Customer Acquisition Cost and Lifetime Value

Two numbers that help businesses decide how much to spend on winning customers, and why many start-ups have struggled when they got them wrong.

Every business needs customers, and getting them costs money. Two measures help businesses judge whether their growth is healthy: customer acquisition cost and customer lifetime value.

Customer acquisition cost

Customer acquisition cost, or CAC, is the average cost of winning one new customer. It includes spending on advertising, promotions, discounts and sales staff, divided by the number of new customers gained.

If a business spends 100,000 rupees on marketing in a month and gains 500 new customers, its CAC is 200 rupees per customer.

Lifetime value

Customer lifetime value, or LTV, is the total profit a business expects to earn from a customer over the whole relationship. It depends on:

How much the customer spends each time.
How often they buy.
How long they stay a customer, called retention.
The profit margin on each purchase.

The key comparison

A business is on healthy footing if lifetime value is comfortably higher than acquisition cost. Many investors look for LTV to be several times CAC. If CAC is higher than LTV, every new customer loses money, and growing faster just loses money faster.

These kinds of calculations are called unit economics: whether the business makes money on each customer or each sale.

The discount trap

A delivery start-up offers huge discounts to attract users, spending 500 rupees to win each customer. But the average customer places a few orders, earning the company only 150 rupees in profit before leaving for a rival app. Each new customer loses 350 rupees. Rapid growth made the company look successful but deepened its losses. Many start-ups funded by venture capital faced this problem.

Improving the numbers

Businesses improve their unit economics by:

Retaining customers longer through good service and quality.
Encouraging repeat purchases.
Lowering acquisition costs through word of mouth and referrals.
Raising margins.

Thinking more customers always means more success

Customers acquired at a cost higher than the profit they bring make a business weaker, not stronger. Healthy growth requires each customer to be worth more than it cost to win them.

Key takeaways

Customer acquisition cost is the average cost of winning a new customer.
Lifetime value is the total profit expected from a customer over time.
Healthy businesses have lifetime value well above acquisition cost.
Retention, repeat purchases and referrals improve unit economics.