If you’re struggling with your digital marketing investment, this episode is for you.

Today, we focus on the Lifetime Value Ratio (LTVR), a fundamental formula for determining business growth and success, and how the LTVR can clarify your marketing budgets.

On the last episode of our podcast, we went in-depth on the most confusing things about digital marketing today. We concluded that you can gain digital marketing clarity by focusing on the 3:1 lifetime value ratio. But what is the Lifetime Value Ratio?

What Is The Lifetime Value Ratio?

The Lifetime Value Ratio (LTVR) is the relationship between the lifetime value of a customer (LTV) and the cost of acquiring that customer, also known as the customer acquisition cost (CAC). The LTVR shows you how much your dollar is worth. So, in our ideal 3:1 scenario, you should be getting 3 before-tax dollars back for every 1 before-tax dollar you spend.

Here’s what it looks like as a formula:

Lifetime Value of a Customer / Customer Acquisition Cost = The Lifetime Value Ratio

To calculate the LTVR, we first need to calculate the lifetime value of a customer and the Customer Acquisition Cost.

The Lifetime Value

Here’s a simple formula to calculate the Lifetime Value of a Customer:

(Average Value or Value of a Sale) x (Avg Number of Sales in Customer Lifetime) x (Gross Margin) = LTV

Let’s fill some numbers into this equation, shall we?

Let’s say you’re a business lawyer and you’ve been contracted by a company to help them resolve a case for 12 months. You bill your client $1000 monthly and your business has a gross margin of 35%.

 $1000 Per Transaction x 12 Transactions in a year x 35% Gross Margins =$4200 Lifetime Value of a Client

We now know the average lifetime value of a client of this type is $4200. 

The Customer Acquisition Cost (CAC)

Your customer acquisition cost is the total marketing costs (both sales/marketing programs and salaries) divided by the number of customers acquired for a specific time period.

Total Marketing & Sales Costs / Customers Acquired = Customer Acquisition Cost

Time to fill in that formula. Using the same example above, you’re a business lawyer. Your total marketing costs amount to $25,000 per year. This year, you’ve acquired 20 clients.

$25,000 Per Year/20 Clients = $1250 CAC

So, it costs you $1,250 to gain ONE client. 

Calculating the Lifetime Value Ratio

So, we now know your LTV and your CAC. Let’s fill in the numbers for our LTVR formula.

$4200 LTV/$1,250 CAC = 3.36

Your Lifetime Value Ratio is 3.36:1

Now we know that your LTVR is 3.36:1. That’s super close to 3:1!

So, why is 3:1 ideal?

As Len explains in the podcast above, 3:1 is the ideal ratio because it is a great sign of a successful business. As tech companies and start-ups began shifting to subscription based services, investors looked to the 3:1 ratio to assess the health of those ventures. Eventually, industries began taking that model and fitting it to their respective businesses to great success.

The general rule is that a company that is at 14:1 is spending too little on their marketing budget. A company that is 1:1 or -1:1 is spending too much.

That is not to say that a business that has an LTVR of 7:1 or 14:1 or 1:1 is going out of business tomorrow. Quite the contrary.

Many e-commerce businesses, for example, operate on a 6:1 or 7:1 ratio. Companies in a growth mode may operate closer to a 1:1 ratio, where spending money to make substantial growth leaps is key.

A 3:1 Lifetime Value Ration Does Three Things:

  1. Sets a goal post for your business
  2. Helps determine your marketing budget
  3. Is a metric that shows the health of your digital marketing

So, how do I determine my marketing budget, anyway?

It’s actually quite simple now that we know the CAC and the LTVR. Let’s go back to our business lawyer example. Your CAC is $1,250 per client. So, how many clients do you want? 

Take your CAC and multiply it by the number of clients you’re looking to get. That’s how much your budget needs to be. Back to the business lawyer example. Let’s say you want 45 clients this year.

($1,250 CAC) X (45 clients) = $56,250

So, now you know you have to spend $56,250 over the year to acquire your 45 clients. If every client is giving you $12,000 a year, as in the original example, then your business would make $540,000 without gross margins, and $189,000 with gross margins.

Okay, so I know my marketing budget. But how much should I be spending on digital marketing?

At Commexis, we suggest spending about 50-65% of your marketing budget on digital marketing efforts. That’s not on one specific platform, mind you, but on the entire digital strategy.

And what does that digital strategy entail? Well, that’s where Commexis comes in. Our strategy utilizing The Buyer’s Journey will help you determine where your customers are online and how to market to them effectively. Or, contact us for a consultation. 

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