ 7.07 to attract one client.
CRR stands for customer retention. It is a ratio that measures the ability of a business to maintain a relationship with a customer. If the CRR is high, it means that customers are coming back to you for new purchases. If it is low, it means that they make one purchase from you and do not come back. Customer retention work begins with the first contact between the business and the individual.
Formula for calculating CRR
where E is the number of clients at the end of the billing period
N – the number of clients received during this period
S – the number of clients that already exist at the beginning of the billing period
For example, at the beginning of the year we had 10 clients (this is S). For the whole year we have attracted 35 more clients (N). By the end of the year, 5 clients stopped using our services, in total, the total number of active clients at the end of the period was 40 people (E).
CRR = (40 – 35) / 10 = 0.5 * 100% = 50%. Our total retention rate is 50%.
LTV / CAC is the ratio of the customer’s lifetime value with, in fact, the duration of his “life” for the company. This metric marketing is conventionally called the quality of the client, that is, how profitable the client is for the business financially.
When LTV is bigger than CAC, the company can live. When, on the contrary, it’s less, then it’s time to change something
A good metric is LTV / CAC = more than 3. In this situation, it turns out that each $ 1 invested in attraction brings the company $ 3. Not bad, right?
What about other ratios:
1:1 or less is bad, because for every dollar invested, you get a dollar;
2:1 – very low return on customer acquisition costs;
3:1 – the business is productive and profitable, it is worth striving for;
4:1 – it’s time to give interviews on business management.
When to calculate marketing metrics
CAC and LTV are important to calculate and use during the forecasting phase. Within the same niche, there may be multiple customer groups that have different acquisition cost, conversion revenue, and lifetime value. In this case, the calculation and forecast must be made for each category of customers separately.
When planning capital investments for attraction, it is important to determine the break-even point of the business. This is the moment when the acquisition costs are equal to the income received from the client.
Let’s take a look at the 2 typical cases.
Case 1: the customer predictably won’t repeat conversions.
In this case, the income from its conversion (point 3 on the graph) should definitely be greater than the total cost of attracting it (point 1). If the income turns out to be less, the activity will be unprofitable.
Case 2: customer lifetime value is high. Here it is important to determine the relationship between the cost of attracting a buyer (point 1) and its lifetime value. In this case, the income from the first conversion is admissible below the break-even point (point 2). However, thanks to subsequent conversions, the investment pays off (point 4).
As you can see, it is imperative to segment customers so that the indicators are calculated correctly and do not mislead us. For the calculation, consumers are divided into groups according to certain criteria. For example, if we work with language courses, we can choose the following division:
1 – clients only go to group classes,
2 – order both individual lessons and group lessons,
3 – individual only,
4 – speaking club only.
We calculate the indicators separately for each of the groups.
The customer retention rate will be different in each case. Analyze and look for the correlation between the indicators: from which group the customer leaves more often; where the costs of attracting is higher; what is the retention period in each case. Calculating LTV for each group makes it possible to decide which type of customer is better for the business to acquire in order to get the maximum benefit.
– How do you know how many customers are coming from specific channels and sources?
Use the Google Analytics report by sources and channels; add UTM tags to all sponsored links; connect call tracking if most of your customers come through phone calls. Plan a tracking method for each customer acquisition channel you have.
– What if leads do not turn into customers immediately, but after a while?
Even if customers converted months after the first interaction, you can correctly count the number of customers using end-to-end analytics. End-to-end analytics is a built-in connection between the source where the visitor came from and his first purchase, whenever it was made. And thanks to a properly configured attribution model in Google Analytics, we can identify the primary source and properly distribute the weight among all channels and sources.
– Who should count all these indicators?
Business analyst, marketer, entrepreneur. The commercial director also needs to know these metrics.
– Are the calculations for evaluating advertising and marketing in a complex somehow different?
No, they are not. Media Buying is part of marketing and uses the same KPIs.
– What are the most common mistakes related to LTV, CAC, CRR and LTV / CAC ratio?
The main mistake is that very few people consider it. And those who want to count face technical difficulties, because Excel pivot tables, CRM customization and other nuances are needed. This repels some of the people – and then the business lives without clear financial indicators of its existence.