Stop measuring marketing spends with CAC/LTV

If you are using LTV to justify CAC, you are probably making a mistake.

Why?

Firstly, you aren’t calculating LTV for cohorts of customers. Let’s say you can identify 2 (or 10) cohorts of customers, maybe based on industry, size, or % of their overall budget that they are spending on you. Cohort A finds lots of value and sticks with you for years, paying more each year. Cohort B struggles to find value and either churns faster or down-sells. Logically, your CAC can be higher for Cohort A and should be much lower for Cohort B. But many companies just blend everything together, so your CAC/LTV ratio is not accurate for any of the cohorts.

Sometimes you aren’t spending enough on acquiring the customers you really need. Far more often, you are spending too much on acquiring customers that will not be profitable.

Also, keep in mind that you are looking at LTV retrospectively. Just because customers you onboarded 2-3 years ago have not churned, it doesn’t mean that a similar customer you acquire today will behave the same way. The world is different today, and so is your product and your team.

Secondly, LTV is usually a revenue metric, not a profit metric which is more important in the current economic climate. Company A pays $3000 per month but uses up lots of engineering, support, and CSM time. Company B pays $500 per month and requires minimal support. It is certainly possible that Company B is a more profitable customer, and 6x of Company B is vastly more profitable than 1x Company A, even though the LTV shows the same number.

Lastly, CAC/LTV is not strategic. It’s usually reported to try to establish whether marketing is spending the right amount – this doesn’t help with planning. A better approach is to plan how much CAC you can incur for each of your target cohorts. If breaking into a new industry is critical, then you can plan to incur a higher CAC to ensure that spending is directed according to priorities. Everyone should agree that CAC will go up (or maybe the payback period will increase) so there are no surprises at the end of the quarter/year.

Similarly, if you are trying to move upmarket, then onboarding larger, more complex customers will help you to develop support and CSM processes that can be optimised over time. You may want to deliberately call out a higher target CAC for these types of accounts.

Winning accounts from competition has different approaches. In some cases, taking market share is critical, so a higher CAC can be tolerated. But if you win accounts from competition through discounting or contract buy-outs, then a higher CAC could result in a payback period that lasts for years.

In summary:

1. plan CAC targets in prospect cohorts
2. look at the payback period driven by the gross margin, rather than just the revenue or estimated LTV
3. set the CAC targets in advance to align with strategy, rather than trying to mimic ‘industry benchmarks’

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?Have a great weekend!

Chris