CAC and LTV: the cost and value of a customer

Customer acquisition cost, or CAC, is the total sales and marketing spend in a period divided by the number of new customers won in that period. If a company spends ₹50 lakh on advertising, sales salaries and offers in a month and wins 1,000 new customers, its CAC is ₹5,000.

Be careful about what goes in the top line. A fair CAC includes ad spend, the salaries of the sales and marketing team, agency fees, tools and the cost of free trials or sign-up bonuses. Leaving out salaries makes CAC look lower than it really is. Some companies also report a blended CAC, which counts all new customers including those who came for free through word of mouth, and a paid CAC, which counts only customers won through paid channels. The paid figure is usually higher and more honest about the cost of growth.

Lifetime value, or LTV, is the total profit a customer is expected to bring over the whole time they stay. The simple version for a subscription business is: average monthly revenue per customer, times gross margin, divided by the monthly churn rate. Churn is the share of customers who leave each month.

Take a customer who pays ₹1,000 a month, with a gross margin of 80%. The company keeps ₹800 a month. If 4% of customers leave each month, the average customer stays about 25 months (1 divided by 0.04). LTV is then ₹800 times 25, which is ₹20,000. For a shop or an app that sells one-off items, LTV is the average profit per order times the number of orders a customer places over their life.

• CAC = sales and marketing spend divided by new customers won
• LTV = average monthly gross profit per customer divided by monthly churn
• LTV to CAC ratio = LTV divided by CAC
• CAC payback = CAC divided by monthly gross profit per customer, in months

A rule of thumb widely used by investors is that LTV should be at least three times CAC. At 3 to 1, a company earns three rupees of profit for every rupee it spent winning the customer, which leaves room for fixed costs and profit. A ratio near 1 means the company is just breaking even on each customer before other costs. A ratio far above 5 can mean the company is not spending enough on growth.

It is a guide, not a law. A business with very low churn and cheap upfront costs can work at a lower ratio. A business with expensive customers and long sales cycles, such as enterprise software sold to large firms, may need a higher one because of the risk that a big customer leaves.

CAC payback is the number of months it takes to earn back the cost of winning a customer, using the gross profit they bring each month. If CAC is ₹5,000 and the customer yields ₹800 a month in gross profit, payback is about 6.3 months.

Payback matters because cash is limited. A company with a 24-month payback has to fund two years of each customer's cost before getting its money back, so fast growth drains the bank. A company with a 6-month payback recycles cash quickly and can grow with less outside funding. Many investors check payback first for exactly this reason, and it is easier to estimate than LTV, which depends on guesses about the future.

The first mistake is using revenue instead of gross profit in LTV. Revenue ignores the cost of serving the customer, so it flatters the result. The second is assuming churn will stay low forever. Early customers are often the most enthusiastic, and later customers may leave faster. The third is mixing groups: a company serving both small shops and large chains has two very different CACs and LTVs, and the average hides both.

The fourth is a long-looking LTV that is really a guess. If a company has only been operating for a year, a claim of a five-year customer life is a forecast, not a fact. Treat a high LTV from a young company with caution, and give more weight to payback and cohort data, which show how real groups of customers behaved.

In India, CAC varies widely by channel and city. Winning a user in a large metro through paid ads is usually costlier than winning one through a referral or a local partner. Many consumer startups spend heavily on discounts, which are really a form of acquisition cost, and the way the discount is counted changes the apparent CAC.

Investors reading a pitch or an annual report look for a trend: is CAC falling as the brand grows, is LTV rising as customers buy more, and is payback getting shorter? A company can improve all three by building repeat purchases, referrals and a product people recommend. These are the same levers behind the retention and cohort guides on StopDown.

No. Customers come through different channels at different costs, and they stay for different lengths of time. A customer won through a referral may cost almost nothing and stay for years. One won through a big discount may cost a lot and leave after one purchase.

Good teams therefore compute CAC and LTV by channel and by customer segment, then move spend to where the ratio is best. This is more work than one average figure, but it prevents a profitable channel from being starved or an unprofitable one from being funded because the average looked fine.