A few terms you’ll frequently hear are “Customer Lifetime Value” (CLV) and “Cost Per Acquisition” (CPA). Many marketers, including myself, often talk about these marketing metrics in terms of how to measure your success.
However, if you’re running an agile marketing team, these metrics aren’t only beneficial for measuring results—they can help you pave the way for success too. Give me five minutes and I’ll show you how to transform your CPA by working with your CLV, just as I do for my clients when I start a new project.
Customer Lifetime Value = How Much You Earn from Each Customer
At a very basic level, you can calculate CLV by multiplying the average retention time of a customer and the average sale amount and the average number of purchases a customer makes in a year. The trouble with stopping at that is your happy customers will refer others and that increases the CLV too.
To calculate CLV, you’ll need to know:
- Tenure: Average customer tenure in cycles in months or years
- Volume: Average customer purchase volume per cycle
- Referrals: Average number of new referred customers from each existing customer
(Tenure) x (Volume) = A
(Referrals) x (A) = B
A + B = CLV
CLV Calculation Example
To put this into action, let’s say your average customer stays with your company for 48 months and spends $500 each month during his or her time with you, but also refers two new customers as well. Your formula will be:
A. (48 months) x ($500) = $24,000
B. (2) x ($24,000) = $48,000
($24,000) + ($48,000) = $72,000; your CLV is $72,000
Cost Per Acquisition = How Much is Spent to Gain One Customer
When businesses look at CPA, it’s often used as an instrument to identify how much is being spent to convert one person into a customer.
To calculate CPA, you’ll need to know:
- Spend: The total amount of money spent on marketing, typically per channel
- Conversions: The number of people who become customers
(Spend) / (Conversions) = CPA
CLV Calculation Example
To put this into action, let’s say you’re spending $25,000 per month on pay-per-click ads and, each month, two people purchase your product. Your formula will be:
($25,000) / (2) = $12,500; your CPA is $12,500
If This is How You’re Using CLV and CPA, You’re Doing it Wrong
Yes, this is the traditional method used by marketers everywhere, but it’s wrong. If you’re only using CLV and CPA to measure your results, and, like most marketers, you’re setting your budgets based on historic spend, you aren’t being agile or strategic. Worse yet, you may get trapped in the mindset of how to reduce spending rather than how to get greater ROI from your marketing investments.
Set Your Maximum Investment Based on Your CLV
If you’re focused on strategic and agile marketing techniques, you should be using your CLV to determine your CPA investments when you’re establishing campaigns.
To calculate your maximum investment, you’ll need to know:
- CLV: Customer lifetime value, as calculated above
- Ceiling: The percent of a customer’s lifetime value you can comfortably spend on each customer acquisition
CLV & CPA Calculation
(CLV) x (Ceiling) = Maximum Investment
CLV & CPA Calculation Example
Let’s say your organization has a high-profit margin. You can comfortably say you’re able to spend 20% of your CLV to acquire each customer and you have the $72,000 CLV from the first example.
($72,000) x (20%) = $14,400; your maximum investment is $14,400
Using Your CLV to Calculate a CPA Amplifies Your Marketing Results
Again, under the more traditional marketing model, you’re essentially spending what you’ve always spent where you’ve always spent it. It doesn’t allow you to allocate more resources to channels that are performing better or capitalize on what’s really working for you.
By flipping the way you look at CPA and using your CLV to determine a maximum investment, you become more agile and dynamic with your marketing approach. You can rapidly allocate your investments to what’s really working for your business here and now.
Develop a Powerhouse Digital Marketing Strategy
Not every company can set the CPA ceiling at 20 percent. If your organization has a lower profit margin, you may need to reduce yours to 15 percent, 10 percent, or something else entirely. If you’re not sure what your ceiling is or you want to have an agile digital marketing strategy that generates real ROI from your investments, I can help.
As an experienced business and digital marketing consultant that has transformed Fortune 100 companies and SMEs across the globe, I welcome the opportunity to ensure your organization meets its goals too. Contact me for a consultation.