LTV and CAC: build the right metric, please.
Digital is all about metrics, right?! So, why don’t use the right one.
Much of the literature and blog posts world about LTV and CAC is focused on pushing the idea that the metric for you to keep under control is LTV/CAC.
It seems reasonable that taking the LTV, the CAC and combining them into a ratio gives you a clear view of your business.
Well, LTV/CAC is for sure a useful metric to be in control of. But does it tell us what we want to hear?
The meaning behind LTV/CAC ratio is to understand how the business is efficient in its growth process.
In other words, it tells you how much value you get out for every euro spent in acquisition.
The higher the value and, of course, the better for the business.
It’s like driving a car with a consumption of 20 km/l instead of 10. If you want to drive from Rome to Berlin, you need to invest less if your car runs at 20 km/l.
Back to our business, you can achieve your goal with a lower investment.
The profit metric: LTV - CAC
Let’s take the LTV and the CAC and combine them into another metric: LTV – CAC.
This is not an efficiency measure of the growth process. From it we get an absolute value, in euro/dollar, which represents the income statement of the average customer.
Such value is directly related to the upper part of the whole company income statement and hence, tells the entrepreneur how he’s going to pay the bills at the end of the month.
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According to the car example, it’s like having under your buns a 120CV car instead of 90CV one. When you push the pedal, no matter how efficient you are, you just get more power with 120CV and hence get to Berlin (the goal) faster.
In fact, consider the entrepreneur asking himself how he could raise the business profits. Is it better to make the acquisition more efficient by lowering the CAC or improving the customer repeat purchases (i.e: one the components of the LTV)?
According to the LTV/CAC metric, it seems that lowering 10% the CAC is better than improving 10% the customer repeat purchases.
While, according to the LTV - CAC metric, lowering 10% the CAC is worse than improving 10% the customer repeat purchases.
The LTV - CAC tells the truth.
The LTV - CAC metric is a direct expression of the business profitability. So, coming back to the question above, you would rather improve the customer repeat purchases instead of lowering the CAC when you want to generate more profits.
By the way, if you want to be prepared to cope with LTV - CAC worse-case scenario, just have a look at how making LTV-CAC a more meaningful metric.
Is LTV/CAC useless?
No, LTV/CAC is an efficiency metric. While LTV – CAC is a metric directly related to your profits.
The two metrics tell us that looking for a lower CAC is the best way to scale making an efficient use of money, but it’s not the best way to pay the bills faster.