Revenue: Understanding your customer lifetime value
This is the fifth article of our growth marketing series based on the popular AAARRR or pirate funnel. This framework will help you better understand user behaviour, from the very first stage of the buying journey (awareness) and data gathering and testing (acquisition) to spurring a user into action (activation), choosing retention strategies and the right revenue model and, finally, how to drive referrals.
In this article, you’ll learn about important metrics to consider in the Revenue phase, from revenue churn and average order value per customer, to CAC, CLV and number of repeat purchases.
Revenue is the fifth stage of Dave McClure’s AARRR funnel – the growth marketing framework better known as the pirate funnel. In this stage, there are two important metrics to know: customer acquisition cost (CAC) and customer lifetime value (CLV).
By comparing the CAC to the CLV, you can determine what needs to change in order to build revenue and grow your business. Understanding how customers are moving through the AAARRR funnel and detailing each step for improvements is a good start. Looking at the product pricing and how it aligns with the target customer base is another way to improve that ratio.
What is Customer Acquisition Cost (CAC)?
Customer acquisition cost (CAC) is what you spend to acquire a new customer – all the costs and resources necessary to win over a new customer. Marketers use a formula like this to better understand their CAC and to help improve their company’s profitability, profit margin and marketing return on investment:
Why is CAC so important?
This key metric is one of the deciding factors to determine whether your company has a viable business model that can yield profits while keeping acquisition costs low as you grow. The challenge is balancing the total sales and marketing costs required to get new customers (CAC) with the revenue generated by each customer over their lifetime (CLV). If you’re too prudent, you risk losing out on potential customers and the revenue they could bring. But if you spend too much, you are ultimately paying them to be your customers. We generally use a ratio of 3:1 of a customer lifetime value to customer acquisition.
There are two key reasons why measuring your CAC is so important. For example, say your company’s monthly spend on social media, in-store events and telemarketing looks like this:
1. Analysing your marketing return on investment
When you understand the cost to acquire new customers, you can accurately see what your marketing return on investment is. In our example, the most cost-effective way to acquire customers is telemarketing, so it makes sense to invest more in that channel.
2. Boosting your profitability and profit margin
By using the CAC calculation, you can easily analyse the value per customer to improve your profit margins. If, for example, you know that the value of each customer to your business is €70, you will know that social media and telemarketing would improve your profitability as the CAC is lower than the value per customer.
What is Customer Lifetime Value (CLV)?
The Customer Lifetime Value (CLV) is a calculation to help you measure the value of a customer to the business throughout the customer’s full lifespan. The last thing you want to do is spend money and resources on customers that won’t be profitable for you long-term. While CAC tells you how much it costs to acquire a new customer, the CLV reflects how much is a customer worth.
Together, these two measurements can help you can work out the Return On Investment (ROI) a business can gain from an acquired customer. One of the best examples to understand this ratio is to use that of a subscription business.
Say you’re selling monthly beauty boxes under three plans
A small box costs €10/box, medium costs €15/box and large €20/box. An average customer buys twelve boxes every year for 7 years, so the revenue from a given customer equals:
€1260 [(10+15+20)/3 * 12 boxes * 7 years = €1260
So, to earn this amount of €1260, you must first target and acquire customers. If you spend €5000 a month to acquire 100 customers, that’s a CAC of €50 (€5000/100) – meaning, you spend €50 on each customer. Compared to the CLV, this amount is relatively low, provided those customers stay loyal to you for many years. If you see them dropping off, you may have to increase your prices or spend more on retention strategies.
How to find your best performing marketing channels
One way to find the channel with the lowest CAC is to apply the Bullseye Framework developed by Gabriel Weinberg. With this 4-step process, inspired by a bullseye, you’ll discover which marketing channels bring traction for your company (when your marketing strategy is successful):
Step 1: Think of ideas for each marketing channel and put those in the outer ring.
Step 2: Using your experience and knowledge, move potential traction channels (previous success stories) to the middle ring.
Step 3: Test your middle ring channels to find out which of them can be more successful.
Step 4: Move the top performing channel to the inner ring and put all your focus on that channel.
>> Download our free Bullseye Framework here
Next up, finding your ideal customer segment
You can’t be all things to all people. And you don’t want to waste your money and resources on customers that are not valuable to you. The PVP index is a popular framework to help you find your most lucrative customer segment. Featured in The 1-Page Marketing Plan book by Allan Dib, PVB stands for:
- Personal fulfilment: Who do you enjoy working with the most?
- Value: Who most values your product or service? How are you different from competitors? Why do these consumers love your brand?
- Profitability: Which customer is willing to pay top dollar for your products or services?
By scoring each segment on a scale of 1 to 10, you can define your ideal target audience. Knowing your ideal customers means that you can better spend your marketing budget and up the revenue you get.
How to best price what you’re selling
Another important factor in your revenue is what you are charging for your product or service. You want to keep your price as reasonable as possible, yet stand out from the competition while providing good value and keeping customers loyal. Here are some elements to consider in your pricing decision making:
- Competition: Take a close look at the pricing strategy of similar businesses, the customers they are targeting and which products and services they concentrate on. You could then either undercut their prices or offer better prices where their focus isn’t.
- Supply/Demand: Study the supply and demand of your product. If there is a high demand but low supply, you could get away with charging a higher price.
- Cost: Be sure to factor in all your expenses (labour, transport, materials, overheads) to decide on a profit margin.
- Market: See which products move quickly – the better priced ones or the most popular ones – to see if your business should focus on a more niche offering.
- Client feedback: Use a survey or speak to clients directly to gauge their opinions of your pricing structure.
- Build your network: Other business owners can help you with insights on pricing structures so keep an eye out for local business groups or associations where you can network with fellow businesses.
AAARRR vs RARRA – which is best for your business?
The AARRR framework is a way to analyse your business and decide where to focus your attention. It stands for:
- Awareness – How many people do you reach?
- Acquisition – How many people visit your website?
- Activation – How many people take the first important step? (E.g. Sign-up, install an app or post their first comment)
- Retention – How many people come back again for a second or fourth time?
- Revenue – How many people start paying, and how much?
- Referral – How many people refer others to your business?
Some people also use the RARRA framework, which contains the same steps but changes the sequence to prioritise Retention. RARRA therefore stands for Retention, Activation, Referral, Revenue, Acquisition. In this case, the focus is on retention because certain companies fail not because of acquisition but customer churn. Since customer retention is much cheaper than customer acquisition, an emphasis on the retention phase is the more sensible choice.
As you can see from our article, there are several metrics to consider in the Revenue phase, from revenue churn and average order value per customer, to CAC, CLV and number of repeat purchases. If you want to work with a growth hacking expert to build your revenue and grow your business, get in touch with us today.