Don't track LTV/CAC; Instead track LTV/CACD, Why? | VC Remote Jobs & More
Successful startups track LTV/CACD not LTV/CAC, Why?
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Deep Dive: Don't Track LTV/CAC, Instead Track LTV/CACD, Why?
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TODAY’S DEEP DIVE
Track LTV/CACD Rather Than LTV/CAC, Why?
You read it right - successful startups track LTV/CACD, rather than LTV/CAC, why? What does D stand for in CACD? Why it’s better to track LTV/CACD than LTV/CAC? Let’s understand this…
If you are not aware of these terms -
LTV, or Lifetime Value is the total amount of value a customer brings to a business over the entire duration of their relationship.
CAC, or Customer Acquisition Cost, is the amount of money a business spends on average to acquire a new customer.
The LTV/CAC Ratio compares the Lifetime Value (LTV) of a customer to the Customer Acquisition Cost (CAC), providing insight into the efficiency and sustainability of a business's customer acquisition strategy.
LTV/CACD, by the end of this writeup you will get the idea on this, what D stand for in CACD and why it’s right to track LTV/CACD than LTV/CAC.
A business is an engine that attracts customers, delivers something of value to them, and then extracts that value in the form of profits. That’s what a business is.
Thus it logically follows that the ‘cost of attracting a new customer needs to be less than the value we can extract from that customer.’ Let’s take a simple example - If for our startup it costs us $15 in advertising to get a customer, and we can only make $7 from them then we have a problem. But if it costs $15 to get them, and then once they are a customer, they make a bunch of repeat purchases that yield $75 in profit, then we are happy.
Ultimately every venture of every kind has to have a Customer Acquisition Cost (CAC) that is less than the Lifetime Value (LTV) of a customer. It’s a simple, self-evident concept.
“Yet It’s A Leading Cause Of Startup Death.”
A high percentage of startups die because their cost of getting customers turns out to be higher than they can make from them. Partly this is just because we’re all optimists — we all think our startup is so awesome that people will flock to become customers and they will remain customers forever. But eventually, that optimism fades as we realize that marketing is expensive and no customer stays forever. The immutable laws of economics set in, and at some point, many startup founders find that their LTV/CAC ratio is slowly draining their bank account.
To paraphrase Ernest Hemingway, Startups go broke two ways:
gradually, and then suddenly.
Investors Tend To Obsess Over The LTV/CAC Ratio.
Investors care about your LTV/CAC ratio because it’s the essence of a successful business. But it’s also a proxy for the potential ROI of their investment. If you have proof that you can spend $1 on customer acquisition activities and get $5 in value back (an LTV/CAC ratio of 5.0), investors will want to shovel as much money as possible into that engine.
Most of the VCs look for ‘just-add-money opportunities.’ Having a business with an LTV/CAC ratio of over 5.0 looks like a “just-add-money opportunity” to investors.
But It’s A Blunt Tool That Is Better If Sharpened.
Let’s say that during the quarter we spent $10,000 on sales and marketing and got 1,000 new customers — a CAC of $10. But probably some of those customers came through word-of-mouth, some came as referrals, some came from our PR efforts, and some came from paid advertising. So we had a blended CAC of $10, but that doesn’t tell us anything about the relative effectiveness of each of our different customer acquisition efforts. Which leads me to the next point:
Not All Customers Are Created Equal.
If you look at some of the successful startups you will find that at some point 80% of profits come from 20% of customers.
And the LTV (Lifetime Value) of our entire universe of customers, we’ll probably see that 20% of them have a much higher individual LTV than the rest. Wouldn’t we want to focus our CAC efforts on getting more of the high-LTV customers? Yes, we would.
Therefore, cohorts matter.
The two points above would indicate we want to track the LTV/CAC ratio by customer cohort. For example, what’s the ratio of customers acquired through Facebook advertising vs those acquired through Google advertising? Knowing that would tell us a lot about how we should allocate advertising dollars. What’s the LTV/CAC ratio for customers acquired through our referral program? Knowing that would tell us how much we can afford to offer in a referral fee. Knowing your company’s blended LTV/CAC tells you the health of the overall engine, but it doesn’t tell you how to optimize the engine’s performance for the next quarter. Tracking customer cohorts tells you that.
Velocity also matters, and that's what makes a successful startup stand out from the crowd.
They don’t care about the LTV/CAC ratio, what they care about is the velocity with which invested CAC comes back in the form of LTV.
They generally used CACD rather than CAC — the D is for “doubled”. CACD answers the question, “If we spend $12 in customer acquisition activities, how long does it take for us to get $24 back?” Even As an investor, they always want to see a business with a CACD of less than eight months. This formula gets to the heart of an inherent flaw in the LTV/CAC ratio: it doesn’t include a time factor.
A business with an LTV/CAC ratio over 5.0 might seem good at first, but if you have to service a customer for 10 years before you make back the money you spent getting him, then it doesn’t seem so good, right?
Velocity matters. So think about how you can measure CACD for your business. Putting $12 somewhere where it returns with a high velocity will accelerate your engine of growth.
That’s it! So, from now trackLTV/CACD than LTV/CAC.
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✍️Written By Sahil R | Venture Crew Team
Great writeup! 🔥