You’re spending all of your energy acquiring new customers, creating new products, and simply trying to stay afloat in this fast-paced online world.
Running an online retail shop isn’t easy. But a firm understanding of lifetime customer value will help you understand
Everyone wants to acquire customers for as little as possible, but do you know how to actually track the numbers associated with each customer? It all starts with two basic concepts: Cost Per Acquisition (CPA) and Lifetime Customer Value (LCV).
CPA is simply how much it costs to acquire one customer. You may run a Facebook Ads campaign which costs you $100 and you convert 3 customers which means this campaign had a CPA of $33. The CPA will change for each campaign, but you will eventually have an average for your business.
LCV is how much a customer is worth to you as a business. Taking the above example, let’s say that each of those 3 customers comes back two more times and purchases an average of $50 each time. Each of these customers spent $150 with you, which would mean that these customers are worth $150 to you. Once again, this average will become more visible once you have more data on how much and how often customers buy from you.
To acquire customers profitably, you need to make sure LCV > CPA.
The lifetime value of a customer needs to be more than the cost to acquire those customers. How much more will depend on your business costs, profit margin, etc. But at its core, this is what to keep in mind if you want to acquire customers profitably.
These two numbers are important because they can give you a quick overview on how your business is performing. In the early stages of business, your CPA might be really high, but eventually your LCV should be more than your CPA.
The LCV is important because getting a customer to buy more is easier than acquiring a new customer. You could run specific marketing campaigns trying to incentivize existing customers to purchase more and to move the needle upward on the LCV, instead of spending more money on acquiring new customers.
Imagine that you spend $1000 to acquire 20 customers at a CPA of $50 each. Any effort that you put into getting these customers to buy more than what you paid to acquire them means you are now getting the most out of your original $1000 without having to spend more money. LCV gives you a quick way to see how much value you’re getting out of each customer.
A full discussion on how to calculate LCV is beyond the scope of this blog post. (Though Kissmetrics has a helpful infographic you should see for a more in depth calculation.) But one simple way you can start to get a good idea of LCV is by taking all the customers who have purchased from you (# of customers) and the total revenue from these customers (total revenue). Then divide the total revenue by # of customers:
Total Revenue / # of customers = LCV
Let’s say you have processed $5000 in total revenue from 120 customers. The LCV for an average customers is $42. Any efforts that you do to improve LCV can be quickly measured against this original number.
$5000 in total revenue / 120 customers = $42 in LCV
If your LCV is quite low, then perhaps it makes more sense to spend time improving this number rather than trying to bring more customers in. If you have a leaky bucket, it makes sense to stop the leaks before you try too hard to fill the bucket with water. Your online store could be a very leaky bucket right now and you’re working like crazy trying to keep it full.
CPA can also be figured out in broad terms to give you a starting point to measure. Look at any campaign, whether its a Facebook Ads campaign, Google Adwords, etc and then look at how many conversions that produces.
Let’s say we run a Facebook Ads campaign and we spend $500 on it. It produces 17 new customers who purchase something from us.
$500 in spending / 17 new customers = $30 in CPA
Taking our LTV value from above:
$42 in LTV > $30 in CPA
This is awesome news, right? Yes and no. You can expect averages to be consistent on the macro scale (over a year) but it might change drastically over specific campaigns. The customers from this Facebook campaign might only purchase $10 on average, which is obviously a loss, but it’s also a learning lesson on what type of traffic will convert and buy more from us.
Another example you will probably encounter is when the CPA to acquire a customer is less than what they purchase with you right away. These same customers may purchase two more times over the next 12 months, making the LCV higher than your original investment, but it also means waiting 12 months to “recover” your CPA.
This term of time is called “time to recover CPA” which is usually measured in months. You should strive to keep this number between 6-12 months, and you need to keep this in mind when working out the cashflow for your business.
Don’t discount marketing campaigns that may have atrocious CPAs/LCVs ratios, but do spend a large amount of time making sure those customers purchase more from your over the coming months.
Don’t get bogged down in all the calculations, either. Start simple and then tweak the numbers as you go. You can then start measuring the number per campaign and see how it’s changing over time. Just starting to measure will make it more likely that you can improve it.
Do you have any tips around measuring and improving your LCV or CPA? Let me know in the comments!
Tagged cac, cost to acquire customers, lifetime value, ltv