All you need to know about CAC, LTV, and the ratio that connects them. Master your inbound go-to-market strategy with a helpful framework.
I normally don’t write go-to-market pieces, but I really think understanding this will help a lot of entrepreneurs, as it has myself.
To kick this off, let’s quickly define the different types of marketing. Roughly speaking, there are two:
The Customer Acquisition Cost (CAC) is important for both, but particularly for inbound marketing. Why? Inbound is mostly Paid Advertising or Performance Marketing for which you can set a budget beforehand and determine how much money you are willing to spend for acquiring a single customer. This single customer should then provide you with more value than a single purchase. That is where Life-time Value (LTV) comes into the picture.
LTV is relevant for both short (e.g. e-commerce) and long funnel (e.g. SaaS) businesses. In short funnel Shopify stores, for example, a customer who completes a purchase creates a high LTV for a company once they become repeat customers — this is usually measured in the Average Order Value (AOV). For long funnel SaaS on the other hand the LTV is not repeat purchases, but the length of the subscription you lock a customer in.
In both cases, the CAC can be determined based on your budget and estimated Conversion Events (CVEs) which can tell you how many customers you might receive from spending X amount of money.
Without this kind of thinking, you will be throwing money into a deep black wormhole, called Facebook or Google — and they will gladly take it. I mean, who would blame them…
All jokes aside, let’s illustrate this a bit better. Here is a typical e-commerce marketing (short) funnel for this:
A simple funnel right? Short and to the point. Low-friction.
Now, to get the numbers right, a final conversion percent to become a customer in point 4 is normally around 2–3% from all of the leads that actually click on your ad and visit your landing page.
Yes, you heard that right. And on top of that, a customer needs to be exposed to your brand around 7 times on average before being psychologically ready to make a purchase with you.
So getting these thought processes for inbound marketing right is imperative.
Here are some basic buzzword definitions and formulas I use:
The difference between the two is simple. CAC is a hard fact and LTV is a dream number whenever you plan a budget for your paid ad expenditure. Of course, LTV only becomes tangible after a certain timeframe (this is where retention comes in —a different kind of monster), but when you start calculating your Return On Investment (ROI) from any marketing related activities, you should make a prediction to understand how much you need to spend for the desired outcome you want to achieve. It’s simple maths really.
But then comes the big hammer: your LTV:CAC ratio should never be below 3:1 in order to be effective in the long term. This is a golden rule. And to get there, the name of the game is optimization. But first, let’s look at how these numbers actually start to make sense in a real-life scenario.
An example calculation for a short funnel ecommerce:
The above is ideal. That said, it is very tricky to engineer your campaigns to get achieve this scenario in the beginning. But if you know beforehand what to engineer for (that is, your numbers), you will be much faster at creating returns from your funnel.
It’s important to create a high LTV:CAC ratio, so you can plan an appropriate budget and also engineer a return on investment from money spent on ads — make calculated bets, not just conjecture.
Depending on the resulting numbers of your CAC, LTV & ratio, you can either plan in a budget for performance marketing or not. This is especially relevant for early-stage startups, which most of the time do not have the budget to spend the necessary amounts that warrant a go-to-market strategy oriented towards performance marketing in the beginning. In which case, they are better off focusing on virality/referrals, content &/or sales & partnerships.
There are more effective ways to market your product than your friend telling you to throw some money at Facebook or Google Ads.
That in and by itself is horrible advice.
Rather, you should input your numbers into the Pyramid of Inbound Marketing (that’s what I call it). It has 5 levels:
Visualizing this will bring you to two conclusions: 1. if the foundation is unstable, your pyramid will collapse and 2. if your customer # to be acquired is not enough to give you the returns you desire, the pyramid will cave in.
So if you want to nail inbound marketing in your go-to-market strategy. First, don’t put all your eggs in on one basket — try organic, SEO & referrals at the same time. Second, get all 5 levels right. Define the foundation, top, then work yourself up. And most importantly: always know what your LTV:CAC ratio is. If it’s below 3, get back to the drawing board — otherwise, your efforts to acquire customers will implode in the long run.
I am by no means a guru who knows it all. I am honestly still learning, but I think it’s important to share my learnings as I go through this life, so other people can grow as we just did.
As you probably read in between the lines, I only get into performance marketing as the next step on my journey of acquiring customers. My initial marketing approach is always organic-first. To me, that’s logical…
If you can already get customers through the door without paying a penny for it, you’re onto something.
Anyways. I will be writing more about my learnings from applying my outlined thought processes & model for when I “throw some money” at Facebook for BOOTSTRAP OS. If you haven’t heard of this product, no problem. It helps you get your idea to business, step-by-step. Right in Notion.
So if you’ve made it this far, grab yourself -10% off here.
Thanks for your attention.
I’ll see you around.