Savvy PPC marketers often praise LTV:CAC as a superior KPI for measuring profitability and guiding budget decisions.
While insightful, correctly leveraging LTV:CAC is far more complex than it seems – and certainly not as straightforward as ROAS, which itself can be misleading.
To avoid missteps, it’s crucial to understand when LTV:CAC is useful, its limitations, and how a poorly calculated metric can lead you to the wrong north star.
If your agency recommends increasing your PPC budget based on a “great” LTV:CAC ratio, be cautious. There may be critical nuances (or even conflicts of interest) at play.
This article breaks down the fundamentals of LTV:CAC, including:
What LTV:CAC is and why it’s important.
Common pitfalls when using the metric.
How to refine LTV:CAC, plus alternative KPIs.
What is LTV:CAC?
LTV:CAC (customer lifetime value to customer acquisition cost) measures the relationship between the value a customer brings to a business over time and the cost of acquiring that customer. It’s calculated as:
LTV:CAC = LTV / CAC
This ratio helps businesses assess whether their customer acquisition efforts are profitable.
A higher LTV:CAC indicates that customers generate more revenue than their acquisition cost, while a lower ratio could signal inefficiency or unprofitable marketing.
Breaking down the components
LTV (customer lifetime value) represents the total revenue a customer generates throughout their relationship with a business.
Formula:
LTV = (Average order value x Total transactions) / Unique customers
CAC (customer acquisition cost) is the average cost incurred to acquire a new customer within a specific period.
Formula:
CAC = Total marketing costs / Number of new customers
Note: Always calculate both metrics using the same time period to avoid skewed results.
Why is LTV:CAC important – and how can it be dangerous?
LTV:CAC serves one core purpose: ensuring profitability.
This KPI is critical for a company’s future because it measures whether the value generated from newly acquired customers justifies the cost of acquiring them.
It’s often compared to return on ad spend, or ROAS, (revenue generated by ads / ad costs) but goes a step further.
While ROAS focuses on immediate returns, LTV:CAC considers the long-term revenue potential of a customer.
This broader view can encourage marketers to lower ROAS targets and increase budgets, assuming future revenue will balance acquisition costs over time.
For example, imagine a marketer spends $30 to acquire a new customer who generates $30 in immediate revenue (100% ROAS).
Based on historical data, the finance team predicts that this customer will make three additional purchases of $30 each, totaling $120 in revenue over their lifetime.
Total revenue = $30 (initial purchase) + 3 x $30 = $120
LTV = $120
CAC = $30
LTV:CAC = $120 / $30 or 4:1
This 4:1 ratio might suggest strong profitability and justify increased spending.
However, it can be dangerous.
Profitability metrics like LTV:CAC often require deeper financial oversight, yet marketers may lack visibility into key cost components, such as payback periods, retention variability, and operational costs.
Misunderstanding these factors can lead to overestimations of profitability and misguided budget increases.
Let’s break down some of the common traps that make LTV:CAC a potentially misleading metric.
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7 common pitfalls of using the LTV:CAC ratio
1. Ignoring the impact of customer retention
LTV:CAC is often praised by top marketers as a superior KPI, which might tempt you to adopt it too.
While it can be valuable in scenarios with high retention and repeat purchase rates (like SaaS), it’s not always reliable.
Before using LTV:CAC, run a retention analysis to answer: “How many times do my customers purchase on average over a set period?”
In ecommerce, customer retention is typically around 30% at best.
Using the earlier ROAS example, if you spend $30 to generate $120 in revenue (400% ROAS), you might assume retention will increase total revenue by 30%, raising it to $156. This would suggest a higher 520% ROAS.
While appealing, it’s far from transformative enough to justify dramatically increasing your budget.
2. Overlooking payback period and cash flow
Even if your retention is strong enough to justify using LTV:CAC as your north star metric and your ratio slightly exceeds the standard 3:1, increasing your PPC budget blindly can be risky.
Why? Because LTV:CAC doesn’t account for the payback period – the time required to recover CAC expenses, or how long it takes for revenue to break even with acquisition costs.
If your payback period is 12 months, customers won’t become profitable until the 12-month mark.
During that time, your balance sheet remains negative, putting strain on cash flow and limiting your ability to reinvest in PPC campaigns or other growth strategies.
To scale faster, you need cash on hand since existing funds are already tied up in customer acquisition.
Options include raising capital or improving fundamentals (e.g., lowering CAC, raising prices, or encouraging prepayment).
Bottom line: A positive LTV:CAC doesn’t guarantee you can safely scale your budget.
3. Misunderstanding marketing LTV vs. finance LTV
Marketers often calculate LTV using basic metrics like revenue – sometimes even pre-tax figures – resulting in inflated and misleading values.
Naturally, both LTV and CAC should accurately reflect the balance sheet, but this is where many marketers go wrong.
Finance teams often step in to correct these calculations, which can lead to uncomfortable conversations if marketers lack financial literacy.
To avoid this, marketers need to understand finance-level metrics and how their stakeholders calculate profitability.
LTV is fundamentally a finance KPI. Some finance teams calculate it using gross profit margin (COGS), while others factor in operating expenses (OPEX), making it closer to an EBIT-based KPI.
Ultimately, it’s not about challenging their process but aligning with it.
To collaborate effectively, marketers should understand key cost components like:
Support.
Infrastructure.
Materials (for physical products).
Sales and marketing expenses.
Development costs.
Other operational expenses.
By aligning with finance teams and using accurate metrics, LTV:CAC can become a far more reliable KPI.
Dig deeper: 3 PPC KPIs to track and measure success
4. Miscalculating CAC by ignoring non-marketing customer sources
PPC, marketing, and other customer sources are critical when assessing CAC and its impact on LTV:CAC.
Lowering CAC is an obvious way to improve the LTV:CAC ratio, but it can complicate calculating CAC accurately.
A common issue is calculating CAC by dividing total marketing costs by total new customers, disregarding other customer sources.
In some businesses, where marketing drives about 95% of customer acquisition, this approach might not significantly affect the LTV:CAC ratio and simplifies the calculation.