How do you calculate the ideal marketing budget? More
importantly, how do you figure out your optimal business spending to bring in
and keep the most new clients while still being profitable?
The two most crucial measures for determining these answers
are customer lifetime value (CLV) and customer acquisition cost (CAC) for an
eCommerce organization. One counts a little more than the other (we\’ll discuss
that below), but both are very important in assisting you in assessing and
enhancing the success of your company.
We\’ll go through the fundamentals of CAC and CLV in this
piece, along with the importance of both to online retailers. We\’ll go into
more detail about how the two measures relate to one another and how retailers
may win in cutthroat markets by maximizing their CLV to CAC ratio. Let\’s get
going.
What does it cost to get new
customers?
The overall direct and indirect costs involved in turning a
member of your target market into a paying client are referred to as customer
acquisition costs.
These expenses for internet retailers can differ greatly. In
addition to the cost of associated marketing initiatives, CAC also accounts for
the costs of packaging, transporting, and storing the actual goods as well as
any marketing or sales personnel involved in acquiring the client.
This is a business-level metric, to put it another way. This
makes a lower cost of customer acquisition a crucial KPI for the entire firm
because it inevitably increases the possibility for profitability.
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Why it\’s important to understand CAC
As a business-level indicator of success in eCommerce, CAC
frequently serves as a quick check for sustained revenue.
Simply said, in order to make money, your average CAC must
be lower than your average order value (AOV). Focusing your marketing efforts
on lowering client turnover will help you lower your CAC if it is trending
higher than your AOV.
CAC is a useful indicator of a competitive climate. According
to SearchNode\’s analysis on 2021 Ecommerce Trends, 84% of eCommerce merchants
think that competition is harsh or extremely tough.
How to determine CAC
This straightforward technique will help you determine your
CAC:
Total Cost of Sales and Marketing (CAC) (Number of Customers
Acquired)
Total expenses for sales and marketing may include:
·
The cost of any contracts or salaries for anyone
working on your marketing campaign. Only use the same fraction to determine
their wage if they only work part-time in marketing.
·
Any extra costs for things like office space or
equipment.
·
Any equipment required to bring in new clients,
such as an internet store, a payment processing system, or email marketing
software.
For channels like Google, social media, programmatic
displays, etc., all direct advertising expenditures.
All expenses associated with getting your goods into your
customers\’ hands after conversion, such as packing, shipping, and handling.
For instance, if a business invests $1,000 over the course
of a year to bring on 20 new clients, their CAC would be $50.
Consistency is essential when utilizing CAC to guide company
choices, keep in mind. Only if you factor in the same kinds of costs each time
you benchmark your efforts will your CAC calculation produce long-term insights
that are trustworthy.
What is the lifetime worth of a
client?
The total amount of money that a current client will
generate over the course of their usual lifetime is known as the lifetime value
of a customer.
Consider a scenario in which a typical consumer remains with
your business for around two years and makes five transactions from your
website, each of which costs $50 on average. In this instance, your CLV would
be $250.
Why it\’s important to understand your
CLV
When you sell products online, CLV is important because it
gives you a comprehensive picture of the possible revenue from your consumer
base. You gain a true understanding of the lifetime value of each customer you
acquire rather than focusing on first-buy metrics like AOV.
As a result, you can use this statistic to switch your focus
from client acquisition to customer loyalty in addition to evaluating the
effectiveness and success of your marketing investments. If the buyer makes
their biggest purchase after trying your products out, it doesn\’t really matter
how much AOV there was for the initial conversion.
How to determine CLV
CLV can be calculated in a variety of ways, from
straightforward to sophisticate. A popular formula is as follows:
(AOV times Repeat Purchase Rate) – CAC = CLV
Divide income by the total number of orders over a specific
time period to determine your AOV. The proportion of clients that make
additional purchases from you during a given time period is known as your
repeat purchase rate.
How CAC and CLV interact
One emphasizes price, while the other emphasizes the value
side of the trade-off. That may give it away: CAC and CLV work best when they
are strongly correlated to present a comprehensive picture of business success.
Ecommerce experts advise concentrating on a metric called
CLV to CAC ratio in order to achieve that goal. This statistic contrasts the
total worth of a customer with the price paid to acquire them.
If the ratio is less than one, every time the business adds
a new customer, it loses money. A ratio greater than one indicates increased
revenue but not necessarily profitability. After all, there are company
expenses that are unrelated to client acquisition.
