The Dangers in Making and Using CLV and CAC Calculations

, ,

This Strategy Lab turns our attention to incredibly important and incredibly misleading statistics used by just about every company, every investor, and every analyst:

The Cost of Acquiring Customer (CAC),  and;

The Customer Lifetime Value (CLV; sometimes called LTV, for Lifetime Value).

Let’s dig in.

Conceptually, subscription businesses — and most businesses end up being subscription businesses at some level — need to understand the value of a customer and the cost of acquiring that customer. This analysis drives decisions on sales cycles, pricing, marketing channels and just about every other activity related to sales and customer retention.

Customer Lifetime Value (CLV)

Customer Lifetime Value (CLV) is an estimate of the value of the customer. The best way to estimate this is to take:

  • An educated average of a customer’s likely time with the company and multiply that by
  • An estimated incremental contribution by period for that time.

In example form:

  • Over the past 4 years, the company sees its customers terminate the relationship after 36 months. The range is between 12 months, and not-at-all-yet, but those that did leave lasted on average about 36 months.
  • The company’s weighted average revenue per client per month is $1,000 (the subscription value), and the company estimates its gross margin at 70 percent, and its incremental sales expense at 5 percent. So, a starting estimate for the contribution would be revenue x 65 percent = $650 per month.
  • CLV could be estimated at 36 months x $650 per month, or $23,400.

So many choices, so many pitfalls

Like most analyses, the most dangerous outcome is the simplest: I know with absolute certainty that the $23,400 CLV is wrong. Decisions that use this will be equally, and perhaps tremendously more so, wrong.

The most common shortcut, and it is most commonly used by advertisers and customer channel providers in their pitches to a company, is to substitute customer revenue for gross profit. In the example above, that would change the contribution from $650 per month to $1,000 per month.
Most companies suffer from a dramatically different, variable cost structure. Check the marketer’s math, and substitute a realistic contribution value for the shortcut.

The second most common shortcut or error is the exclusion of identifiable marginal costs. In our example above, the sales channel is paid a marginal 5% commission on revenue , or $50 per month. That’s easily included. There may be others that are generally true: Is there an incremental support expense for an ‘average’ customer? Look for something that is outsourced, for example.

Finally, people collectively and frequently overestimate customer life times —> they underestimate churn. The reason for this one is really simple: It’s hard to fess up to customer losses. Everyone wants to believe that they create customers for life. It’s honestly healthier to place a more conservative, or shorter, estimate on customer decision cycles. That mentality will usually force a more candid perspective on investments and payoffs associated with customer retention.

Which leads into the second part of the equation:

The Cost of Acquiring Customers (CAC).

This should be sub-titled: The Lengths People Will Go In Efforts to Reclassify Selling Costs.

There is growing investor interest in lead or demand generation. Oversimplifying to some degree: This is the web 2.0 version of “build it and they will come.’ We think of it as a ‘network effect’ benefit. If a company builds buzz, and the interest in the offering exceeds sales resources, demand generation becomes a powerful growth tool.

Most hyper-growth companies utilize some demand generation management approach. That does not mean that demand generation created hyper-growth companies. In our experience, few companies actually get to this point. For the rest of us, sales is an honorable necessity.

As a result, CAC should include the selling and marketing expenses, broadly defined, and divided by the normalized number of customers acquired in the measured period.

To continue our simplified example:

  • The company employs 2 marketing people, 2 sales people (on a combination of commission and base salary and expenses), and several outsourced resources supporting channel efforts. The company also participates in several conferences, regular advertising and software to manage leads and opportunities. The total burdened departmental costs are $2 million annually, or $500,000 per quarter.
  • In the last quarter, the company signed 100 new customers.
  • The resulting CAC is $5,000 ($500,000 / 100).
  • The resulting CLV : CAC = 4.68 (23,400 / 5,000).

