Tutorial

By Ed Soehnel

Customer Acquisition Costs (CAC), Customer Lifetime Value (CLTV),

Breakeven (BE) and Marketing Efficiency Ratio (MER)

This article will discuss 4 key metrics in direct marketing for a consumer product
business. Those metrics are breakeven (BE), customer acquisition cost (CAC),
customer lifetime value (CLTV) and media efficiency ratio (MER). The latter is an
industry term most commonly used in direct response TV and radio media, but I find
it helpful for any form of direct marketing and like to refer to it also as “marketing
efficiency ratio”.

Calculating these metrics is fairly straightforward in principal, certainly more difficult in

action. BE can be reported in many different ways, from breakeven marketing spend
to breakeven net income and more I will use BE as a ratio of revenue divided by
costs, which is also MER. CAC is operating costs of the business divided by the
number of customers. CAC may also be called cost per order (CPO). This metric
should be calculated weekly for TV, radio or other forms of recurring media spends
and by event for specific marketing activities, such as purchasing an email list. It is
your total costs divided by total customers. CLTV is average revenue per customer
over the lifetime that that individual will remain a customer. MER is your revenue
divided by your costs. It is represented as a whole number to the 10th or 100th
decimal place. For example, if your marketing spend in a week is $50 K, and your
revenue is $110 K, your MER is 2.2. Breakeven MER means that your costs at a
given marketing spend (marketing spend is included in costs) are equal to your
revenue. I will leave the details about using the proper assumptions to calculate
these metrics for another article.

CLTV can be used a couple of ways. Its useful for determining your product’s ability to
please a customer such that they return to buy more. If you sell an ingestible
product and your CLTV is equal to or close to the average revenue per first
purchase, then customers are generally only buying once and not returning. If the
average time period in your industry to retain a customer is 6 months and you sell
them a 3 month’s supply, then you may have a problem because customers are not
returning to purchase more. You might fix this by either getting your customers to
buy a 6 month supply on first order, so at least you extract the maximum value out
of them as possible, or you might go back to product development to work on the
features and benefits of your product to increase its appeal and utility to customers.
The former is a short-term fix, while the latter is a fix that could bode well for the
long-term sustainability of your business.

Second, the CLTV helps you understand the profitability in your business and where you
have margin to spend. For example, you breakeven at a $60 CAC spend week in and
week out; that is, you can spend $60 each week to acquire each customer and
breakeven on the P&L of your business. Your CLTV is $100, which means that you
acquire an additional $40 over time from that customer; so, the customer spends
$60 on first purchase and over time, comes back and spends an additional $40 for a
total CLTV of $100. You could use some of those profits at times to boost marketing
expenditures to acquire future revenues. Lets say you boost your CAC to $80. Your
are now unprofitable by $20, but you will make it up with an additional $20 over time
from that customer. Your short-term P&L suffers, but profitability in the future is
increased.

The problem with CLTV is that you cannot get an accurate figure of your CLTV because it
requires sufficiently reliable operating history and is constantly changing. You
could limit the time period for calculating your CLTV. For example, 12 months may
be a rule-of-thumb baseline period for including the revenue you receive from a

Copyright © Ed Soehnel. All Worldwide Rights Reserved

 Tutorial
By Ed Soehnel

Customer Acquisition Costs (CAC), Customer Lifetime Value (CLTV),

Breakeven (BE) and Marketing Efficiency Ratio (MER)

customer, with day 1 of the 12 month period beginning when you first acquire them.
You need to adjust it to better match your industry and product category. CLTV is
best used as a guide and not something on which to place significant reliance.

The argument I have read is that you should always spend so that CAC = CLTV. Thus,
your short-term P&L will be negative, but will catch up in the future if you reduce
your CAC or find some additional leverage in your business to add sales. I could
agree with that in certain circumstances. For example, your strategy for direct
marketing is to acquire customers and create brand awareness so that you can
develop a path to retail, where you will make up for the current deficit-producing
expenditures from the multiple you get in sales on retail shelves. Also, you have
cash and risk capital in an industry where you have to get big fast. Or, maybe your
shareholders want to see you get big as quickly as possible. Equity investors like
the CAC = CLTV argument because they want to give you more cash (and take more
of your equity) with the chance that you will be the 1 in 10 in their portfolio that hits
it big.

Recall that BE is a ratio of revenue divided by costs, which is also MER and expressed as
a whole number to the 10th or 100th decimal place. Your BE is a ratio that can be
compared to the norm for your industry. If its higher, then your operating costs may
be out of sync, your customer pricing too low, your order cancelations, declines and
returns too high, a combination there of, or a host of other metrics are off. Your BE
will also tell you your minimum marketing spend required and tell you how well it
must perform to achieve BE. A higher BE can limit your selection of marketing
channels that can reliably perform at the BE.

Your MER is always looked at relative to BE MER and how much better it is over the latter.
If you want to employ the strategy previously mentioned for fast growth now at the
expense of cash flow for future increased return, then a general rule of thumb is to
spend the maximum amount on media such that your MER and BE are equal. If your
MER is 1.7 and you are currently hitting at 2.2, then you will want to spend more
until you reach 1.7 (greater media spend yields diminishing returns). This helps
keep you out of debt or sacrifice equity for investment.

In summary, CLTV and CAC are good metrics that help you understand the health of your
business as it relates to selling products to customers. CLTV in particular gets
more at the long-term viability of your product and company. It’s a quantitative
number that can say a lot from a qualitative perspective. It can also be useful if you
are looking to spend now with available cash for future expected payoffs, but needs
to be treated with care due to inherent accuracy issues. BE and MER, on the other
hand, are accurate metrics that really get at the heart of the current financial health
of your business and are more useful for maximizing media spend and staying profit
neutral.

Copyright © Ed Soehnel. All Worldwide Rights Reserved