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How can you improve LTV and CAC? June 15, 2010

Posted by jeremyliew in CAC, ltv.
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A lot of the startups that have quickly reached millions in monthly revenue rely on the arbitrage of being able to acquire customers through paid marketing for less than the lifetime value of that customer.

CAC < LTV

As a reminder, lifetime value, or lifetime contribution as it should perhaps more accurately be named, is given by the formula:

LTV = Expected Life x ARPU x Gross Margin

where Arpu = average revenue per user in each time period. This equation can hold whether you are in a subscription business or an ecommerce business with repeat purchase behavior. Although you need to be a bit more nuanced with non subscription businesses, the same cohort analysis techniques still allow you to approximate LTV in this manner. I’ll post more about this later.

Both LTV and CAC are key metrics that the management teams should be focused on improving.

Usually CAC is a blended average of several customer acquisition costs from several different channels. Each of these channels typically can be optimized by better targeting, better copy and creative on the advertising, better landing pages,optimization ofthe flow through to checkout, more and better payment options, and increased viral pass along.

Some of the tools that can be used to improve LTV include retention programs to extend life, cross sell and upsell campaigns to increase ARPU, and improving gross margin.

Both metrics are very important. However, if resource constraints force a choice between focusing on one or the other (it can be hard enough to do one thing at a time at a startup!), I would choose to focus on lifetime value. There are two reasons for this. Firstly, most of the improvements that can be made to LTV will improve LTV for all users, both current and future, and regardless of channel of acquisition. In contrast, many of the improvements that can be made to CAC are channel specific (e.g. copy of a particular ad) and none of them improve the economics of existing customers, only new customers. You get more leverage out of your efforts on LTV.

Secondly, because LTV is typically already higher than CAC, an x% increase in LTV has more impact to the company than an x% reduction in CAC.

I’d love to hear what others think about this choice, and about other ways to improve both CAC and LTV

Comments»

1. Sachin Rekhi - June 15, 2010

Great post Jeremy! Would love to see more discussion like this on optimizing revenue vs acquisition costs.

I definitely agree that it is often the right decision to focus early on on maximizing LTV. In addition to your reasons, I think another important one for focusing on LTV first is that you can potentially open up new acquisition channels by increasing your LTV. For example, paid search might not make economic sense for your startup when you have a low LTV, but as your LTV increases, it may become an option. And ultimately you may find it to be a better ROI to optimize a new acquisition channel that becomes available to you instead of prematurely optimizing your initial limited channels.

2. Rubicon Project To Streamline, Achieve Profit By Q4 Says Addante; Today’s M&A – IBM Buys Coremetrics; And New NY Times Frankenstein Site - June 15, 2010

[…] Lightspeed Venture Partners' Jeremy Liew writes a definitional post on his company's blog about some key metrics for many startups – where understanding the cost of acquiring customers (CAC) and lifetime value (LTV) of the customer is critical. Depending on the stage of the startup, one or the other may be more important. Read more. […]

3. Chris - June 16, 2010

Your math is a little simplistic, as it focusses on average. I prefer to do a cohort analysis, i.e. calculating the lifetime value for different segments at a different time. E.g. of 100 acquired customers via TV ads from calendar week 15 there are 80 left in week 16, 60 in week 17 and so forth, then looking at revenue per cohort.

This way you can max CAC spending on segments where LTV are even bigger, and you get an early warning system when LTV change over time. Been there, done that, works miracles.

4. Eren Bali - June 18, 2010

Nice post Jeremy.

I want to add that for startups that have a reasonable virality coefficient, we can improve the equation as
CAC 1) or the advertising game. However if you have decent virality (let’s say 0.5) and LTV, you can afford to invest on acquisition channels that are not immediately profitable.

My 5 cents,

Eren Bali
CEO & Co-founder, Udemy

Eren Bali - June 18, 2010

Sorry my comment got screwed because of the greater-than, less-than symbols.

The equation would be
CAC less-than LTV * (1+V)
where V = Virality coefficient (how many users an avg user brings to the site from various viral channels)

5. patrick - June 18, 2010

Good stuff, but gee — didn’t book clubs, record clubs, etc. pioneer this in the 1960’s? I think so…

In fact, the basic direct marketing actuarial math which has been around for decades is at the core of many web and mobile businesses today. What held them back years ago were crushing production and distribution costs — and the good ones still made tons of money doing it. You could actually jazz this up a bit by throwing in revenue bands at different confidence intervals, or some multivariate forecasting based on observed variations in leads and sales generated.

Still, another step in the right direction: accountability in marketing spend is here to stay.

.

.

