By Trevor Lew

Key Steps to Calculating CAC

The Customer Acquisition Costs (CAC) to Customer Lifetime Value (LTV) (CAC to CLV) ratio is one of the most talked about concepts in all of venture capital. On the surface, it’s very simple: is a company making more money on each customer than it took to acquire him or her? However, things are much more complicated after zooming in.

For example, customer acquisition costs aren’t static. They change all the time. If a company is running a digital ad strategy, then the cost of the ads changes due to the bidding system or time of year. If a company has a direct salesforce, then it’s difficult to directly tie what specific costs were for signing up which customers. Furthermore, there’s no guarantee that the historical costs will persist into the future or that a company’s cost structure won’t change a lot along the way (hiring more to the marketing team or customer’s success, etc). Customer lifetime value usually suffers from similar issues of uncertainty, measurement capabilities, and variability.

So what’s the answer?

Smart investors are going to understand that the ratio is inherently imperfect and the product of certain assumptions. However, the utility and importance of the ratio isn’t diminished. What’s key are the different variables and assumptions being used in the calculation. Are there new marketing channels being introduced? What is the performance attached to those? How can web traffic be optimized further? Are there weaknesses to the way the data is collected? Why wouldn’t these processes scale effectively?

In another lens it’s important to think through the customer journey or sales conversion funnel. Smart investors are going to dig into the nitty gritty of these numbers and appreciate companies that have great mastery over their presentation. If you’re running Facebook and Google ads that have multiple impressions over time or retargeting, then understanding where those customers are along that journey and how much it takes to get them to each stage is critical to analyzing CAC.

Sometimes there’s the temptation for companies to cherry pick data points with CAC because of its imprecise nature. However, I encourage companies to be direct and upfront about their CAC’s strength and weaknesses. Doing so shows there’s an understanding that it’s not a stock metric viewed in isolation, but it is an ongoing key performance indicator connected to other critical businesses elements. All startups have risks, and investors are trying to get a sense of the founder’s viewpoint on them.

Hopefully these are some helpful tips as companies go about understanding and explaining their CAC!