Do you know the relationship between lifetime value and customer acquisition cost? This is an important metric to track. If a company does not know this relationship, it will not be able to measure or direct its efforts toward goals.
Simply put, this ratio measures the difference between the money a company spends on acquiring a new customer (for most companies this is their sales and marketing budget) and the amount of money a customer brings in over the entire period. the time they do business with your company.
For SaaS companies this is a particularly crucial measure, because customers generally don’t stay forever, so the search for new customers is constant.
This business category is similar to a mobile phone company that establishes contracts, or a newspaper, which makes its customers subscribe to receive information for a certain period of time.
If too much money is spent chasing clients, this affects the ROI. If little is invested, opportunities can be lost.
How do you know if your customer acquisition cost is correct?
To know if you are spending the right amount you need some numbers.
First, you need to know how long the average customer stays with you before canceling your service. Because, of course, the longer a customer stays with you, the more value they have.
Do you know why customers leave? Start by taking a look at your churn rate: the number of people who cancel their subscription in a given month.
If you have 1,000 customers and every month 20 of them cancel, that is equivalent to 2% monthly churn. By simply investing this value (1 / monthly churn rate), you will be able to calculate how many months your customers stay with you. If you have 2% monthly churn, that gives you a result of 50 months.
You will also need to know the percentage of profit that is left after you pay your costs for the product or service, and then you need to know how much money the average customer brings in per month.
Customer Lifetime Value = Gross Margin % x (1 / Monthly Churn Rate) x Average Monthly Subscription Revenue per Customer
By knowing the average lifetime value of a customer, you can focus your attention on calculating how much you spend to acquire a customer.
Sales and marketing budgets are generally the same. Basically, the cost of acquiring a customer is the total sales and marketing budget divided by the number of new customers acquired in a given period.
This works really well if your sales cycle is short, where your sales and marketing costs can be tied to new customers in the same period of time. If the period is longer, you may want to spread the costs and gain new clients for better results.
Cost of acquiring a customer = sales and marketing cost / new customers gained
Ideally, you want to recover the cost of customer acquisition in around the first 12 months. The value of a customer must be three times greater than the cost of acquiring them. If the ratio is close, i.e. 1:1, it means you are spending too much and if the ratio is very far, i.e. 5:1, it means you are spending too little. In fact, if so, you may even be losing business. The ideal is 3:1.
It sounds simple and the reality is that it is. But the point of knowing what your numbers are is to put them into practice. The more you understand what drives your business, the better the results you will achieve.