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[…] How can you improve LTV and CAC? (lsvp.wordpress.com) […]

7. spanky - July 7, 2010

Yes, I agree w/ Eren, it’s imperative to model the viral ratio into the LTV calculation to get your CAC below LTV, especially in today’s competitive ad space. Another lever worth mentioning is to tweak your pricing via split tests to increase your ARPU.

8. How to estimate Lifetime Value « Lightspeed Venture Partners Blog - July 19, 2010

[…] help in accelerating decisions about marketing and customer acquisition.  I recently posted about how you can improve LTV and CAC for your subscription or repeat purchase business.  But how do you estimate Lifetime […]

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12. Why Lightspeed Invested in Bonobos | PR Blog - December 16, 2010

[…] initially steady, but has really taken off in the last few quarters as they got a better handle on Customer Acquisition Cost versus Lifetime Value. As I’ve mentioned before, companies who understand these customer level economics can […]

13. Why Lightspeed Invested in Bonobos - business-newz.info - December 16, 2010

[…] initially steady, but has really taken off in the last few quarters as they got a better handle on Customer Acquisition Cost versus Lifetime Value. As I’ve mentioned before, companies who understand these customer level economics can […]

14. Customer Lifetime Value (CLV) vs Customer Acquisition Cost (CAC) | Customer Retention Analytics - SkyGlue - January 23, 2011

[…] are constrained by resource, focusing on the lifetime value maybe more meaningful. Jeremy in his blog mentioned a few […]

15. Ritesh Tiwari - April 18, 2011

considering budgeting constraints..
the money u save on CAC aids u to target and acquire more customers and thereby have a CLV in the first place. thus optimizing CAC vs CLV is important and cannot be generalized to “investments in CLV is better than CAC”…
the catch here becomes CAC is what % of CLV… and the expected CLC(customer life cycle)
granted, for very long CLCs it would be true.

16. E-Commerce: Beyond The Metrics « UpToDateForFun - July 4, 2011

[…] at low prices. As disruptive as the online catalog has been, the success of these online stores is measured by three and four letter acronyms: LTV ?lifetime value? and COCA ?cost of customer acquisition.? […]

17. » E-Commerce: Beyond The Metrics 50psi - July 7, 2011

[…] at low prices. As disruptive as the online catalog has been, the success of these online stores is measured by three and four letter acronyms: LTV “lifetime value” and COCA “cost of customer […]

18. Finantex - E-Commerce: Beyond The Metrics | - July 31, 2011

[…] at low prices. As disruptive as the online catalog has been, the success of these online stores is measured by three and four letter acronyms: LTV “lifetime value” and COCA “cost of customer […]

19. Nick Lim - August 18, 2011

Hi Jeremy, good post. I believe that with connected games, the game industry will eventually look like traditional consumer industries, except with greater frequency and depth of touch points.

I believe the days of focusing only on player acquisition are fading. It’s time for the games industry to adopt well used customer (player) lifecycle management techniques from other consumer industries to improve LTV. Telcos and finsrv companies all have well honed loyalty programs and predictive analytics capabilities to optimize LTV.

The main business opportunity here is how to lower the barriers and cost of these programs. Telcos and finsvcs all spend upwards of millions per year on these programs with large customer or base management teams. That won’t work for games. But since more game developers can survive due to greater internet/mobile distribution, any company that can provide lifecycle management services efficiently can also reach a larger market.

In terms of LTV versus CAC, I agree that LTV is first. However, there will come a point where you want the LTV techniques to also spill over into acquisition -> ie. how to acquire players with high predicted $ value and social influence.

Best,
Nick Lim
Sonamine LLC

20. 资源有限的小团队应重点关注LTV而非CAC | GamerBoom.com 游戏邦 - August 28, 2011

[…] to hear what others think about this choice, and about other ways to improve both CAC and LTV.(soure:lsvp.wordpress) 分享到: QQ空间 新浪微博 开心网 […]

21. Cheap Chic Delivered Straight To Your Door « fashionfunded - November 9, 2011

[…] Liew again, quality should be a heavy determinant in the “expected life,” and hence Lifetime Value (LTV) of a customer, a key metric the management teams of these companies focus […]

22. Android guy - January 11, 2012

Is the formula applicable to all types of companies ? Looks like there could be some deviation when you compare it to mobile phone companies ?

23. Customer Lifetime Value (CLV) vs Customer Acquisition Cost (CAC) | Simple web event tracking for Google Analytics: SkyGlue - January 25, 2012

[…] are constrained by resource, focusing on the lifetime value maybe more meaningful. Jeremy in his blog mentioned a few […]


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