Customer lifetime value (LTV) and customer acquisition cost (CAC) are two terms that all Shopify brands hear constantly. Independently, these concepts are highly useful for the growth of DTC subscription businesses — but they are especially valuable when compared with one another. Knowing your LTV:CAC ratio allows you to directly monitor your brand’s health and can be instrumental in informing marketing efforts and optimizations.
Of course, simply understanding how to calculate LTV:CAC is just the beginning. It’s crucial to be able to grasp whether your brand actually has a “good” LTV:CAC ratio in order to then improve your business. Luckily, we’re covering everything you need to know.
We’re diving into the ins and outs of LTV:CAC — including how to calculate it, the ideal ratio, and tips on improving this metric.
As always, we like to start with the basics to ensure we’re all on the same page — and of course, if you’re already familiar with the LTV:CAC ratio definition, feel free to skip this section.
Let’s start with lifetime value (LTV), also known as customer lifetime value (CLTV) — a common term often tossed around in eCommerce marketing. LTV measures the total income that a brand expects to earn from a given customer over the course of the customer’s time buying from the brand. For businesses, the goal is to increase LTV as much as possible — because a higher LTV means more revenue and likely more loyal customers.
Shopify has a helpful breakdown that explains how to calculate LTV because it isn’t always the easiest metric to figure out. You’ll need to figure out your average order value (AOV) and multiply it by your purchase frequency in order to get your customer value. From there, you’ll need to multiply this figure by the average customer lifespan.
Since subscription businesses are contractual and you can identify the exact moment a customer churns, it’s easier to ascertain your average customer lifespan.
It’s an important (albeit obvious) fact that starting with the right data is essential for ensuring your calculated LTV is accurate. If you are beginning with, say, an exaggerated AOV, you’ll end up with an incorrect LTV calculation.
As for customer acquisition cost (CAC), it refers to the average cost of gaining a new customer. CAC is calculated by dividing your total sales and marketing spend over a period of time by the number of customers that you gained in that same time period.
So the ratio of customer lifetime value to customer acquisition cost is simply a mathematical comparison of these two metrics. Knowing this figure helps you monitor exactly how much you should spend on your new customers and how significantly your investments pay off. Essentially, it’s a way to make sure you’re bringing in more money than you’re spending — as well as a tactic to identify growth opportunities.
LTV:CAC ratio has been an especially topical conversation recently. With customer acquisition costs on the rise due to a variety of factors, brands have been more and more concerned with keeping their spending in check while maximizing their revenue. But more on that later.
Let’s take a quick trip back to our middle school math classes for this one. Just like any ratio, it boils down to simple division — and the LTV to CAC formula is no different.
Here’s how to calculate your LTV:CAC ratio: take your customer lifetime value and divide it by your customer acquisition cost. That’s it. For the visual learners out there, here’s a graphic:
So let’s say your customer lifetime value is $1,000 and your CAC is $500. $1,000/$500 is 2, so 2:1 would be your ratio.
We’ve said it before and we’ll say it again: is there ever one golden rule that applies to every single eCommerce brand in existence? Of course not. Your metrics — along with what’s considered healthy for your brand — can vary based on your industry, how long your brand has been around, the size of your brand, and other factors.
Having said that, we know “it varies!” is hardly a helpful response. And it’s also inaccurate to claim that all brands are too unique to generate relevant estimations and benchmarks.
This is all to say: it’s generally agreed that, at a bare minimum, a good LTV:CAC ratio should be 3:1. In other words, brands should typically be making at least three times whatever they spend to acquire a customer. But take this with a grain of salt.
Even if you’re not precisely operating by this 3:1 benchmark, you can still use your brand’s ratio to more broadly assess how you’re doing and what changes you might need to make.
For example, if your LTV is lower than your CAC, that indicates that you’re spending too much on your customer acquisition and you’re failing to effectively earn back your investment. If your LTV is comfortably higher than your CAC, you’re in a good spot in terms of earning back what you invest in acquisition. However, if your LTV is significantly higher than your CAC, that may signify that you have more room to grow and can afford to increase your spend on customer acquisition.
Consistently measuring and monitoring your LTV:CAC ratio is a smart way to have a finger on the pulse of your brand’s success.
