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Wednesday, November 14, 2012

If CLV > CAC then business else hobby

Customer Lifetime Value (CLV) and Customer Acquisition Cost (CAC) are two perhaps the most important figures you must know about your business. Using these figures you can understand your business and its profitability better. Let me give you a couple examples how these could work out in practice.

CLV and CAC of a restaurant

Consider a restaurant. It might or might not cost them to acquire a customer. They'll usually have ads around (cost) to get people into their place. If they do not manage to retain the customers and make them regulars, their CLV is likely somewhat low. Instead they'll need to keep on attracting new customers to keep the business running.

Keeping this in mind it is not surprising that many restaurants apply various loyalty schemes. You might get tenth pizza for free. Or they might reward you otherwise. Sometimes it is something less obvious. Just having great food and service could be the thing that separates the restaurant from the rest. I remember one particular place that albeit costly had the best burgers in the whole city. Even though crowded it still was worth the wait.

CLV and CAC of an app

Things get somewhat different in the realm of immaterial. Consider iPhone apps for instance. I can identify at least several models. Some use a freemium model. The basic app itself is free. Addons cost. In this case CAC is somewhat minimal, especially if the app goes viral. The challenge lies in CLV. How do you bump that up? Usually this is achieved using either an advertisement based scheme or by supporting in-app purchases.

Sometimes apps have some fixed price that ranges from a few dollars to tens, even hundreds in special cases. At times there might be special sales to increase acquisition while sacrificing a bit of margin in hopes of longer term gains.

Those expensive apps are an interesting case. How do they justify their value? Usually they are designed for really specific purposes and a specific market. Sometimes they complement some other product.

CLV and CAC of Facebook

I have to admit I'm not the greatest fan of Facebook and rarely even use the service. I don't even have an account there (trendy, eh?). These days their CAC is pretty close to zero. Almost everyone uses the service because their peers use it. Nothing works better than some social pressure. Initially they kept the whole service exclusive and made it desirable that way.

I think challenge of Facebook lies in CLV. How do they convert their users into actual paying customers? In my mind Facebook is a bit like Google. They have a dual-sided market. The users make the service valuable for another market, advertisers. This doesn't mean they couldn't extract some profit directly from their users, though. In fact it seems they are currently in process of figuring out ways to do this.


I hope the brief examples above gave you some idea how CLV and CAC work out in practice. I didn't get into actual numbers, you can crunch them out yourself. Depending on your product the calculations can get quite complex. It's valuable to have some approximation of these numbers. By knowing them you'll have a better idea of how to optimize your business. Either increase CLV, decrease CAC or do both.

If this sounded interesting, you should check out what Steve Blank has said on the subject. Especially the funnel model is powerful in understanding how to groom your customers.