Higher Isn’t Better: The Truth About LTV:CAC
I had a conversation with an executive recently who was proud of their 5:1 LTV/CAC ratio. They thought they were crushing it. After all, the conventional wisdom in SaaS is that you want a 3:1 ratio, so 5:1 must be even better, right?
Wrong.
If your LTV/CAC ratio is significantly above 3:1, you’re leaving money on the table. Here’s why. Let’s say your lifetime value is $900 per customer. With a 3:1 ratio, you can spend up to $300 to acquire each customer. If you’re only spending $100, your ratio looks great at 9:1. But you could spend $200 more per customer and acquire significantly more of them. Each of those customers adds $900 of lifetime value to your business while costing you $300 or less to acquire.
The executive I spoke with had a 5:1 ratio and thought they were doing great. What they were actually doing was missing out on customers who would increase their company’s valuation.
At Rewind, we’ve been on both sides of this over ten years. We’ve overspent with ratios below 3:1 and underspent with ratios above 3:1. A few months ago, we cut our marketing budget by thirty percent, mostly paid ads where we couldn’t tie spending to pipeline. Our ratio improved from 2.5 to 3.4. Now we’re hiring more sales reps to drive it back down toward 3:1, because 3.4 means we’re leaving growth on the table.
Your ratio will fluctuate. The key is tracking it and understanding what it’s telling you.
Two things most founders get wrong when calculating LTV/CAC.
First, make sure your CAC is fully loaded with all sales and marketing costs. Second, and more important, your LTV needs to account for gross margin. Most founders calculate LTV by taking revenue and dividing by churn. That’s not your true lifetime value. You need to multiply that by your gross margin.
If your gross margin is eighty-five percent and your revenue-based LTV is $900, your true LTV is $765. That changes how much you can spend on acquisition.
The goal isn’t to maximize your LTV/CAC ratio. The goal is to optimize your company’s enterprise value. And that means spending right up to the point where the math stops working, which in SaaS is typically a 3:1 ratio.