The Power of the Lifetime Value Framework
Are you losing money on your customer acquisition costs (CAC)?
If you answered yes, you’re not alone. CAC is a huge pain point for a lot of SMBs. One effective way to turn around your CAC is through the Lifetime Value Framework (LVF). While the framework is designed to ensure that businesses break even on customer acquisition, the underlying analysis paves the way for long-term growth and profitability.
The LVF ensures that every dollar spent on acquiring a new customer is offset by the revenue generated from that customer.
For example, if a customer typically brings in $100 in profit, then the business can afford to spend $100 to break-even on acquiring a new customer. This approach prevents both underspending, which could limit growth, and overspending, which could lead to financial strain.
Calculating Customer Lifetime Value (CLV)
To effectively use the LVF, businesses must first calculate their Customer Lifetime Value (CLV). CLV is the average revenue generated by a customer over their entire relationship with the company. The formula for CLV is fairly straightforward:
CLV = (Average Duration) x (Average Order Frequency) x (Average Order Value)
For example, if a customer typically stays with the company for 3 years, makes 3 purchases per year, and each purchase is worth $5,000, the CLV would be:
CLV = 3 years x 3 purchases/year x $5,000 = $45,000
Challenges in Calculating CLV
The formula seems simple, right?
The challenge is accurately determining each component of the formula. This can be a struggle due to the complexity of your product lines, sales channels, and customer segments. Furthermore, CLV calculations depend on the quality of your data. If your data is siloed, incomplete, or inaccurately reported, the resulting CLV figure may be unreliable.
Additionally, calculating an “average” can be difficult when dealing with a customer base where purchasing patterns may vary significantly. For many B2B businesses, a few customers can account for a large portion of revenue, while the majority contribute significantly less. This skewed distribution can make it difficult to arrive at a single, accurate CLV figure.
Your CLV model might ultimately differ from the formula outlined above! Businesses should build a CLV model that accounts for variations across different products, channels, and customer segments. This bespoke CLV should be updated regularly to reflect changes in customer behavior and market conditions.
Calculating Customer Acquisition Cost (CAC) Allowable
Once you’ve determined your CLV, the next step is to calculate your Customer Acquisition Cost (CAC) allowable, which is the maximum amount a business can spend to acquire a new customer without risking profitability. The formula for CAC allowable is:
CAC Allowable = CLV x Average Net Margin
For instance, if the CLV is $45,000 and the average net margin is 20%, the CAC allowable would be $9,000. This means that spending up to $9,000 to acquire a new customer would ensure that your business breaks even. Any amount spent beyond that could result in a loss.
Applying the LTV
After developing your Lifetime Value (LTV) framework, you’ll begin applying this insight to individual campaigns. This will allow you to make data-driven decisions to optimize future campaigns based upon profitability and performance of each stage of the funnel.
Not only will you be able to understand how each touchpoint contributes to overall conversion, but you’ll also be able to pinpoint exactly where adjustments can enhance conversion outcomes. This can range from fine-tuning messaging, reallocating budget, or refining targeting strategies.
Once you’re able to identify the variables that create a successful campaign, LTV framework will also help you forecast future campaign performance. Ultimately, the LTV framework is a tool that will help you and your marketing team fine-tune your strategies in response to real-time data.
The Importance of a Data-Driven Approach
Ultimately, the success of the LVF hinges on the accuracy of your CLV and CAC allowable data. That isn’t to say you need to get stuck on finding perfect data—just use the best available data that allows you to make decisions to reach your strategic goals. It’s like what they do at Amazon: it’s better to act on partial data than to wait for perfect information.
The Lifetime Value Framework offers a powerful tool for SMBs to manage customer acquisition costs effectively while positioning for long-term profitability. By focusing on CLV and CAC allowable, businesses can break even on initial conversions and leverage post-conversion activities to drive sustainable growth.