What a customer costs to acquire, what they are actually worth on margin, and how many months it takes to get the money back. The argument for and against buying growth.
Each customer costs $120.00 to acquire and returns $471.27 of gross profit over 3.0 years.
| Orders per year | LTV:CAC | Payback |
|---|
Two numbers come out of this, and they answer different questions. The ratio asks whether acquiring customers is worth doing at all. The payback period asks whether you can afford to do it at the pace you want.
A business can have a spectacular LTV:CAC ratio and still run out of money, because the profit arrives over three years while the advertising invoice arrives every month. Payback period is the number that decides how fast you can grow without external funding.
Lifetime value is the one metric in paid media where you can produce any answer you like simply by extending the time horizon. If the lifespan and repeat rate in this calculator have not been observed in your own cohort data, treat the output as a hypothesis rather than a number.
Everything spent winning a customer who was not already yours. For most businesses that is media spend, management or agency fees, creative production, and any sales cost involved in converting.
What does not belong: spend aimed at existing customers. Retention email, loyalty programmes and remarketing to past purchasers are not acquisition, and folding them in makes the acquisition cost look worse than it is. Brand campaigns sit in a grey area; include them if you believe they drive new demand, but be consistent about it from period to period.
Blended CAC divides total acquisition spend by all new customers, including those who arrived through word of mouth, organic search and direct. Paid CAC divides paid media spend by customers attributed to paid channels.
Blended is the more honest business number and the harder one to game, because it cannot be improved by changing an attribution setting. Paid CAC is the more useful channel management number. Most businesses should watch both and be clear about which one they are quoting.
The single most common error in this calculation is using revenue. A customer who spends $1,000 with you over three years at a 48 percent margin is worth $480, not $1,000, and the acquisition cost is paid out of the $480.
This is a simple model and it is deliberately so. It assumes a constant repeat rate, a constant margin and a clean end to the relationship, none of which is quite true. Businesses with the data to do better should be running a cohort-based calculation with a churn curve and a discount rate applied to future profit. This version is for working out whether the answer is roughly right before spending money on finding out precisely.
The commonly quoted target is an LTV:CAC ratio of at least 3:1. It originated in venture-backed software, where gross margins run above 75 percent and the calculation behaves very differently from a retail or services business. It is a rule of thumb, not a law, and it is frequently applied to businesses it was never designed for.
| Ratio | Commonly read as | In practice |
|---|---|---|
| Below 1:1 | Losing money | Every new customer destroys value. Nothing about scale fixes this. |
| 1:1 to 2:1 | Fragile | A small change in margin, return rate or repeat behaviour puts you underwater. |
| 2:1 to 3:1 | Workable but thin | Viable if overheads are low and payback is fast. Little room for error. |
| 3:1 to 5:1 | Healthy | The range most businesses are aiming for. Enough margin to cover overheads and reinvest. |
| Above 5:1 | Strong | Often a sign of underinvestment. You may be leaving growth on the table by bidding too conservatively. |
Payback period bands are similarly rough. Under six months is comfortable for most businesses, six to twelve months is normal, twelve to eighteen months requires real working capital discipline, and beyond eighteen months you are financing growth from somewhere and should know where.
An ecommerce business spends $30,000 in a month on media, fees and creative, and acquires 250 new customers. Average order value is $150 including GST at a 48 percent gross margin. Customers order 2.4 times a year and stay for about three years.
The first order recovers 54.5 percent of the acquisition cost, so the business is underwater on a new customer until roughly the second purchase. That is workable, but it means every dollar of growth needs about nine months of funding behind it. Figures are illustrative and returns vary by industry.
Doubles or triples the figure for most retailers, and it is the most common version of this error by a wide margin.
Repeat purchase is measured, not estimated. Pull the cohort: of customers who first bought twelve months ago, what percentage bought again, and how many times? Assumed repeat behaviour has sunk more ecommerce businesses than any single bad campaign.
If the customer count includes people who have bought before, the acquisition cost is understated and everything downstream looks better than it is. First-time buyers only.
Profit arriving in year three is worth less than profit arriving today, and a lot less if you are funding the gap on a credit facility. This calculator does not discount future profit, which makes long-lifespan results optimistic by design.
Divide everything spent acquiring new customers in a period by the number of first-time customers won in that period. That includes media spend, management or agency fees, creative production and any sales cost. Exclude spend aimed at existing customers, such as retention email or remarketing to past purchasers, and exclude returning customers from the count.
Gross profit. Revenue includes the cost of goods, shipping, packaging and payment fees, none of which you keep, so a revenue-based lifetime value overstates what is actually available to pay back acquisition cost. A customer spending $1,000 over their life at a 48 percent margin is worth $480, and that $480 is what the acquisition cost comes out of.
Three to one is the figure most often quoted, though it originated in venture-backed software where gross margins exceed 75 percent and does not transfer cleanly to retail or services. Below 1:1 you lose money on every customer. Between 1:1 and 2:1 the business is fragile. Above 5:1 you may be underinvesting and leaving growth unbought.
It is the number of months of gross profit needed to recover what you spent acquiring a customer. It matters because it determines how fast you can grow without external funding. A business with an excellent LTV:CAC ratio and an eighteen-month payback still has to finance eighteen months of working capital for every dollar of growth.
Both, for different purposes. Blended CAC divides total acquisition spend by all new customers including organic and word of mouth, and is the more honest business figure because it cannot be improved by changing an attribution setting. Paid CAC divides paid media spend by customers attributed to paid, and is more useful for managing channels. Be clear about which one you are quoting.
Only as long as your own cohort data supports. Lifetime value is the one metric where you can produce any answer you want by extending the time horizon, and three years is already a long assumption in most consumer categories. If you have not observed customers from three years ago still buying, do not model them as if they are.
It affects the value side. If you are registered for GST, the 10 percent collected on a sale is remitted to the ATO and is not revenue, so lifetime value should be calculated on ex-GST figures. Using GST-inclusive order values inflates lifetime value and the LTV:CAC ratio by roughly 10 percent. Confirm your GST position with your accountant.
Only if repeat purchase is measured rather than hoped for. Businesses with genuine repeat behaviour can rationally buy first orders at or below break-even because subsequent orders carry no acquisition cost. Businesses selling one-off purchases cannot, and assumed lifetime value that never materialises is one of the most common causes of ecommerce failure.
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The model is deliberately simplified. Among other things, it does not account for:
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Acquisition cost only means something next to a ceiling. These work out where yours sits.
The return on ad spend an order has to produce before it makes you a cent.
How much budget it actually takes to hit a lead or sales target, or what a fixed budget will realistically return.
Blended CAC, marketing efficiency ratio and incrementality testing, in one framework.
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