A guide to customer lifetime value, customer acquisition cost, and unit economics

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If I asked you how healthy your business is, how would you answer? Would you give me total user figures, user engagement numbers, revenue, growth rate, or EBITDA?

These are all useful. But they’ve one flaw: they tell us the current health of businesses, but they don’t do a good job of predicting your business’ financial health in the months and years ahead.

That’s the job of unit economics. In essence, unit economics is a method of working out how efficient your business is in spending money to acquire customers on a per unit basis, that is, on the level of the individual customer.

It has two components: customer lifetime value (LTV or CLV), and customer acquisition cost (CAC). The basic rule is that you’ll want to increase your LTV and lower your CAC as much as possible.

Your company’s survival depends on your ability to nudge those two numbers.

How to calculate customer lifetime value?

LTV refers to the amount of money each customer is expected to spend on your products and services.

Your ability to get an accurate LTV depends on the stage of your company. If you’re still concocting your business plan, your LTV will be nothing more than a guesstimate. Once you start generating some sales however, you’ll have solid data to work with.

Now, let’s use an example. Suppose you run an online grocery delivery service which has been operational for a couple of years. How would you determine its unit economics?

Here’s a simple formula:

LTV = Average monthly revenue per customer ÷ monthly churn rate

Churn rate is simply the percentage of your customers who stop using your service after a certain time.

You can plug in annual instead of monthly figures – whichever you prefer. So, suppose each of your customers buy $100 worth of groceries each month and the churn rate is 5 percent, you’d have a LTV of $2,000.

This is not the only method. This infographic by Kissmetrics presents some rather complex alternatives (take a deep breath before you proceed):

How to calculate CAC?

Weighing customer lifetime value and acquisition cost

A caveat