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We discuss some reasons why LTV is a useful metric.
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Now we know what LTV is,
but why does it matter?
0:00
Well, all else equal, businesses do
better with LTVs that are growing.
0:04
That's because growing LTVs are indicators
that customers are sticking around longer,
0:10
purchasing more from our business, and
or buying higher price products from us.
0:15
So, generally speaking,
0:21
people inside businesses want to figure
out how to grow the LTV of their products.
0:23
There are so many potential uses for LTV
data, but the most common application I
0:29
come across is in the context of comparing
it to customer acquisition costs.
0:34
Let's walk through an example together.
0:39
Here we have data on
a hypothetical business.
0:42
We see the gross profit
LTV of the business and
0:45
also the customer acquisition cost or CAC.
0:48
Sometimes we'll see CAC
referred to as CPR or CPA,
0:52
which are shorthand for cost per
registration or cost per acquisition.
0:57
This is another acronym that can vary by
business so we should confirm it with our
1:03
colleagues or team, but just think of
CAC as the cost to acquire a customer.
1:08
Similar to COGS,
defining CAC can command its own course.
1:13
But in our simple example,
1:18
let's assume that this $30 CAC
represents some advertising spend,
1:20
as well as an allocation for the sales and
marketing teams' salaries and benefits.
1:25
In SaaS or
Software as a Service businesses,
1:31
there is a rule of thumb that we want
our LTV to CAC ratio to be 3 or larger,
1:34
5+ would be exceptional, 3 is good and
1 means we are breaking even.
1:40
Numbers less than 1 mean that we are
spending a lot more to acquire a customer
1:47
than the value they provide our company.
1:52
If our LTV to CAC ratio dips below
1 we should definitely spend time
1:54
scrutinizing this or
closely monitoring it.
1:59
We probably want to stop
the acquisition activity altogether,
2:03
because we're expecting to lose
money on it from the start.
2:06
LTV to CAC is just a ratio
that captures our LTV
2:10
after COGS have been factored in,
and our customer acquisition cost.
2:14
So the ratio doesn't account for
2:18
any overhead costs that we
are going to have to pay for.
2:21
This would include costs for
the finance team or engineering.
2:24
What about rent?
2:28
So in this example let's see what happens
if our customer acquisition costs
2:29
increase significantly.
2:35
Let's say they go to 60.
2:36
Well we're now below that magic number
of 3 for the LTV to CAC ratio so
2:39
we need to dig in and if this goes to 150,
boy we're in big trouble.
2:43
We need to sound the fire alarm.
2:50
In a lot of organizations, finance and
2:52
marketing will monitor these metrics
closely to inform decision making today.
2:55
A marketer might ask, what's the most
we can spend on acquiring a customer?
3:00
Finance would reply with guidance based on
the latest LTV information available, and
3:05
the company's strategic goals.
3:10
If LTV is increasing, all else equal,
3:12
marketing could be given room to
spend more on customer acquisition.
3:16
Companies that are emphasizing
growth over profitability
3:20
have been known to spend at
the LTV to CAC ratio level of 1.
3:24
Note that this is not
a sustainable long run strategy
3:29
without the ability to finance overheads
from other businesses or capital sources.
3:33
If we have a broad business goal
to increase LTV, then teams
3:40
will unpack the components of it, and
try to positively impact the numbers.
3:44
There's a lot of ways to do that.
3:48
We know that ARPU, COGS,
churn, they all impact LTV.
3:51
A product team might look at two different
groups or cohorts of customers and
3:56
make some changes to the user
experience to see if it reduces churn.
4:01
We may conduct an experiment where
we charge a different price and
4:05
see how the changes to ARPU impact LTV.
4:10
We can see that there are many different
possibilities to positively or
4:12
negatively impact LTV.
4:17
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