CAC:CLTV sucks, here's why

And what you should use instead

Jun 13, 2024

👋 Hey, Toni from Growblocks here! Welcome to another Revenue Letter! Every week, I share cases, personal stories and frameworks for GTM leaders and RevOps.

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EVERY. SINGLE. TIME I talk about CAC:Payback:

“But Toni, isn’t it much better to aim for CAC:CLTV improvements?”

Yes. It is, but let me tell you why it’s wrong.

What is CAC:CLTV?

The reason CAC:CLTV is so popular amongst us nerds is simple. it's a very complex metric.

It includes:

Your Sales & Marketing costs - but not really (CAC)
It includes your Net retention - but not really (if it’s north of 100%)
It may include your Gross Margin - but some people don’t like that

The other reason is that it is all-encompassing.

It really is the “end-all-be-all” metric for GTM. Perfectly combining Sales, Marketing, CS efficiency and customer value.

Many VCs have adopted it as a north star too. Because it’s a ratio to break down and benchmark every single company.

And every time a VC gets really excited about a metric, you, as an operator, should take pause and treat it carefully.

So, to answer the question, what is CAC:CLTV?

It compares your efficiency in adding new customers to the length of time those customers stay with you and the amount they pay you.

It’s the perfect profitability metric for SaaS.

So why don’t I like it?

The problem with CAC:CLTV

For an operator, there is just too much stuff going on.

This metric, moving up or down, might have happened because 20 things in a company moved up or down.

Some of those things might have been random, some of them on purpose.

So any direct impact you wanted to take might have been washed out by others.

This fact makes this a very tough metric to use as an operator.

The other reason is that if you have more than 100% net retention - which I hope many of you have - you can actually NOT calculate CLTV.

Yes, you might not know this.

But the way you calculate CLTV (or LTV) is by dividing your average ARR per customer by your Net Retention Rate.

If you have a $20k product and a 90% NRR, then your LTV is $200k because you are going to keep a customer for 10 years.

So, what happens if you have an NRR of 99%? Whoopsy, your LTV is $2M.

That seems… well, wrong, right?

But let’s say you have just one 1%-point more. An innocent 100% NRR.

Well, now your CLTV is… infinite.

So, now your CAC:CLTV is… also infinite.

Instead of “only” hitting 4-5x of your CAC with just 100% NRR, you would hit an infinity payback.

What a fantastic business you have! At least in the spreadsheet world you’re operating in.

So, what do most people do here? Because you can’t actually pretend you have an infinite payback.

They cap the lifetime at 3 years if you are SMB, and 5 years if you are Enterprise.

Yes, that is how that metric works.

And you know what you now don’t need to optimize in this all-encompassing metric?

Your NRR (at least if you keep your NRR above 66% in the SMB and 80% in the Enterprise).

Well… I thought that kind of was the point of SaaS, no?

So, lots of confusion and complexity but in the end - because it breaks for most of us - some super stupid simplification that knee-caps the whole idea.

So, what should you be doing instead?

The solution is very simple.

Simply split the two metrics.

CAC Payback (for all its flaws)
Net Retention Rate

If you want to be super fancy, and I haven't yet seen a SaaS CRO/RevOps who really cares:

You can also look at Gross Margin

Use the metrics tree to improve your CAC Payback.

Use targeting, customer success, pricing, and product to improve NRR.

For those of you who really want an LTV over CAC, my LinkedIn Post yesterday spawned some good discussions. Check it out here.

And Ray posted the current solution he is proposing to account for the infinity problem.

Instead of ARR, use ARPA (Average Revenue per Account). The reason this is different is that ARPA also accounts for upsell happening later on.

Then - he really likes adding Gross Margin (but only for the SaaS business, not e.g. your service business)

And then use Churn (1-GRR) to determine lifetime. This is on a revenue basis, not logos. This works because ARPA already includes the upsell piece.

In a formula it’s:

LTV = ARPA * GM / (1-GRR)

It still produces funky results for high-GRR businesses. For example, it generates lifetimes of +10 years if you are 90% GRR.

But at least it's not infinite.

The Revenue Letter

CAC:CLTV sucks, here's why

And what you should use instead

What is CAC:CLTV?

The problem with CAC:CLTV

So, what should you be doing instead?