Understanding the Significance of CLV vs CAC

Introduction

One of the important goals and strategies for business enterprises is to grow and make more money. To measure success and growth, businesses need various tools and metrics. This is where metrics like Customer Lifetime Value (CLV) and Customer Acquisition Cost (CAC) come into the picture.

Customer Acquisition Cost is the cost incurred by the business to acquire a new customer. On the other hand, customer lifetime value is the amount or value that the customer brings to that business in the course of their business relationship.

Both of these tools are equally important for businesses to evaluate and understand. Let us discuss them in detail and their relationship further in this article.

Understanding Customer Lifetime Value

Customer lifetime value helps a business to evaluate and plan how it can benefit from bringing a customer to the business. It explains the value that the business can get from that customer. It is important to estimate the customer lifetime value with the use of certain tools and techniques.

To determine CLV, a business must note how a customer reacts to its business strategies and the total revenue generated by that customer. It helps to ensure that your overall business strategy is working as per your expectations. It also helps to build customer relationships in the long run.

Calculating Customer Lifetime Value

A business can determine the CLV using four main steps, as discussed below:

1. Ascertain Your Order Value: The first and most important step in determining the CLV is finding the average revenue that your business has generated. You can either compile the sales for the entire year or on a quarter-by-quarter basis, as per your convenience.

2. Number of Sales Transactions: The other important factor for calculating CLV is determining the frequency of visit of a customer in your shop. You can make an estimation based on whether the customer visits several times in a week or just once or twice in the entire year.

3. Build Customer Retention Strategies: Customer retention is a crucial aspect of every business's growth. It is even more important than bringing a customer to the business. You must find out how long a customer sticks with your business. You must develop strategies for building customer loyalty toward your business.

4. Calculating CLV : After finding all the above three inputs, you can multiply them all, and the result which you get after multiplying is the CLV of your business.

Understanding Customer Acquisition Cost

Customer acquisition cost is the actual cost incurred in converting a prospect into a customer. The expenses included in this CAC are marketing expenditures, advertising, and other such costs incurred for bringing in new customers.

CAC works as an important tool to measure a company's profitability since it helps to compare the amount gained from a customer and the cost incurred in gaining that customer.

Most of the companies aim to reduce the customer acquisition cost to maintain a balance between the CLV vs CAC and to build a strong customer profitability program.

Calculating CAC

You can calculate the customer acquisition cost by following a simple approach. You must find out the total cost incurred for acquiring a new customer, which includes all your sales and marketing costs. Now divide this cost by the total number of customers gained. This will give you the CLV of your company. While finding out the total cost of acquisition, you can also include the wages and overhead expenses incurred while conducting the marketing programs.

Relationship between CLV and CAC

By understanding the relationship between CAC and CLV, you can maximize your profits and return on CAC.

Usually, there is an inverse relationship between CLV and CAC. And for most of the companies, the amount of CLV is generally higher than the other two. The lower your cost to acquire a customer, the more value you gain from that customer, and vice versa. This also generates higher marketing ROI and long-term customer relationships.

Conclusion

Both the metrics, CAC and CLV are vital for a business and reveal different aspects of it. It reveals how effectively the business is carried on and the circumstances in which you should improve. You must definitely take advantage of these metrics to understand the performance of your business and make calculative decisions.

To achieve the perfect balance between CAC and CLV, companies can take the help of Gonukkad . It will help you to optimize and monitor these tools effectively and efficiently.