In the previous article, we discussed the importance of Customer Acquisition Cost (CAC) and its components in measuring your business’s financial effectiveness. Now, let's delve into another crucial metric: Lifetime Value (LTV).
LTV of a customer is a critical metric that estimates the total revenue expected from that customer throughout their relationship with your company. Accurately calculating LTV involves analyzing user lifespan through cohort analysis and retention data.
For example, if the average user stays with your SaaS for three years—resulting in a churn rate of approximately 33.33%—the LTV becomes an important indicator of value. Using a gross profit per user of $312,the overall LTV would amount to $936 (3 years * $312). This figure reflects the potential earnings from each customer and is essential for strategic planning(see Exhibit 1).
As a CEO, it’s important to seek benchmarks to evaluate your company’s performance effectively. A key metric to monitor is the relationship between LTV and CAC. This benchmark is critical for assessing the long-term profitability and sustainability of your business.
Understanding the ratio between your LTV and CAC is essential. This knowledge will inform your investments in customer acquisition and retention strategies. Many CEOs recognize the importance of realistic benchmarks in their discussions on unit economics, as these insights can guide informed decision-making (see Exhibit 2).
In my article, "Why Realistic Benchmarks Matter for Startup CEOs," I delve deeper into the significance of these benchmarks. By analyzing LTV and CAC relationships, you can measure growth potential and effectively communicate your company’s value proposition to investors, steering your SaaS business toward success. For example less than 6 months to recover CAC in SMBs as a strong indicator.
As a CEO, if you cannot clearly articulate your unit economics, grasp the nuances behind calculations, or identify the main drivers influencing results, you risk failure in your funding and M&A processes. It's critical to incorporate these insights into your preparations to ensure ongoing success!
