Now is the right time for a check-up: it’s the season for most companies to establish their annual plan for next year. Having sharpened CAC and LTV figures in hand will help you align your strategy and your teams for the healthiest outcome.

As CEO, your job is to be the brain of the corporate body. You direct the body through strategy to take action. You also make sure the body parts have the right resources and focus (time, talent, and money).

 

Done right, the body grows and thrives. Done wrong, weakness, injury, and death await. Sometimes you have to be the brain and the surgeon: dissecting, diagnosing, fixing, and stitching back together. To do that well, you’re going to need the sharpest instruments available. Among the sharpest is the LTV/CAC analysis, which can help you allocate capital in the most efficient way, as well as helping you diagnosis and correct what ails your company.

 

Download the CAC LTV Calculator Tool to see how CAC:LTV is calculated for products that are still in a growth phase, to evaluate five different products side by side, and to find the CAC:LTV ratio for each product.

 

Blood and Guts

 

Capital is the precious lifeblood of a company. Just like in the human body, blood has to go where it is needed the most, e.g., for exercise, thinking, digesting, etc. If you’ve ever had to run after a big meal, you know it is hard to two of those things at once. It’s best to plan and choose. The efficient allocation of capital is a lot like the efficient allocation of blood: the brain of the causes the blood to flow where it’s needed most. Unlike the human brain – which does this autonomically – moving a company’s life-blood around is highly intentional. It requires a lot of thoughtful planning and good information to be successful.

 

If your company goal for capital allocation is to grow (as opposed to making investors happy through other means, such as dividends or stock buy-backs), efficient capital allocation is key. And while definitions of capital efficiency can range widely, you can use a simple and customer-focused measure: the ratio of Customer Lifetime Value  (LTV) to Customer Acquisition Cost (CAC).

 

With that tool, you can:

 

  • Determine the best way to distribute capital to achieve your growth goals
  • Uncover challenges with your strategy
  • Optimize your operations to support your strategy

     

Like good operating instruments, having sharp CAC and LTV figures on hand makes daring procedures possible more successful.

 

Your Operating Instruments

 

Let’s take a step back and look at this tool. It seems simple and obvious, doesn’t it? If LTV is how much money comes in from a customer, and CAC is how much it costs to get that customer, this ratio would tell you if you are making money or not.  Apply it to different products and segments (part of the body) to get deep insights. It would seem that every company would be crystal clear on these figures.  However, SBI research has found that nearly 80% of companies don’t know and consistently measure their CAC and LTV.  So let’s take a moment to make sure the 80% know how to direct your teams to measure CAC and LTV in the first place.

 

CAC – To measure the specific costs of acquiring a new customer, be accurate and thorough. For best accuracy, use Activity Based Costing (ABC). ABC is applying specific costs of an revenue-generating activity to those products, business units, or segments that are actually demanding the activity. For example, lead generation costs would only be allocated to the degree they drove revenue from a particular product or segment. To be thorough, look at all aspects of sales and marketing for each.  Finally, allocate fixed costs the entire population of newly acquired customers.

 

LTV –  Determine (or, for new products, forecast) the average duration of the relationship with the customer. Then multiply that duration times the average annual customer spend. For products that are subject to churn, or have substantial ongoing support costs, you should factor in the churn rate and cost to serve (CTS).

 

Parts of “The Body” –  to make these tools useful to your strategy, you need to look at each from the perspective of the parts of the strategy you are trying to analyze. For example, you may want to look at market segment (if you think you should emphasize SMB, mid-market, or enterprise), region (EMEA vs APAC), product, or industry vertical.

 

Still not sure how to do this? You can use SBI’s CAC LTV Calculator Tool. 

 

Now You’re Operating

 

Now that you have the operating instruments, you can begin to dissect your strategy.

