Josh Leider, Head of Growth at Graphite
Today’s eCommerce space is more competitive than ever, and keeping up with rapidly changing consumer expectations is a massive challenge.
It’s estimated that there are currently 12 to 24 million eCommerce sites worldwide. However, your biggest competition likely comes from just one site: Amazon. 59% of millennials make Amazon their first stop for online shopping. If you’re going to succeed in eComm, you’ll need to find a way to differentiate yourself from this online retail giant.
To effectively compete, you need to be laser-focused on your eCommerce growth strategy. Tracking your metrics and KPIs is a big part of this undertaking, but how do you determine which metrics will help you achieve the growth you’re looking for?
Two staple metrics for eCommerce brands are LTV (lifetime value) and CAC (customer acquisition cost).
While these metrics both provide valuable data, it’s important to determine where they fit into the context of your business and how to leverage them to gain a competitive advantage.
What Do LTV and CAC Mean?
LTV stands for lifetime value, which indicates the average amount a customer will spend with you over their lifetime.
CAC stands for customer acquisition cost, which refers to the amount of money your organization needs to spend in order to get a new customer.
How to Calculate LTV
To calculate your customer LTV, start by identifying the average number of purchases a customer makes in a given period of time (usually a year) and the average amount spent on each purchase.
Multiply your average purchase frequency by the average purchase value to get your customer value, then multiply that by the average number of years a customer stays active.
For example, if your average customer made five $10 purchases per year and actively spent money with you for an average of 25 years, you’d have an LTV of: (5 x 10) x 25 = $1,250.
How to Calculate CAC
To calculate your CAC, start by adding up the total amount spent by your team during a specific time period on sales, marketing, and any other expenses used to attract customers. Then, divide that amount by the total number of new customers acquired during that time period.
For example, if you spent $10,000 this quarter on customer acquisition expenses and drew in 5,000 new customers, your CAC would be: $10,000 / 5,000 = $2 per customer
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Which Should You Care About More: LTV or CAC?
LTV and CAC are both valuable metrics, but depending on the context, one may be more relevant to focus on than the other at different moments.
Essentially, you’re asking yourself whether you should focus on keeping acquisition costs low or extracting the most value out of each customer. When you’re thinking this through, you need to keep in mind current customer trends in the eCommerce market as well as your business goals.
While both approaches have value, there’s one big caveat to keep in mind when prioritizing LTV. Because the eCommerce market is so competitive, it’s possible that your customers won’t stick around long enough to reach their full LTV, resulting in a much faster cash burn rate than you initially planned for.
Many organizations justify high customer acquisition and retention costs with the idea that their customers will continue to spend money with them for years to come, only to struggle when that never comes to fruition. This is why it’s crucial to always keep your CAC in mind when planning your expenditures.
Optimizing Your LTV to CAC Ratio
An effective way to balance both of these key metrics is by assessing your LTV to CAC ratio. Calculating this ratio is simple—you divide your LTV by your CAC.
For example, if your LTV is $200 and your CAC is $100, you’d have an LTV to CAC ratio of 2:1.
Ideally, you’ll want your LTV to be significantly higher than your CAC. Many organizations aim for a LTV:CAC ratio of 3:1 or higher, but ultimately, your goals will depend on your product and your business. If your LTV is lower than or the same as your CAC, you’ll lose money in the long run.
When considering these metrics, it’s important to take into account factors like:
- The lifespan of your product.
- The average amount spent on each purchase.
- The number of direct competitors.
If your product is designed to last for years, you’ll likely need to focus on keeping your CAC low, as customers won’t be returning frequently to buy replacement products.
Additionally, eCommerce brands always need to keep competition in mind. Your CAC might go up as more competitors enter the space, and you need to be prepared for this possibility.
Staying on Top of Your Key Metrics for eCommerce Growth
Ultimately, there’s no cut-and-dry solution to managing your eCommerce metrics. You need to adapt your strategy to the unique needs of your business and adjust your goals over time to reflect changing trends.
Having financial experts by your side will help you determine which metrics are most important for your eCommerce brand and how to evaluate them.
At Graphite, we offer accounting, financial modeling, and fractional CFO services, all designed with growing eCommerce startups in mind. Here’s more about how we help eCommerce brands like yours.
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