In our last post, we discussed Customer Acquisition Cost “CAC”. A related and similarly important number is the Lifetime Customer Value “LCV”. Only when we know with reasonable certainty the LCV can we determine whether a proposed CAC is acceptable.
The LCV is determined by estimating the average duration of the relationship and the average value of the customer over that same period.
Continuing the previous example of our client in the education business. Each student is worth approximately $6,000 per year, of which $1,800 is net income. LCV can be employed using both figures, and this dual analysis is valuable because in a scalable marketing campaign, margins are likely to improve dramatically.
In this case, the client keeps his customers on average for 36 months. Therefore, the LCV is:
LCV (Rev) $18,000
LCV (Margin) $5,400
Now the client can prudently consider marketing options and the associated CAC. What would you pay today to receive back, net, $5400 over three years? A shrewd investor might pay upwards of $3,000 today, since a $5,400 return over 36 months exceeds the 20% per year figure achieved by only the most successful billionaire investors.
Of course, we know from the previous post the client is acquiring customers at a fraction of that price.
Consider the equation if the client acquires a substantial number of customers and his margins improve to 50%, a more than reasonable assumption. With a LCV (Margin) of $9,000, he can afford to spend a significant sum to acquire customers and still experience a very aggressive return on his investment.
Regrettably, very few businesses operate this way. With no sense of the LCV, there is no way to measure whether a CAC is acceptable. More often than not, businesses are underfunding their marketing, treating it as a cost rather than an investment. This is why so many businesses fail in the early years, and why so many mature businesses struggle for years before eventually closing or selling to a better managed (and marketed) business.