What Is A Good LTV CAC Ratio For SaaS Businesses?
One of the most important things for any business is to have a significant return on investment (ROI). After all, what’s the point of investing money into a project if you don’t expect to get more money out of it down the line?
For traditional businesses, it’s generally easier to track ROI because there are more tangible products that you buy and sell per unit. Calculating your gross margin is as easy as subtracting your cost of goods sold (COGS) from your revenue.
However, for a SaaS business model, calculating ROI can be a bit more complicated. You have a digital product that your customers pay for on a recurring basis, usually monthly or annually.
So how do you determine what a good ROI looks like for your business?
This is where the LTV:CAC ratio comes in.
In this article, we’ll take a look at what the LTV:CAC ratio is, why it’s important to track, what is a good LTV CAC ratio for SaaS businesses, and how you can improve it.
What Is The LTV:CAC Ratio?
LTV:CAC is a SaaS metric that measures how much revenue you are generating in relation to the expenses you are incurring to acquire new customers.
There are two main components to this ratio: The lifetime value (LTV) and the customer acquisition cost (CAC).
Lifetime Value (LTV)
The LTV or customer lifetime value (CLV) is a metric that measures the total revenue that a customer will generate for your business over the course of their relationship with you.
There are a few ways you can calculate your LTV, depending on the availability of historical data about how long your customers tend to stay subscribed to your product. But both methods require another metric called the average revenue per user (ARPU).
Your ARPU is simply your total recurring revenue divided by the number of paying customers.
For example, let’s say you have an annual recurring revenue (ARR) of $1 million and 1000 customers. That would give you an annual ARPU of $1000.
As for the rest of the calculation, let’s talk about two certain methods:
Calculating LTV With Historical Data: If you’ve been in business for quite a few years now, you likely have some data on how long your customers stick around.
In this case, you can find your average customer lifespan by simply finding the average time that your customers stay subscribed to your product.
Then you can calculate your LTV by taking the average customer lifespan and multiplying it by the ARPU.
For example, let’s say that the average customer stays subscribed to your product for 4 years and they generate an annual ARPU of $1000. This would give you an LTV of $4000.
Calculating LTV Without Historical Data: If you don’t have any historical data on hand, you can still estimate your customer lifetime by dividing 1 by your churn rate.
So for example, let’s say you have a monthly churn rate of 2%. Divide that by 1 and you get 50 months or around 4.17 years. Multiply that by your ARPU of $1000, and you get an LTV of $4170.
For a much simpler calculation, though, you can just divide your ARPU by your customer churn rate.
Of course, this is just an estimate and your actual LTV could be higher or lower. But it’s a decent starting point if you don’t have any historical data to go on.
Customer Acquisition Cost (CAC)
As the name suggests, customer acquisition cost (CAC) is the amount of money that you spend to acquire a new customer
This includes marketing expenses, sales expenses, and any other costs associated with getting someone to sign up for your product.
More specifically, they include the following:
- Paid advertising spend
- Content marketing expenses
- Sales and marketing tools (CRM, sales automation, SEO, etc.)
- Marketing team salaries
- Sales team salaries and commissions
To calculate your CAC, add your sales and marketing spend and divide the sum by the number of new customers you’ve acquired.
For example, let’s say you spend $75,000 on marketing and $25,000 on sales. You acquire 100 new customers. This would give you a CAC of $1000 per customer.
How To Find LTV:CAC Ratio
Once you have your LTV and CAC, you can calculate your LTV:CAC ratio by dividing the LTV by the CAC.
For example, let’s say your LTV is $4000 and your CAC is $1000. That would give you an LTV:CAC ratio of 4:1. Which means for every dollar you spend on sales and marketing, your business earns $4 in return.
The Standard LTV CAC Ratio For SaaS Businesses
The standard LTV CAC ratio for SaaS businesses is around 3:1 to 4:1.
This means that for every dollar you spend on acquiring a new customer, they should generate $3 to $4 in lifetime value for your business.
But let’s talk about what different LTV:CAC ratios mean for your business.
Less Than 1:1 Means You’re Losing Money
If you end up with an LTV:CAC ratio of less than 1, it means you’re losing money on your customer acquisition efforts.
This is because your customers are costing you more to acquire than they’re worth to your business. And that’s not a sustainable position to be in for the long term.
If your LTV:CAC ratio is less than 1, you need to find a way to reduce your CAC or increase your LTV. Or both. Preferably both.
1:1 Means You’re Breaking Even
A 1:1 LTV:CAC ratio means that you’re breaking even on your customer acquisition efforts.
This is because your customers are costing you as much to acquire as they’re worth to your business.
While this isn’t ideal, it’s not necessarily a bad thing either. After all, you’re not losing money on each new customer.
And if you can find a way to increase your LTV while keeping your CAC the same, you’ll start generating a profit from each new customer.
More Than 5:1 Means You’re Missing Out On Potential Growth
The higher your LTV:CAC ratio is, the better it is for your business, right?
While a high LTV:CAC ratio is certainly a good thing, it can also be a sign that you’re missing out on potential growth opportunities.