The most important question you’ll probably have after getting an accurate sense of your LTV:CAC ratio is what you can do to improve it. And given the climate of rising customer acquisition costs, it’s more likely that you’ll be looking at a lower LTV:CAC ratio. This means most brands are in a position where they are looking to increase their LTV — and one of the best strategies to do so is to lean into retention and post-purchase marketing.
Of course, if you are in the less-likely position where your LTV is significantly higher than your CAC, this is a great signifier that you can afford to play up your marketing efforts (as we’ve discussed). As you’re funneling more money into your marketing, it’s always a good practice to ensure you’re making smart decisions instead of just throwing money at the wall. Some great ways to optimize your marketing efforts include targeting the right audience by leveraging your data as well as testing and refining your advertising channels & campaigns.
But we’re big believers that the future of eCommerce is in post-purchase marketing, a known LTV driver — so here are some strategies to help boost your LTV and improve your LTV:CAC ratio:
Ultimately, customer churn is the enemy of LTV. Putting your attention into retaining and delighting your current customers is step one in improving your customer lifetime value.
Leveraging effectively-timed discounts, giving out an unexpected free product, and playing up personalization are all great ways to celebrate your current subscribers and encourage retention.
Additionally, implementing a loyalty program is a proven strategy to prevent churn and incentivize customers to spend more. Studies show that customers spend about 67% more when they participate in a loyalty program. Enable your consumers to accrue loyalty points that they can exchange for free products, discounts, exclusive items, and more.
Offering flexible subscription management options is key to illustrating to subscribers that they can mold their subscriptions to their lives, no matter what changes they experience. Utilize your email marketing to make this flexibility clear to your current subscribers. There’s nothing worse than a subscriber churning because they misunderstood your offerings and felt trapped in their subscription.
Speaking of churn: utilizing pause and cancel reasons is another effective way to improve your retention. Not only can you provide your subscribers with relevant retention actions based on their reason for leaving (.e.g., too expensive? Offer a discount), but you can also use your data to look for overall patterns and make subsequent optimizations. Returning to the ‘too expensive’ example, if you’re noticing you’re losing a lot of subscribers because of cost complaints, it might be time to revisit your pricing.
In addition to keeping subscribers around, a great way to boost LTV is to take things a step further and ensure you’re engaging your audience every step of the way. A robust customer account portal is the prime spot to enrich your subscribers’ experience. Not only can this account portal house your loyalty program, but it can also feature a variety of other touchpoints to drive up your LTV.
This includes a referral program, trending upsells, one-time add-ons, creator picks, Instagram feeds, and more. All of these components help enhance the customer experience and can have a substantial impact on revenue.
Offering strong customer support is another obvious must for retention, but it can also be leveraged to deepen engagement. For example, we’ve seen brands open communication via SMS to answer personal questions that don’t necessarily have to do with something going wrong with the product.
Take Pot Gang — a gardening subscription brand. The team has a ‘Pot Line’ where they happily provide gardening support to their growers. This could mean giving suggestions as to where an optimal spot is to plant a tomato, offering watering advice, or helping identify when a vegetable is ready to harvest. This method helps Pot Gang position themselves as a supportive expert on the subject and foster a strong relationship with their audience.
Leveraging reviews is a stellar way to increase average order value and, subsequently, drive up your LTV. With 88% of consumers actually trusting user reviews as much as personal recommendations, this method is essentially a form of replicating word-of-mouth marketing.
Displaying positive reviews wherever you can helps increase social proof and subliminally encourage consumers to trust your brand and/or try new products. It also has a measurable impact on your revenue. Research shows that pairing higher-priced items with positive consumer reviews can increase conversion rates by as much as 380%.
Especially after a positive interaction with a subscriber, try to encourage reviews wherever you can. The more reviews you can generate, the more consumers will trust the rating of your product.
Understanding and consistently tracking your LTV:CAC ratio is an important way to assess the state of your brand and implement optimizations, both from a marketing and retention perspective. Additionally, equipping yourself with an advanced Shopify subscription app is the secret weapon to improving this metric and scaling your business.
At Smartrr, our LTV toolkit is specifically designed to engage your subscribers and boost your revenue — all in the name of growing your business. Interested in learning more? Send us a note.