LTV vs CAC: the vital balance for growth

For any startup, growth only makes sense when the value generated by each customer is higher than the cost of acquiring them. That is why the relationship between LTV and CAC is so important: it helps determine whether a business can scale sustainably, invest in marketing with confidence, and avoid growing at the expense of profitability.

• LTV / CAC ratio: Measures how much value a customer generates in relation to the cost of acquiring that customer.
• CAC payback period: Indicates how long it takes the company to recover the investment made to acquire a customer.
• Traction capacity: Evaluates whether the model can grow and acquire more customers while keeping positive results. Access the online traction validation tool.
• Marketing investment: Helps define how much can be invested in acquisition without compromising profitability.

It is important to keep in mind that the LTV and CAC ratio will not have a precise value until the startup has found a repeatable and scalable sales process. Until then, the metrics will be useful, but only up to a point.

LTV / CAC ratio

The relationship between these two metrics is usually worked with through the following ratio:

This ratio is especially important in business models where, when scaling, any cost that is not marketing does not grow proportionally with the number of customers. These types of businesses are often related to technology, with SaaS (Software as a Service, such as Dropbox) being one of the clearest examples.

Following the SaaS example, LTV can be obtained by multiplying subscription fees by time:

As for the cost structure, it would be:

Therefore, when establishing the relationship, we will see that revenue must be sufficiently higher than costs:

When looking at a relationship with a large number of customers and other costs that have not grown proportionally, we can see that marketing-related costs (number of customers * CAC) are much higher than the others. This allows us, as a mathematical approximation, to disregard the other costs because they are masked by marketing costs.

For this reason, we can see that the revenue-cost relationship of the business is determined by the relationship between LTV and CAC, because the number of customers appears on both sides of the equation and cancels out. In this way, this approximation allows us to see that the health of a SaaS-type business does not depend on the number of customers, but on the LTV / CAC relationship, while always considering that we have, or will have, a large volume of customers.

A good LTV to CAC ratio is usually estimated to be above 3. Although this number depends on the business, it is a good approximation if we consider that the smaller the target market, and therefore the more niche it is, the higher the ratio will need to be.

In addition, if the general costs of the business also grow as the number of customers increases, the ratio will need to be higher to support those other costs, as explained above.

CAC payback period

To determine a startup's cash position or cash needs, it is very important to know how long it takes to recover that marketing investment. The following metric is especially important for recurring revenue models.

When the customer pays a recurring fee, it is easier to calculate the value:

If, on the other hand, our business does not work through fees, we will need to calculate the average euros obtained from each customer over a given period of time, usually one month.

In business models where recurrence is important, as in SaaS, the reference point is the time needed to recover the marketing investment, which should be less than 12 months. The shorter the time, the better for the business.

Traction capacity (a question of volume)

Usually, having a good LTV / CAC ratio means that the business works well at a small scale. This means that if we increase customer volume, we will have a good business, as long as costs, except marketing costs, are under control and do not grow in proportion to the number of customers.

If you want to learn more about the LTV / CAC ratio, see the dedicated section.

Marketing investment and spending control

The relationship between LTV and CAC will also allow us to know what marketing investment will be needed, as well as the results we need to obtain.

To do this, we need to:

1. Know how much money we expect to obtain from each customer (LTV), based on the euros spent on each purchase and the number of times they will buy over time.
2. Using the LTV/CAC ratio we want, calculate the maximum CAC we can afford to ensure the business is healthy at a small scale.
3. Once we know both the CAC and the number of customers we want, we can obtain the total marketing investment, as shown in the following formula.

Now let's look at an example:

Thanks to this formula, we know that acquiring 1,000 new customers would require a maximum marketing investment of $133,330 in order to maintain a healthy business ratio. In addition, as we implement the corresponding actions, we should monitor that the acquisition cost per customer does not exceed $133.33.

If marketing is outsourced, these data will be essential for setting the objectives and control metrics of all campaigns carried out.

Identify the segment with the highest economic contribution

Another aspect where the LTV/CAC ratio helps us is in identifying the customer segments that are economically better for us. Cohort analysis allows us to identify them.

Once they have been determined, we can analyze why those segments perform better, and the learning acquired can be applied to other segments to try to improve them.

LTV / CAC diagram

Series: Fundamental Metrics for Startups and SMEs

Your business is already speaking through its data: learn how to interpret the key metrics that reveal whether you are growing with direction, building a profitable model, or simply moving forward blindly.