In general, merchants focus on a ratio greater than three,
though this might vary depending on the merchant\’s stage of development,
whether it is high growth or maturing, the competitive climate, and other
considerations.
Additionally, a ratio over five can point to improvements.
It\’s a crucial sign that increasing marketing spending would enhance
acquisition strategies and increase online sales.
What counts more for the success of ecommerce:
CAC or CLV?
The success of your company can be measured using both CAC
and CLV. However, for a few reasons, increasing your CLV is frequently more
important than reducing your CAC.
It is more challenging to adjust CAC because it is, at least
in part, determined by your audience and the competitive landscape. Focusing on
CLV can therefore have a more noticeable influence on revenue.
A greater CLV enables you to spend more on each customer\’s
acquisition, spreading out and improving the return on your customer
acquisition spending.
Because it places a strong emphasis on cutting expenses, CAC
can be a contentious metric. It\’s possible that non-marketing executives will
want to reduce your marketing budget.
Voice seven techniques to raise your CLV to CAC ratio.
You can concentrate on either side of the equation in any
endeavor to increase your CLV to CAC ratio. The strategies listed here are just
a handful of the many ways you can decrease wasteful spending while maximizing
value. To accomplish both, you must concentrate on raising your customer
retention rate.
1. Introduce a subscription-based service
According to a conventional eCommerce business model, your
CLV is reliant on clients making unique decisions to purchase your goods each
and every time. By automating this procedure, a subscription model gives your
consumers additional ease while also assisting you in creating a steadier and
predictable cash stream.
The conventional eCommerce model can coexist alongside a
subscription-based service. However, since subscriptions are a more efficient
means to increase CLV, it\’s crucial to demonstrate the benefits of subscribing
to clients.
2. Establish a client loyalty program
A loyalty program encourages customers to do business with
you for a longer period of time. It offers users points, discounts, or other
benefits in exchange for their first and subsequent purchases. Your CLV consequently
rises as a result while your CAC stays the same.
Added benefits of loyalty programs include an improvement in
consumer satisfaction and, as their name implies, brand loyalty.
3. Promote and reward client recommendations
Your acquisition costs might be significantly reduced via
referrals. A customer appreciating your goods in front of their social circle
or professional network is entirely free advertising for your brand. Even
rewarding them with a robust referral program is less expensive than a thorough
advertising plan based on demographic indicators.
Naturally, referrals only succeed if your clients adore your
brand and product. But when they do, taking a calculated strategy to motivating
them can significantly lower your CAC and raise your CLV/CAC ratio.
4. To reduce friction, make use of reordering options.
What if you could persuade clients to place repeat orders
when they have the highest needs? A quick text or email reminding customers to
place new orders for things they use up over time could be quite effective.
By doing this, you lessen friction. Spending on client
retention can be made more effective when the tool you use can pinpoint the
best times to contact customers. This decreases the importance of CAC while
increasing your lifetime value.
5. Using search and order history to upsell and cross-sell
Utilizing data you\’ve obtained about the consumer to upsell
and cross-sell is one of the finest methods to increase the CLV portion of the
equation. These strategies assist in raising AOV, which raises CLV.
If a consumer is steadily upgrading, you can recommend more
expensive things to them or products that go well with their recent or frequent
purchases thanks to their order history. Upsell and cross-sell to new clients
based on cookie-driven browsing patterns.
6. Improve paid advertising for acquiring customers
The cost of acquisition is skyrocketing due to paid-ad
competition and changes to privacy data, whether it be in search or social.
These expenses can drastically reduce your profit margins if you don\’t perform
frequent ad audits.
It\’s crucial to routinely do A/B tests to see which
advertisements resonate with clients in order to control these expenditures.
Google gives you the option to switch up the headlines and
descriptions of your search ads until you discover the one that converts the
best. You may even experiment with the timing of your adverts to adjust your
spending to the times when they are most likely to result in sales.
Visuals are crucial for social media ads because you only
have a brief window to capture clients\’ attention while they scroll. Check
which short videos and photographs receive the most clicks using an A/B test.
7. Define a free shipping cap.
An AOV boost from a free delivery threshold is similar to cross-selling
and upselling. It encourages customers to add items to their carts up until
they reach the threshold required to receive free shipping. Internal studies
show that a free delivery threshold can boost AOV by as much as 27%.