Many businesses sell products and services that are subject to higher or lower demand at certain points throughout the year. This is referred to as “seasonality,” and needs to be considered thoughtfully when approaching a marketing strategy.

The Customer is an Asset

In marketing, we seek to enhance the value of the businesses we work with, primarily by conveying the value of the business’s products and services to new and existing customers.

We typically observe heterogeneity in the value of customers. In other words, some customers might have high lifetime value, coming back to purchase multiple times throughout their ‘lifespan’ as a customer. Others might have low lifetime value, perhaps only purchasing once.

The most academically current method for understanding the lifetime value of a business’s customers involves using a mathematical model to project the customer’s future or residual lifetime value by analyzing the recency, frequency, and monetary value of their historical purchases.

Businesses should work with a qualified data scientist to understand how much a customer is worth over the course of their lifespan with the firm. They can then group the customers into cohorts, to see how those values differ based on certain common characteristics, such as when the customer was acquired, and which initial product they purchased.

It is also useful to determine an average lifetime value for all clients, often by averaging the lifetime value of some of the most recently acquired cohorts, on the assumption that customers acquired in the near future will have similar value on average.

In the absence of such data, it is reasonable to multiply the Average Order Value of new customers by the average number of purchases (or subscription charges, in the case of a subscription business) per customer. For example, if the business has an AOV of $51, and the average number of purchases in the customer file is 1.17, they can use $59.67 as their initial calculation of how much revenue they can expect from an acquired customer on average.

This is a simple and limited heuristic, since it does not project the future value of newly acquired customers, but it at least accounts for a little extra revenue on top of the revenue driven by the initial purchase.

• NOTE: We use terms like lifetime value to describe the amount of revenue being derived from a customer over the course of their lifespan. Some leaders in the field of customer lifetime value argue that the word value should refer strictly to profits, since a business can theoretically have very high revenues without being very valuable if their costs exceed their revenues. We agree with this line of thinking, but choose to use the term lifetime value as opposed to more accurate terms like ‘customer lifetime revenues’ for the sake of sticking with the most commonly understood terminology.

It is important to note that the value of the customers your business acquires will be reduced when discounts are introduced to the equation. Discount promotions are a powerful tool for increasing the likelihood that a shopper converts, but they will reduce the revenue driven by that order. Conversely, strategies intended to boost AOV - such as product bundling - can make customers more valuable by increasing the average revenue driven from each purchase.

Once we have achieved an understanding of the value of the customers we’re acquiring, we can make better decisions about how much we are willing to pay to acquire them.

How Much Should We Pay to Acquire a Customer?

In order to decide how much we are willing to pay to acquire a customer (Customer Acquisition Cost, or CAC), we must first understand some of the other costs inherent in the customer acquisition process.

By accounting for the other costs involved in acquiring a customer, we ensure that we are driving profitable acquisitions, meaning the customer’s lifetime revenues will sufficiently exceed all of the costs involved in acquiring them.

Cost Of Goods Sold (COGS) and Gross Margin

• COGS can sometimes be used to refer holistically to all of the costs involved in acquiring a customer. But it more accurately refers to the cost of manufacturing the products.

• Gross Margin is calculated as revenue minus COGS divided by revenue. It is the profit left over after accounting for the cost of producing the products being sold.

We recommend aiming for a gross margin around 70%. This requires pricing the products appropriately, and optimizing COGS to create enough margin that can be used for other factors in the acquisition equation.

Shipping & Fulfillment Costs and Landed Gross Margin

• The next cost to account for in ecommerce are the shipping and fulfillment costs of getting the products to the customer’s doorstep.

• Landed Gross Margin refers to the profit margin remaining after COGS as well as Shipping & Fulfillment Costs. In other words - what is our margin after accounting for all the variable costs of making and delivering the product to the customer?

• We recommend that businesses strive for a Landed Gross Margin at or above 50%.

Customer Acquisition Cost (CAC)

• CAC is the summation of all sales and marketing costs involved in acquiring a customer. For ecommerce businesses, this is mostly comprised of marketing spend. For B2B or SaaS companies, the costs of sales personnel may also be accounted for.

• The formula for CAC is Sales and Marketing Expenses divided by Newly Acquired Customers.

• This calculation does not typically contain COGS or Shipping and Fulfillment.

Setting a CAC Target

Assuming the other benchmarks we discussed have been met (Gross Margin of 70% or higher, and Landed Gross Margin of 50% or higher), a good benchmark for CAC is 1/3 of lifetime value. This is referred to as the LTV/CAC ratio.

For example, a business that has an average lifetime value of $90 might set a comfortable CAC target of $30.

In addition to using an LTV/CAC framework for customer acquisition, marketers and stakeholders should align on an exhaustive profit and loss statement that accounts for all of the costs and revenues involved in running the business - including those not accounted for above, such as employee wages and other operating expenses.

Coupling the LTV/CAC approach with an exhaustive profit and loss analysis is the best approach for scaling confidently. This enables marketers and stakeholders to rally around a single metric for acquisition, while also accounting for the financial state of the business as a whole.

Creating Offers

One of the most common tasks that marketers have is to reduce CAC in order to achieve a LTV/CAC ratio that their business is comfortable scaling at.

Some of the most effective strategies for reducing CAC and scaling ads involve optimizing click-through rates (CTR) and conversion rates. By fine-tuning ad creatives, targeting, and landing pages, businesses can improve CTR and conversion rates, leading to lower acquisition costs and increased scalability

Promotional offers are a popular tactic for reducing CAC because they impact both of those levers at the same time by simultaneously attracting more shoppers and making it more likely that they convert into paying customers.

As we noted earlier, promotional offers centered on discounting can harm unit economics by reducing AOV.

Marketing decision-makers can choose between two main avenues when it comes to designing offers that preserve healthy unit economics:

Option 1: Reduce LTV/CAC ratio in exchange for revenue volume.

• This approach is common during the Black Friday - Cyber Monday promotional period in ecommerce. Presented with the opportunity to potentially score the highest revenue numbers of the entire year, brands will acquire customers less profitably.

• More generally, businesses prioritizing scale may at times tolerate a lower LTV/CAC ratio in order to achieve the economic benefits of scale.

Option 2: Design offers that preserve a higher LTV/CAC ratio.

• After reducing LTV by the amount of the discount, and reducing CAC according to the expected CTR and conversion rate improvements from the offer, it’s possible that the resulting LTV/CAC ratio is still at goal.

• This may involve relying on more modest discounts - such as a 10% welcome offer, or taking a less aggressive competitive posture during Black Friday - Cyber Monday.

By carefully weighing the costs of running an offer against the expected impact on CAC, businesses can plan sensible acquisition strategies that enable confident scaling.