Beyond testing for general reasonableness, there is not much good that comes from this figure alone. It is equally dangerous to drive comparisons to peer groups or industry expectations (search for ‘what is a good CAC ratio’ for examples of what not to do).

There are some great things that come from the doing the analysis. Here are a few:

  1. Because the numbers can be worked so easily, we now know to review them skeptically. Purchase cautiously from any vendor or channel partner that leads with some ridiculous CLV : CAC expectation or ROI calculation. You are so warned. A lot of work done in automotive retailing relies on claims of 25: 1 ROI multiples, and even some that are higher. They all rely on retail revenue, in an industry with gross margins of 2 or 3 percent.
  2. There is real insight to be gained in thinking through the efficacy of channels, and CAC via a specific channel is a good analytic tool. Channel investments and tradeoffs are a great use of CAC –> an internal check and review.
  3. CAC will fluctuate wildly, based on the calculation of acquired customers. Rarely are sales numbers and trends linear, or even necessarily predictive. We guide clients through a deeper understanding of sales cycles and timing and cost to gain real insight into a ‘normalized’ number or expectation.
  4. Use the analysis to consider trends, and test the reasonableness of assumptions around the elasticity of the ROI. At some point, even for the greatest situations, diminishing returns show themselves.
  5. Customer churn, or more positively retention, is a more interesting and productive dialogue. A penny saved is indeed a penny earned. If CLV is declining, spend some time considering the tenure and potential of longer retention.

If you are still committed or required to use these figures and ratios on their own, we encourage conditional ranges and scenarios. And, be very cautious in assuming, especially early in the growth curve, any network effect or magical demand generation. Yes, it can happen, and yes, it is totally magical, and yes, many hyper-growth companies see this happen. It just doesn’t happen as frequently as many would believe. There is strong history and experience to encourage proper suspicion and skepticism of plans or vendors that promise or depend on this occurrence.

Instead, use the opportunity or question around CAC to think and talk about the customer acquisition model, and which variables and assumptions need to be tested, can be extrapolated, or are of real value. CAC and CLV are valuable starting points to a conversation, just not great punch lines on their own.

379 replies
  1. custom writing says:

    University students have always been busy with work, studies, and other responsibilities. This situation makes them an easy target for swindling sites that promise quality papers and fail to deliver them on time. They charge high fees for their services but produce low quality work in the end. The situation has led to students getting poor grades in the academic work. We offer cheap academic assistance through our online platform, to ensure that the students get the high-quality work they deserve. Our focus is not the money, but motivation to share knowledge and to eliminate extortioners in this industry. Our professional writers from various academic backgrounds understand your needs and are ready to extend their support. While you handle other responsibilities, our writers will be busy creating your paper. We also offer sample papers to guide you in completing actual assignments from school. It is our pleasure to partner with you in your academic journey and with our services it’s a guarantee you shall enjoy a fruitful academic life. You can communicate with our customer support team for inquiries, samples. We will also help you to place an order in case you come across any difficulties. The procedure will only take a few minutes. We value your time, and your demands are our commands, for we offer exactly of what you ask. Our main goal at is to deliver high-quality papers for all university students

  2. Like says:

    Auto Like, Increase Likes, Status Auto Liker, Photo Auto Liker, autolike, Autolike International, autoliker, Autoliker, Working Auto Liker, auto like, Auto Liker, Autoliker, ZFN Liker, Autolike, Status Liker, Photo Liker, auto liker

  3. says:

    I’m really enjoying the design and layout of your blog. It’s a very easy on the eyes which makes it much more enjoyable for me to come here and visit more often. Did you hire out a designer to create your theme? Excellent work!

  4. Cryptocurrency Trading & Investing Strategy for 2019. Receive passive income of $ 7,000 per month says:

    Invest $ 5,000 in cryptocurrency once and get $ 7,000 passive income per month:

  5. 예스카지노 says:

    Link exchange is nothing else except it is just placing the other person’s weblog link on your page at appropriate place and other person will also do same in favor of

  6. says:

    Howdy! Quick question that’s totally off topic. Do you know how to make your site mobile friendly?

