“Data-Driven Thinking” is written by members of the media community and contains fresh ideas on the digital revolution in media.
Today’s column is written by Cary Lawrence, CEO of Decile.
Many marketers think of cost per acquisition (CPA) as the holy grail, looking to this insight to determine how well ads are performing. Marketing teams are analyzing the transactional side of the equation, celebrating that return on ad spend is strong and customer count is increasing.
On the opposing side, finance is struggling to find long-term profitability, as acquisition costs keep rising, but customer value isn’t increasing.
While CPA may indicate short-term insights, like customer count and return on ad spend (ROAS), it doesn’t account for anything beyond the initial purchase.
As we’ve seen time and time again, rapid customer acquisition doesn’t always equate to sustainable growth. To further complicate things, many businesses discount heavily to drive that first purchase.
If a marketer’s goal is to acquire any old customer, they’ll quickly find that this strategy isn’t going to yield much growth. Ad costs are increasing, and return on ad spend isn’t what it once was. More is needed to make an impact. The goal should be to understand the characteristics of high-value customers and learn how to attract more of them.
Rather than looking at CPA, a better metric to consider is the lifetime customer value: acquisition cost ratio, also known as LTV:CAC.
Breaking down the ratio
LTV helps understand the entire breadth of each customer’s value, from the first purchase on. Meanwhile, customer acquisition cost (CAC) accounts for acquisition costs of customers who have made at least one purchase. These metrics are powerful on their own, but when paired together, they paint a fuller picture of long-term profitability.
If a customer purchases time and time again with a high average order value, the cost to acquire them is not as significant. For example, Susan orders a $50 sweater and never makes another purchase from the brand. Rachel purchases the same $50 sweater, but she returns a week later to purchase a pair of pants and a top for $150. Pairing that insight with customer acquisition cost provides a better analysis of true cost to acquire each customer.
Even if the brand spent $10 to acquire Susan as a customer and $15 to acquire Rachel, Rachel’s value still remains higher when those acquisition costs are compared to total lifetime value. Judging by the first purchase alone, it looks like acquisition costs are actually stronger for Susan. But LTV:CAC paints a different picture, with Rachel clearly identified as a higher LTV customer.
Building an acquisition strategy
So you know your LTV:CAC ratio. Now what? You’ll want to find more customers who have a strong LTV:CAC ratio, meaning the highest lifetime value and lowest acquisition costs.
Look at characteristics that make up your best customer groups. Do they have a similar first purchase? Do they share similarities in demographic characteristics, interests or household income? Are they being acquired through a specific advertising channel? This data will enable more strategic marketing decisions and help optimize campaigns.
Profitable growth is the name of the game for long-term success. It’s time to throw away the tired and ineffective CPA mindset. With LTV:CAC, marketing and finance teams will be aligned and ready to build a loyal and valuable customer base.