Use CAC and CLV to Monitor Ecommerce Growth, Profit

Growing an ecommerce company can feel like juggling knives whilst riding a unicycle on a tightrope. Owners and managers have so much information available and a lot of key performance indicators, it can be tricky to know where to focus attention or investment.

While there are lots of possible metrics or KPIs, companies geared toward long-term, steady ecommerce growth would be wise to concentrate on two: customer lifetime value (CLV) and customer acquisition cost (CAC).

CLV-to-CAC Ratio

Both metrics may even be combined to one KPI: the CLV-to-CAC ratio (CLV:CAC). It tracks the connection between what a company pays to find a first-time buyer and just how much that customer is very likely to invest over time.

A CLV:CAC of you to a (i.e., 1:1) informs you your organization is failing. With this ratio, ecommerce growth can only be achieved with significant investment, and you shouldn’t expect to earn much gain.

On the other hand, a CLV:CAC ratio of three-to-one or greater indicates that your organization is building value. Investing in your company should lead to profitable growth.

There are limitations, too. If the CLV:CAC ratio is too large, state 25:1, you’re investing too little and might be exposed to competition.

Let us review how you are able to compute both CLV and CAC.

Calculating CLV

There are a couple methods to calculate customer lifetime value. You could attempt to forecast CLV, but for purposes of this guide, I will compute CLV based on a organization’s historical sales data.

CLV = Average Purchase Value x Buy Frequency x Margin

First, locate your ecommerce firm’s average order value (AOV) for the last year. AOV is the total sales for a given period divided by the amount of orders for that same period. (Some ecommerce platforms comprise AOV in their default reports.)

AOV = Total Revenue ÷ Purchase Count

Next, multiply your institution’s AOV from the average number of times a specified client made a purchase in the past 12 months. If your organization had 10,000 orders and 8,250 clients in the last year, your purchase frequency could be 1.2.

Buy Frequency = Total Orders ÷ Client Count

Finally, multiply your result by your own margin, which is what is left after all expenses. Therefore it would be your typical purchase value less cost of products sold and less typical overhead.

Margin = AOV - Cost of Goods Sold - Typical Overhead

Calculating CAC

The CAC for a particular period is the total of all promotional costs divided by the amount of new customers obtained. I addressed it earlier this year, at “How to Measure Customer Acquisition Cost.”

CAC = Complete Promotional Costs ÷ Number of New Clients 

Your company’s promotional cost includes the cost of an advertisement, labor to create the advertisement, and similar. The secret is to include everything required to get the new client.

Using CLV:CAC

Look at your organization’s CLV:CAC ratio in two ways. Both options should help track ecommerce growth and provide you an indication of how to spend your resources. But each has a slightly different standpoint.

12-month view. Consider calculating your 12-month CLV:CAC ratio every month. Put another way, every month look at your company’s CLV:CAC ratio for the previous 12 months. Thus, examine the AOV for the previous 12 months, purchase frequency for the previous 12 months, and margin for the previous 12 months.

The monthly CLV:CAC ratio should be a great indicator of your company’s health and overall growth prospect. Also, as you look at this figure monthly, you can see trends in your organization’s performance.

Three-month view. Separately, have a look over your ecommerce firm’s CLV:CAC ratio for the previous 3 months. Again, run the report each month, but instead of looking at the ratio for the last year, consider just the previous 3 months.

This ratio can allow you to spot immediate trends, identify peaks or valleys, and possibly see issues before they get too big. This comparatively shorter perspective also helps to determine seasonal trends like the way the Christmas holiday could be influencing your company.

Ecommerce Growth

If your company’s goal is to grow, to increase sales, gain, or both, CAC and CLV can indicate if you’re succeeding and where to concentrate your efforts.

Finally, how well your company develops and keeps customers will determine sustainable achievement.

A CAC that’s too high, as an instance, will tell you to concentrate on improving how your organization attracts shoppers or improving how well it converts them. While a CLV that’s comparable to your CAC, by way of instance, shows that you ought to pay attention to customer loyalty.

In my experience, there’s no fantastic KPI. You’ll likely have to juggle several of these. However, an understanding of CLV and CAC will help any ecommerce company.

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