Importance of Customer Lifetime Value and Customer Acquisition Costs

Whether you’re a B2B or B2C operation, you have a customer paying for a service or a product. While the aim of any business should be to increase sales while reducing costs, the true power of a successful business lies in better understanding the information they already possess. To truly be successful, you need to understand the importance of Customer Lifetime Value and Customer Acquisition Costs for making better business decisions.

importance of customer lifetime value

For any startup company or accomplished international corporation, from SaaS to e-commerce to manufacturing, there can be annoying terminology and acronyms for every facet of the business, and getting to know all of them can be a tough ask for even the most accomplished analyst or strategist.

While the addition of unnecessary business lingo should be discouraged, there is some that can’t be escaped. Acronyms like KPI, CPA, and others, all have their place. In this post, we look at the CAC and CLV metrics and how they can aid in business growth.

Customer Acquisition Costs (CAC)

In layman’s terms, this is the amount of money you spent to acquire a customer. You can get to this number by taking the amount you spent on marketing and advertising, then dividing it by the number of customers acquired during that same period. It should give you a cost of X per customer.

Customer Lifetime Value (CLV)

Also called CLVT, LCV, or LTV marketing, this metric measures a customer’s value to a company over a set period of time. Though it sounds easy enough, there are sophisticated prediction models that could confuse a lot of people. Have a look at this generic calculation from Gupta et al., 2006:

This extended metric is enough to make one shiver, and exhausting just to look at. It can also make the average, hard-working entrepreneur feel inadequate. If you are able to outsource this specific calculating exercise, then that’s fantastic! Failing that, there are simpler ways to get to an applicable solution.

Here is the simple version of CLV. Without over-simplifying it, take the average annual customer profit and multiply that figure by the average duration of customer retention. Granted, getting to those two averages takes a bit of effort, but it is not too complex. That said, this calculation will give you a new insight to your business, and also to your customer.

The importance of Customer Lifetime Value is that it forces companies to shift their focus from quarterly profits to a long-term business relationship with their customers.

Benefits of CAC and CLV

Okay, now what? What do you do with this information? And what exactly do these two customer tracking processes have to do with each other?

Once you have calculated how much it cost you to acquire a customer and how much that customer spends, you can expand on all the other elements of your business. Just think about it for a bit. Not only will you be able to estimate the financial value of each customer, but you will know what that customer had cost you to obtain in the first place. From there, you can strategise more efficiently in the following ways:

Sell, sell, sell

importance of customer lifetime value

A business survives on sales. Maybe not sales alone, but sales are certainly the primary source of income for most types of commerce.Whether you are selling a service, a product or even an idea, you are still reliant on selling something to someone.

Using the CAC and CLV effectively, you will know exactly where and how to spend money on in order to increase the right type of sales. More importantly, you will identify areas where you can up-sell or cross-sell. Nothing tops seizing an opportunity to diversify revenue streams and to boost customer conversion rates.

Service, service, service

If sales is the primary source of income, then service must be the primary component of income retention. A customer’s continued support or spending, is vital to your business. The customer coming in every morning to buy a cup of coffee, is as much a cash-flow focus point as the client who has a subscription to your unique mobile app.

By applying the CAC and CLV metrics, your customer retention and the user experience suddenly becomes entwined. You will instantly know when something is wrong because you will suddenly feel the lifetime value of your customer shrinking. Providing a superior customer (especially after-sales) service experience will almost instantly affect your CLV.

Improve, improve, improve

Essentially the idea is to improve every facet of your business. If the bottom line is not going up, then there is little point in going on. Paying close attention to your cost per customer acquisition will enable you to spend money on the marketing efforts that deliver the right type of customer.

importance of customer lifetime value

Improving the length of your relationship with said customer, or getting them to spend more money with you, is paramount to the longevity of your enterprise. Securing customer loyalty is worth its weight in gold.

While Customer Acquisition Costs and Customer Lifetime Value both seem like numbers on a page, their use in fine-tuning your business has proven many times over. Even in the current high-tech digital world, the customer still is the most important aspect to any business platform.

In fact, technology has made it far easier to gather information and to track the customer experience. Whether you tracked the information required for the above metrics through campaigns or during day-to-day business, the data will still provide you with a calculable result that you can improve on.

What you do with those figures are what counts. It’s not uncommon for companies to outsource the collection, analysis and reporting of data, and then to do nothing with the results. Once you understand the importance of customer lifetime value and Customer Acqusition Costs, you should aspire to reduce your CAC and increase your CLV. After having begun the exercise, endeavour to conclude it by improving on it.