Most brands are embracing omnichannel approaches for their eCommerce brands, aiming to captivate consumers and boost sales regardless of device or time. However, the question remains: which online avenues deserve investment? Which channels will attract the most customers and generate the most revenue? More importantly, which channels align best with your unique business?
A clear understanding of key factors can significantly simplify the early stages of product-market fit, which can be a turbulent journey. For any eCommerce business, the trinity of success lies in three crucial metrics: Customer Acquisition Cost (CAC), Return on Ad Spend (ROAS), and Customer Lifetime Value (LTV). Read on to discover what each metric signifies and why they are so essential.
What is ROAS?
Return on Ad Spend (ROAS) is a straightforward metric: for every dollar you invest in advertising, how much revenue do you get back? For example, if you’ve invested £1 and earned £3 in return — your ROAS would be £3. Focusing on ROAS certainly has merit, incentivising profitable sales. But, it’s not a magic wand.
While aiming for a specific ROAS may feel secure, it can backfire. By capping your spending and fixating solely on ROAS, you might neglect acquiring new consumers and that would hinder your expansion.
So, while ROAS remains a vital marker, it’s crucial to recognise its limitations and also learn why focusing on customer acquisition costs can be a more nuanced and effective strategy to drive sustainable growth.
How To Calculate ROAS?
Want to know how effective your marketing campaign or channel is? Return on Ad Spend (ROAS) is like measuring the immediate profit from a single sale without considering the long-term value of that customer.
Calculating ROAS is simple: divide your revenue generated by the amount spent on advertising. This tells you how much you earned for every dollar invested, often expressed as a percentage.
ROAS = Revenue Attributed to Ads / Total Advertising Costs
Focusing solely on ROAS risks overlooking the bigger picture. Just because a campaign delivers immediate return, doesn’t guarantee long-term success. For example, you’re focusing on selling single cookies at your bakery. Although you might make a quick profit, you’ll miss out on loyal customers who buy whole cakes.
This is where LTV-based ROAS comes in. LTV, or Customer Lifetime Value, takes into account the total revenue a customer brings.
Essentially, ROAS is like measuring your immediate profit margin while LTV-based ROAS considers the ongoing value of your customer base. Both are important, but relying solely on short-term gains can lead to a less sustainable future.
What is Customer Acquisition Cost (CAC)?
How much does it cost to attract a new customer? That’s where Customer Acquisition Cost (CAC) comes in. It’s the total expenses incurred, from marketing to sales, divided by the number of new customers acquired. Think of it as the price tag for each fresh face in your business.
CAC is a vital metric for various reasons. For marketers, it helps gauge the effectiveness of their campaigns, calculating the return on investment (ROI) in terms of customer acquisition. For investors, it offers a quick glimpse into a company’s profitability and growth potential. Whether you’re a small startup or an enterprise, understanding and minimising CAC is key to sustainable success.
The Difference Between CAC and ROAS
While CAC and ROAS (Return on Ad Spend) are both crucial eCommerce metrics for performance, they serve different purposes. CAC delves deeper into the cost side, whereas ROAS focuses on the immediate revenue generated from advertising efforts. However, neither tells the whole story. CAC doesn’t reveal average order values or customer lifetime, while ROAS estimates can vary significantly across different channels.
In essence, CAC provides the “price” of customer acquisition, while ROAS measures the “payoff” within a specific time frame. Both pieces of information are critical to build a successful customer acquisition strategy, but their limitations require further analysis.
How To Calculate CAC?
Customer Acquisition Cost (CAC) tells you how much it costs, on average, to acquire a single new customer.
Calculating CAC is actually quite simple:
- Step 1: Gather your expenses: Add up all costs related to acquiring customers, such as advertising, salaries, overhead, etc.
- Step 2: Choose a time frame: Determine the period you want to analyse, whether it’s a week, month, quarter, or even a year.
- Step 3: Count your new customers: Track the number of new customers acquired during the chosen timeframe.
- Step 4: Divide expenses by customers: Simply take the total expenses from step 1 and divide it by the number of new customers from step 3.
For example:
Your company spends £200,000 and attracts 2,000 new customers in a month.
Your CAC for that month would be £100 (£200,000 / 2,000).
But is your CAC “good”? Several factors play a role:
- Desired Growth Rate: How fast do you want to grow your customer base? It needs to balance out factors like market conditions, financial resources and internal capabilities.
- Achievable CAR: Can you realistically acquire enough customers at your current CAC to reach your growth target? Analyse your past acquisition rates and identify the channels that have a higher potential for increased volume.
- Ability to scale CAC: Can you optimise your marketing channels or increase customer lifetime value to bring down CAC and sustain aggressive growth?
Remember, there’s no one-size-fits-all “good” CAC for aggressive growth. It’s a strategic balance between speed, cost, and risk tolerance.
A healthy CAC allows your business to grow sustainably. By understanding the factors that influence it, you can make informed decisions and optimise your customer acquisition efforts.
What is Customer Lifetime Value (LTV, CLTV, CLV)?
Knowing how much value a customer brings to your business is crucial, regardless of how much it costs to acquire them. This is where Customer Lifetime Value (LTV) comes in.
Simply put, LTV is the average total amount of revenue a customer generates throughout their relationship with your company. Whether you offer a subscription service or run an online store, understanding LTV allows you to predict future income and make informed decisions.
For instance, in a subscription service, LTV can be calculated by averaging the revenue generated from each customer until they cancel. In an online store, it’s the total value of their purchases over a defined period.