This is because a high LTV:CAC ratio means that your customers are worth a lot to your business. Which is great. But it also means that you’re not spending enough to acquire new customers.
If your LTV:CAC ratio is more than 5:1, you should consider increasing your marketing and sales budget so you can acquire more customers and grow your business at a faster rate.
How To Improve Your LTV CAC Ratio
Obviously, improving your LTV:CAC ratio involves increasing your LTV while optimizing your CAC. Let’s see some more specific ways you can do those things.
1) Reduce Your Customer Churn Rate
One of the best ways to improve your LTV:CAC ratio is to reduce your customer churn rate.
As we’ve already discussed, customer churn is when a customer stops using your SaaS product. And it can have a major impact on your business, both in terms of lost revenue and increased costs.
There are several ways to reduce your churn rate.
Find Out What’s Causing Your Customers To Leave: To address churn at its very core, you need to figure out what’s causing your customers to leave in the first place.
Is it because they’re not getting value from your product? Is it because they’re not using it enough? Or is it something else entirely?
Once you know what’s causing your customers to leave, you can put measures in place to prevent them from doing so.
Make sure your customers know how to use your product and that they’re getting value from it. Offer them assistance when they need it and proactively reach out to them on a regular basis.
The better your customer support and customer success, the less likely your customers are to churn.
Implement A Rewards Program For Loyal Customers: This is a great way to show your customers that you appreciate their business and to keep them coming back for more.
There are a few different ways you can do this. For example, you could offer discounts, give away free products or services, or offer exclusive access to certain features or content.
2) Upsell To Your Existing Customers
Another great way to improve your LTV:CAC ratio is to build a killer upsell strategy.
An upsell is when you sell a customer a more expensive version of what they’re already using. For example, if someone’s using the basic version of your SaaS product, you could upsell them to the premium version.
This is a great way to increase your ARPU and LTV because it allows you to generate more revenue from each customer while still providing them with value.
So how do you upsell to your customers? Here are a few ways:
Identify Upsell Triggers: These are specific events or actions that indicate that a customer is ready to be upsold.
For example, if a customer starts using a certain feature more frequently, it could be an upsell trigger. Or if they are almost reaching the limits of their current subscription plans, that could be another trigger.
Find out what those triggers are for your business and keep an eye out for them. When you see one, reach out to the customer and offer them an upsell.
Better yet, you can automate your upgrade prompts and provide a self-service upgrade system for your customers. This way, they can upgrade on their own when they’re ready, without having to wait for you to reach out.
Develop New Features For Higher Plans: This is a great way to encourage customers to upgrade because it shows them that there’s more value to be had.
If you’re constantly adding new features and improvements to your product, customers on lower plans are going to see the value in upgrading. They’ll see that they’re missing out on all the new stuff and they’ll be more likely to make the switch.
Offer Free Temporary Upgrades: This can be an effective way to get your customers to try out your higher plans and experience the value for themselves.
You can offer them a free upgrade for a limited time, after which they’ll be automatically downgraded to their previous plan.
This gives them a taste of what they’re missing out on. If they have a great experience with the limited upgrade, they might just decide to upgrade their plans permanently.
3) Shorten Your Sales Cycle
The shorter your sales cycle, the more customers you can acquire within a given period of time. This, in turn, will increase your LTV:CAC ratio because you’ll be able to generate more revenue from each customer in a shorter amount of time.
There are a few ways to shorten your sales cycle. Here are a few of the most effective:
Focus On High-Quality Leads: Make sure you’re only spending your time on leads that are actually interested in what you’re selling.
The more qualified your leads are, the easier it will be to sell to them. As a result, you’ll be able to close deals faster and shorten your sales cycle.
Invest In A Customer Relationship Management (CRM) System: A CRM system can help you keep track of your leads and customers, automate some of your sales processes, and close deals faster.
Just a note here though-if you get a paid CRM, the cost will be added to your CAC. But if you use it right, it can make up for the additional cost by closing more deals and closing them faster.
Send Targeted Content For Each Sales Funnel Stage: Make sure you’re sending the right content to your leads at each stage of the SaaS sales funnel.
If you’re selling to someone who’s never heard of your product before, they’re not going to be interested in reading a detailed case study. It’s better to send them helpful and valuable content that can somewhat help them with their pain points.
But if you’re selling to someone who’s already familiar with what you’re offering, they might be more receptive to that type of content.
By sending targeted content, you’ll be able to keep your leads engaged and move them through your sales funnel faster. As a result, you’ll shorten your sales cycle and improve your LTV:CAC ratio.
Final Thoughts About The LTV:CAC Ratio
The LTV:CAC ratio is one of the most vital SaaS metrics that you need to track. It’s a great way to measure your business’s health and see if you’re making progress.
If your LTV:CAC ratio is low, don’t worry. There are plenty of ways to improve it. Just focus on acquiring more customers and generating more revenue from each one.
If you can do that, you’ll be well on your way to improving your LTV:CAC ratio and growing your business.
But this ratio doesn’t just give you a warning if you’re starting to lose money. It can also give you a signal that you’re ready to invest more in growth and acquire even more customers.
Want more guides and tips to help you grow your SaaS business? Visit our blog here.