 

The Best Way to Distribute Capital:

 

Compare your strategy to the your target ratio of LTV:CAC. For SaaS companies, the generally accepted target is 3:1.  How are you going achieve that target?  For example, if your current ratio is 3:1 in North America, but 6:1 in EMEA, you should be investing more in your sales and marketing in the latter market.  If Product A is at 2:1 and Product B is a 4:1, you need to either explore a lower-cost way of selling the Product A (channel distribution?) or excising it completely and transfusing the capital over to acquiring more Product B customers.

 

See below for a Real-World Example of Applying a LTV:CAC analysis.

 

 

Uncovering Challenges with your Strategy:

 

With sharpened CAC and LTV figures you, you can test the assumptions on which your previous strategy was based.  Is that new product that was core to your strategy producing a lower LTV that you thought it would?  What happened? Have more competitors entered the market making your product less sticky? Maybe there are features you can invest in that will extend your LTV and bring your capital efficiency ratio back in line. Or maybe it is time to point your CAC toward something more productive.  Or perhaps your CAC is higher than you thought it would be. It could be that your offering is harder for the market to appreciate, so it requires a greater and more sophisticated sales effort. Or it could be that the demand cycles are longer than you had estimated: your product replaces something most companies review once every 5  years instead of every three years, effectively reducing your annual TAM by 40%. If that’s the case, your fixed costs are spread over fewer sales, sending your CAC through the roof.

 

Optimizing Your Operations:

 

Say you know you have a CAC problem, but the reasons aren’t obvious. Sometimes a deeper look into your revenue operations reveals that your sales and marketing muscles aren’t pulling in the same direction. For example,  marketing might be investing in an ABM strategy that target the enterprise market, but starves the mid-market – which is where sales has the most success and therefore focuses. Which is right? Take a look at your instruments – which segment provides the best LTV:CAC ratio.  You might want to move up market, you might want to move down market. But you definitely want your efforts to be coordinated so you can stop wasting CAC.

 

Another example of how a CAC:LTV analysis might cause a change to your operational strategy is then you find a surprising difference in CAC depending on buyer persona. Your traditional focus might be on the CIO – you, and everyone else. Cutting through the noise to get to that buyer can be an expensive proposition. However, you might find that your product has appeal to the HR side of the house.  If the data shows that the CAC is lower and the LTV is just as good when you enter the sales process that way, you can re-direct marketing and sales efforts in that direction and significantly increase your capital efficiency.

 

Now is the right time for a check-up: it’s the season for most companies to establish their annual plan for next year. Having sharpened CAC and LTV figures in hand will help you align your strategy and your teams for the healthiest outcome.  SBI’s latest research report on the emerging best practices in annual planning [link] will make that operation as painless as possible. Use it in good health.

 

Download the CAC LTV Calculator Tool to see how CAC:LTV is calculated for products that are still in a growth phase, to evaluate five different products side by side, and to find the CAC:LTV ratio for each product.

 


 

Additional Resources

 

Schedule a working session at SBI’s Studio.

 

Located in Dallas, TX, our facility offers state-of-the-art meeting rooms, lounge, full-service bar, and a studio used to tape our TV shows. SBI provides the location and facilitators, all at a compelling price point.

 

As a guest of The Studio, you’ll get unlimited access to SBI’s CEO, Partners, and a handpicked team of Sales Talent experts. Together we’ll focus on developing an action plan for your needs by getting a month of work done in just eight hours. It’s an amplified experience that you can only get in one place: The Studio. I hope you join us.

 

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ABOUT THE AUTHOR

Doug Bain

Delivers transformative strategy, insights, and practices to help clients crush their number.

Doug is a revenue-driving executive operator and consultant with experience that ranges from Fortune 100 companies to startups. He is passionate about bringing emerging best practices to companies to unleash their growth and performance potential.

 

Prior to joining SBI, Doug has been both an enterprise level executive and serial entrepreneur. His experience enables him to quickly identify where improvements and efficiency can be developed in sales and marketing practices to make organizations more effective. He has a special affinity for helping companies achieve impact, whether through innovative consulting approaches or enabling broad-scale adoption of his clients’ new and improved products and services.

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