The simplest way to estimate LTV is to analyse historical data: calculate the total revenue for each customer and find the average. However, not all customers are created equal. Analysing LTV by customer acquisition channel reveals which channels bring in the most valuable customers, informing your marketing and resource allocation strategies.
Knowing your LTV empowers you to:
- Predict future revenue: Understand what level your CAC needs to be. LTV forecasts help you plan strategically and secure funding.
- Optimise marketing efforts: Allocate resources to channels that attract high-LTV customers.
- Prioritise customer retention: High-value customers deserve extra attention and loyalty programs.
How To Calculate LTV?
In business, while customer acquisition is vital, it’s incomplete without measuring Customer Lifetime Value (LTV).
Just as someone might value their future earnings, LTV captures the average revenue a customer generates throughout their relationship with your business. Essentially, it tells you how much money a customer is truly worth — a vital metric for assessing the effectiveness of your customer acquisition efforts.
Calculating LTV might seem daunting, but it’s actually quite straightforward. Think of it as a simple equation:
Customer Lifetime Value = Customer Value x Average Customer Lifespan
Let’s break it down:
- Customer Value: This represents the average revenue a customer brings in per period. To calculate it, multiply the average order value (total sales divided by order count) by the purchase frequency (total orders divided by total customers).
- Average Customer Lifespan: This measures the average duration of a customer’s relationship with your company. Calculate it by finding the average number of days between a customer's first and last order.
By combining these two factors, you arrive at the LTV: the average monetary contribution a customer makes over their lifetime as your customer.
In essence, LTV sheds light on the true potential of your customer base to optimise your strategy for long-term profitability and sustainable growth. Just like focusing on both diet and exercise is crucial for optimal health, considering both customer acquisition and lifetime value is key to achieving business success.
LTV:CAC Ratio
The LTV:CAC ratio compares your Customer Lifetime Value (LTV) to your Customer Acquisition Cost (CAC). It’s a vital metric for eCommerce brands, revealing how much revenue you generate from customers compared to what you spend to acquire them.
A healthy LTV:CAC ratio signals a sustainable business. Ideally, you want LTV to be higher than CAC, meaning you earn more from customers than you spend to acquire them.
Understanding the Ratio:
- LTV:CAC = 1:1: Breaks even
- LTV is less than CAC: Losing money on each customer
- LTV is higher than CAC (2:1-4:1): Profitable customer acquisition
- LTV much higher than CAC (5:1+): Potential for growth
Make LTV:CAC a Collaborative Metric
The entire team should own and contribute to improving LTV. From marketing driving sales to operations managing costs and customer service fostering loyalty, each action impacts the ratio.
Data-Driven Decision Making
Use data and analytics to understand what drives LTV in your context. Identify profitable channels, analyse customer behaviour, and make informed decisions to maximise your LTV:CAC ratio and unlock sustainable growth.
What is CPA vs CAC?
Before diving into optimising acquisition, let’s differentiate between CPA (Cost per Acquisition) and CAC (Customer Acquisition Cost). Both KPIs relate to user acquisition, but they track expenses at different points in the marketing journey.
CPA:
- Focuses on individual campaigns and lead generation, not necessarily paying customers.
- Measured at the campaign level.
- Prioritises platform conversion points. You only pay for actions that bring you closer to your goals, be it purchases, sign-ups
CAC:
- Represents the average cost of acquiring a paying customer.
- Calculated by dividing total marketing spend by the number of new customers acquired.
- A crucial metric for both individual campaigns and overall marketing effectiveness.
Importance of CAC:
A healthy CAC ensures sustainable business growth. In a competitive advertising landscape, an advertiser focused on CPA as their primary metric may be able to bid more aggressively than an advertiser who optimises to their ROAS.
Key Uses of CAC:
- Evaluating Campaign Success: Analysing the success of promotional campaigns and identifying the most effective channels.
- Guiding Financial Decisions: Allocating marketing resources efficiently and predicting new revenue needed for expansion.
- Securing Funding if you're you're a startup: Convincing investors of financial viability and justifying resource allocation based on realistic calculations.
- Cash Flow Forecasting: Predicting cash flow based on CAC to avoid unexpected financial limitations.
Reducing CAC:
- Target the Right Audience: Focus marketing efforts on specific user segments to avoid wasted resources.
- Plug Funnel Leaks: Optimise the sales funnel to prevent customer loss at various stages.
- A/B Test Ads and Landing Pages: Experiment with different variations to identify the most effective ones.
- Discontinue Underperforming Tactics: Stop investing in strategies that aren't driving results.
- Focus on High-Performing Channels: Leverage successful channels with proven conversion rates.
Bonus: Remember, the LTV/CAC ratio measures a company’s viability by showing how much revenue new customers generate compared to acquisition costs. Aim for a high ratio to ensure the success and profitability of your customer acquisition efforts.
When focusing on long-term revenue potential, Customer Acquisition Cost (CAC) can be a more reliable metric than Return on Ad Spend (ROAS). This applies especially when you expect repeated purchases or subscription renewals from new customers, generating increased value over time. In such cases, you can afford to accept a lower short-term ROAS and prioritise customer acquisition for future gain.
However, achieving a balance between immediate profitability and long-term growth remains a constant challenge. It’s like a tug-of-war, with short-term profit pulling in one direction and long-term potential pulling in the other. The choice of where to place your focus, how much emphasis to give each side, determines your strategic direction.
Need a fresh perspective? Let’s talk.
At 360 OM, we specialise in helping businesses take their marketing efforts to the next level. Our team stays on top of industry trends, uses data-informed decisions to maximise your ROI, and provides full transparency through comprehensive reports.
