What is LTV/CAC ratio?
The Lifetime Value to Customer Acquisition Cost (LTV/CAC) ratio is a different way to visualize the customer level economics of a business.
The lower the payback period, the better the customer level economics of the business is. Inversely, a higher LTV-to-CAC ratio indicates that the customer relationship is more profitable.
Example:
Consider an Indian FinTech startup that spends an average of ₹2,000 to acquire each new customer (CAC). It estimates that an average customer will generate ₹5,000 in net margin over their lifetime (LTV). The LTV/CAC ratio is:
LTV/CAC Ratio = LTV / CAC
= ₹5,000 / ₹2,000 = 2.5.
Significance of LTV/CAC:
The LTV/CAC ratio is essential for assessing customer value and the effectiveness of acquisition strategies. Here's how to interpret it:
An LTV/CAC ratio of 1 implies that the cost to acquire a customer equals the value they bring. A ratio above 1 signals a positive return on investment, while below 1 indicates high acquisition costs relative to customer value.
Aiming for a higher LTV/CAC ratio is crucial for businesses, particularly in the competitive Indian market, to ensure profitability and sustainable growth.