A great subscription startup demands wise marketing initiatives. And to be wise about your marketing campaigns you must master key metrics such as Customer Acquisition Cost (CAC), Customer Lifetime Value (LTV), and Return on Investment (ROI).
Probably, you’ve listened about these metrics before. They might seemed interesting, but you didn’t care thaaaat much about them. Right?
In this post, you learn (or re-learn) about CAC, LTV, and ROI, as well as how these metrics can leverage your subscription marketing decisions.
But, before changing how you act, you must change how you think.
And it all starts by seeing your campaigns through an investor’s eyes…
Each Marketing Campaign Is A Subscription Investment
From now on, you’ll act as an investor.
You don’t burn your budget to make noise; You invest your money to acquire subscribers.
Nope. I’m not playing with words. These new words just reflect the required change in your mindset.
So, ‘investing’ will demand from you a different attitude.
You don’t hope things to go well; You wisely assess your investments to maximize your outcome.
Hence, as an investor, you’ll constantly ask yourself:
- How much money do I need to invest (ads, events, design, etc.) in this marketing initiative?
- How much money will this initiative give me in return (in additional subscription revenue)?
But, how to do it in a practice?
Through your marketing metrics, of course.
1. Customer Acquisition Cost (CAC)
CAC stands for Customer Acquisition Cost, and it represents the amount of money you’ve invested to acquire one new subscriber.
Since we’re talking investments, we must see each new subscriber as an asset.
And the Customer Acquisition Cost (CAC) is the price you pay to get access to that asset’s return.
The logic is the same for the price you pay for other assets such as:
- Bonds, to get access to their interests
- Stocks, to get access to their dividends (and potential price gains)
- Real estate properties, to get access to their rent
So, a subscriber, from an investment perspective, is a type of asset that pays you a return (recurrent subscription fee).
Although there isn’t a “subscribers market”, you can calculate the theoretical price you paid to “acquire” one new subscriber.
To do that, you simply divide what you’ve invested in marketing & sales expenses to acquire new subscribers by the number of new subscribers you’ve acquired from this investment.
Let’s suppose you’ve invested $20,000 in marketing & sales expenses and acquired 200 new subscribers.
Your CAC would be $100 ($20,000/200).
That means you paid on average $100 to acquire a new subscriber.
So, that’s the main logic of CAC: it’s the price you paid to acquire an asset called “subscriber”.
Now, let’s talk about return.
2. Customer Lifetime Value (LTV)
LTV stands for Lifetime Value, and it refers to the amount of value you got back from each subscriber during the time they remained as a subscriber.
Okay, you’ve invested some money to acquire new customers. Now, it’s time to assess the return of this “subscriber” asset. And we’ll name this return as customer Lifetime Value (LTV).
Although you may find some differences in LTV calculation methodologies, it is always based on two variables:
- The subscriber’s estimated LIFESPAN (in number of months/years)
- The VALUE a subscriber brings you in a specific period (month/year)
Let’s see how these 2 components form LTV.
You must be aware that every new subscriber asset you acquire will one day be gone. From that day on, you’ll stop receiving their value.
So, your first mission to calculate your LTV, is to estimate the average amount of time a subscriber will be with your startup before cancelling their subscription.
This estimated amount of time is your customer lifespan.
In order to calculate it, you’ll have to use an additional metric: the Churn Rate.
The churn rate is another essential metric for any subscription startup and it represents “the rate at which customers leave a product over a given period of time.” (Patrick Campbell, ProfitWell)
So, if your monthly churn rate is 10%, that means every month you lose 10 subscribers for every 100 subscribers you have.
Okay, Alex. But what about the Lifespan?
To calculate the lifespan you’ll divide 1 by the churn rate.
E.g., Monthly churn rate is 10%. Your subscriber’s lifespan is 10 months (1 / 0.10).
With your customer’s Lifespan on hands, it’s time to estimate the value coming from each subscriber.
First, I must tell you that ‘value’ metric is not exactly a standard among startups.
That means some startups simply consider ‘value’ as ‘revenue’ (so, a $100 per month fee, means $100 per month value).
I prefer being more conservative by using the Gross Margin (instead of revenue) to capture the net value paid by a subscriber.
The Gross Margin means the revenue minus the COGS (Cost of Goods Sold). The COGS considers the cost of activities related to delivering your application to subscribers (support, customers success, and DevOps).
E.g., If your monthly subscription fee is $100, and your monthly COGS (support, customer success, DevOps) is $20 per subscriber, your subscriber’s monthly value will be $80.
The Lifetime Value
Now, it’s the easiest part.
After gauging your subscriber’s Lifespan and Value, you just need to multiply them to find your subscriber’s Lifetime Value. Check it out:
- Customer Value (per month): $80
- Customer Lifespan: 10 months
- LTV = $800 (80 x 10)
- Customer Value (per year): $950
- Customer Lifespan: 2 years
- LTV = $1,900 (950 x 2)
- Customer Value (per month): $200
- Customer Lifespan: 18 months
- LTV = $3,600 (200 x 18)
Caveat: Be sure to use the same time-frame (month, year) for both Value and Lifespan. That means if the you’re using monthly value, the lifespan must be in months.
3. Return On Investment (ROI)
ROI stands for Return On Investment, and it refers to the net % of the investment you got back.
Well, if you have already calculated the CAC and the LTV, calculating the ROI will be a piece of cake.
Here’s the formula:
ROI = (LTV – CAC) / CAC * 100
So, let’s digest the formula in 3 bites.
The first part (‘LTV – CAC’) assesses the difference between your asset’s return (subscriber’s total value) and your asset’s cost (subscribers acquisition cost).
The second part (‘/ CAC’) performs a comparison between the difference mentioned above and your initial investment.
The third part (*100) brings it to a percentage basis.
E.g., If you paid $100 to acquire a new subscriber (CAC) and your subscriber gives you in return $800 (LTV), your ROI would be 700%.
- LTV – CAC = $800 – $100 = $700 (subscriber’s net return)
- $700 / CAC = $700 / $100 = 7 (number of times the net return is compared to the initial investment)
- 7 * 100 = 700% (ROI)
Using Your Metrics to Improve Your Results
The bigger your ROI, the more money you’ll make from each dollar invested in your marketing. So, as a sane investor, your brain tells you to maximize your ROI.
It’s time to use the knowledge you’ve gained in this post to do that.
And what did I learn, Alex?
You’ve learned that the ROI depends on your startup’s CAC, as well as on its LTV. So, if you want to improve a marketing initiative’s ROI, you must:
- Reduce your CAC (by choosing better channels, strategies, and tactics)
- Increase your LTV (by increasing Lifespan, and Customer Value)
Of course, your CAC and LTV will depend on other variables you can influence:
- CAC (conversion rates, funnels design, etc)
- LTV (churn rate, pricing, COGS, etc)
Hey, how about getting a model to help you organize your thoughts and to calculate your Marketing ROI? Take a look at it here.