Decoding Customer Lifetime Value and Acquisition Costs

This is my template model for analyzing customer lifetime value and the cost of customer acquisition. There's a lot to uncover here, so let's start at the beginning.

1? What is customer lifetime value (CLTV or CLV)?

Customer Lifetime Value represents the total net profit a company expects to make a customer over the entire duration of their relationship. In other words, it's an expectation that reflects the financial value of that customer.

The longer a customer continues to buy from a company, the greater their lifetime value generally becomes. The company can increase CLTV by prolonging the relationship or increasing the average purchases.

2? What is cost of customer acquisition (CAC)?

CAC is the total cost of acquiring a new customer. It may include salaries, commissions, phone expenses, advertising, and more.

For companies just starting out, CAC tends to be higher as they have to work harder to be found, recognized, and trusted. But as time passes, CAC ideally decreases as the business becomes better established. A lower CAC related to CLTV implies that the company is getting a better ROI with less investment.

3? What's going on in this business?

I assume a consistent acquisition spend so as to not over-complicate this forecast.

Year 0-2:

The company invests and starts incurring substantial operating costs to acquire customers. We see a loss of $50,000 immediately as the company invests at the outset. Year 1 and year 2 losses are $17,311 and $9,811 respectively. Losses are a common occurrence in the early years.

Year 3-8:

Profits begin to show as customer count increases, while CAC does not. positive from Year 3 and shows a healthy growth trend until Year 8.

4? Final thoughts

A positive CLTV, a decreasing CAC, and a high internal rate of return (IRR) and modified IRR (MIRR) indicate a business model that's not only sustainable but also likely to be profitable in the long run.

The CAC decreases over time while the CLTV increases, indicating an improvement in the business's efficiency in converting its marketing and advertising expenses into new customers.

We must apply present value factors to get the value of this initiative in today's dollar. Otherwise, the value of our analysis would be significantly overstated.

When we take into account the initial investment of $50,000, the overall present value (including the initial investment) is $105,575. This company is making money.

These metrics serve as crucial indicators for businesses to shape their strategies and make informed decisions for enduring growth, especially for startups and companies in the early stages of expansion.

Is there anything that's ever confused you about CAC and LTV analysis? Message me and let me know.

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Understanding the dynamics of Customer Lifetime Value and the Cost of Customer Acquisition is crucial for any business aiming for long-term success. I hope this article helps to break down these vital metrics, offering you actionable insights and strategies to optimize your investments and maximize your profits. For more FP&A insights, follow me on LinkedIn.

Until next time,

Carl