The ROI or Return on investment is the LTV (lifetime value) divided by the CAC (customer acquisition cost). ROI = LTV / CAC
- LTV: Life Time Value, what return does each new client generate for me
- CAC: Cost of Customer Acquisition, what does it cost me to acquire each new customer.
Once you know how much it costs to acquire a customer and you know what return they bring throughout the business relationship with you, you can calculate what benefits each dollar earmarked for digital marketing generates.
Calculating the CAC or Customer Acquisition Cost
For example, the CAC of a client is $30. I have launched an SEM campaign to appear in the top positions of Google, where each click has cost us $1.50. We would need to impact 20 people so that one of them ends up buying on our website or app. The cost of obtaining said client has been $20 * $1.50 = $30
Calculating the LTV or Lifetime Value
For example, if we sell a product for $121 and we know that the average customer buys from us twice a year and then stops buying, what would be the Customer’s LTV? First of all, you have to know what components the price includes, using the above example, we have:
- PVP = $121
- Tax = $21
- Cost of Product = $50
- Gross Margin = $50
To simplify the example, let’s imagine that we do not have fixed costs attributable to the product, such as the rental of offices, nor the salaries of the personnel necessary to carry out the sale. Taking into account the simplified example that we mentioned, the client will buy from us twice throughout the year. With which the client’s LTV will be the margin that we have previously calculated for two, that is, $50 margin * 2 sales = $ 100
Knowing the amount of the CAC and the LTV, the ROI will be: ROI = $100 LTV / $30 CAC = $3.33
In other words, for every euro invested in digital marketing, you’ll make $3.33
Understanding different scenarios
Once the ROI calculation is clear, we can find the following scenarios: LTV < CAC
= Wrong . You are spending more money on acquiring a client than you earn with him throughout his life. You are losing money and your marketing strategy is not effective. You have to analyze the reason. Neutral LTV = CAC
. You earn as much money with a customer as you spent on acquiring them. You are not making any real profit on customers, but you are not losing money either LTV> CAC
. You are getting a positive return on investment through digital marketing since what you make off each client is greater than what it costs you to acquire them.
Decreasing advertising investment returns
If you find yourself in a situation where your ROI is positive, you should keep in mind that ROI and CAC do not have a directly proportional relationship. In other words, if you invest five times more in attracting new customers, they will not report five times more profitability. If you want to know more about how much you should spend on digital marketing campaigns and find the optimal point, follow the link below.