    My website looks weird when browsing from my iphone4. I’m trying to find a
    theme or plugin that might be able to correct this issue.
    If you have any recommendations, please share. Appreciate it!

  7. Lukas says:

    Very great post. I just stumbled upon your blog and wanted
    to say that I have really enjoyed surfing around your blog posts.
    After all I will be subscribing to your feed and I hope you write again soon!

  8. seksiseuraa says:

    Wow, superb blog layout! How long have you been blogging for?
    you made blogging look easy. The overall look of your website
    is magnificent, as well as the content!

  9. Harrison says:

    Do you have a spam problem on this website; I also am
    a blogger, and I was curious about your situation; many of
    us have created some nice practices and we are looking to
    exchange strategies with others, why not shoot me an email if interested.

  10. MatCemn says:

    Cialis Naranja Buy Doxycycline Online With Mastercard Occasion Levitra 10 Mg Orodispersible viagra Priligy Virosta Atlantic Drugstore Reviews Farmacia Viagra Cialis

  11. Santos says:

    Woah! I’m really enjoying the template/theme of this site.

    It’s simple, yet effective. A lot of times it’s tough to get that “perfect balance” between usability
    and visual appeal. I must say you’ve done a excellent job with this.
    Also, the blog loads extremely quick for me on Firefox. Exceptional Blog!

  12. RandHopsy says:

    Purchase Nexium Online No Prescription Length Of Time Amoxicillin Takes Effect Discount On Methylprednisolone 60 4 Mg cheap cialis Amoxicillin Dosage Infection Sinus Samples Of Viagra And Cialis Get Macrobid Cod Accepted

  13. eebest8 michael says:

    “I just could not go away your web site prior to suggesting that I extremely loved the standard information an individual supply to your visitors? Is gonna be again steadily to check up on new posts.”

  14. cam porn xnx video says:

    Its like you read my mind! You appear to know so much about this, like you wrote the book in it or something.
    I think that you could do with some pics to drive the message home a bit, but
    other than that, this is excellent blog. A great read.
    I’ll certainly be back.

  15. sex party xxnx says:

    I feel that is one of the so much vital information for me.

    And i am glad studying your article. But should remark on some common things,
    The website style is wonderful, the articles is in point of fact great :
    D. Good task, cheers

  16. tutorial says:

    Sweet blog! I found it while surfing around on Yahoo News.
    Do you have any tips on how to get listed in Yahoo News?

    I’ve been trying for a while but I never seem to get there!

  17. togel hk says:

    Ahaa, its nice dialogue regarding this paragraph here at this web site, I have read all that, so at this time me also commenting at this place. I am sure this piece of writing has touched all the internet users, its really really good paragraph on building up new webpage. I truly love your blog.. Very nice colors & theme.

  18. online marketing plan says:

    The next time I read a blog, I hope that it does not disappoint me just as much as this one. After all, Yes, it was my choice to read, but I genuinely thought you’d have something interesting to talk about. All I hear is a bunch of moaning about something you could possibly fix if you weren’t too busy searching for attention.

  19. Best Wordpress Plugins says:

    Having read this I believed it was extremely enlightening. I appreciate you taking the time and effort to put this article together. I once again find myself spending a significant amount of time both reading and leaving comments. But so what, it was still worthwhile!

  20. Nonton Anime Subtitle Indonesia says:

    Someone essentially assist to make critically
    articles I’d state. That is the first time I frequented
    your website page and so far? I surprised with the analysis you
    made to make this actual put up incredible. Magnificent activity!

  21. new website marketing says:

    Good day! I could have sworn I’ve visited your blog before but after browsing through many of the articles I realized it’s new to me. Anyways, I’m definitely happy I stumbled upon it and I’ll be bookmarking it and checking back often!

Leave a Reply

Want to join the discussion?
Feel free to contribute!

Leave a Reply

Your email address will not be published.