What the ratio tells you

The LTV to CAC ratio puts two numbers side by side. LTV, or lifetime value, is the gross profit an average customer brings you over the whole time they buy from you. CAC, or customer acquisition cost, is what you spend to win one new customer. Divide the first by the second and you learn how many dollars come back for every dollar you spend acquiring customers.

If a customer is worth $300 in gross profit and costs $100 to win, the ratio is 3, written 3:1. If they cost $300 to win, the ratio is 1:1 and you are only breaking even before rent, salaries and everything else.

Where the 3 to 1 benchmark comes from

The best-known benchmark comes from investor David Skok's SaaS Metrics 2.0 guide (updated in 2016), written for subscription software companies. He wrote: "The best SaaS businesses have a LTV to CAC ratio that is higher than 3, sometimes as high as 7 or 8." Many investors and operators have since adopted 3:1 as a rough rule of thumb for any business that sells to the same customer more than once.

Use it as a starting point, not a law. Software companies usually have very high gross margins, so most of each dollar of revenue is profit. A shop or restaurant with thinner margins needs to calculate LTV carefully with gross profit, or a ratio that looks like 3:1 may really be closer to 1:1.

LTV to CAC ratio for a customer worth $300, at different acquisition costs
  • CAC $3001x
  • CAC $1502x
  • CAC $1003x
  • CAC $605x
  • CAC $407.5x

A calculation, not survey data: $300 of lifetime gross profit divided by each acquisition cost.

Source: Worked example

How to read your number

The chart on this page shows a customer worth $300 at five different acquisition costs. Here is a rough guide to what each range means:

  • Below 1:1. Each new customer costs more than they will ever bring back. Fix this before spending more.
  • 1:1 to 2:1. You roughly cover acquisition but leave little for overhead and profit. Look for cheaper channels or ways to raise repeat buying.
  • Around 3:1. A healthy balance for most businesses: room for overhead, profit and some mistakes.
  • 5:1 and above. Very efficient, but possibly a sign you are holding back. If each customer is that profitable, spending more to win more of them may grow the business faster.

Don't forget payback time

A great ratio can still strain your cash. If a customer is worth $300 over three years but costs $100 up front, you wait a long time to get that $100 back. The CAC payback period measures that wait: CAC divided by the monthly gross profit a customer brings.

Skok's guide notes that many of the best SaaS businesses recover their CAC in 5 to 7 months, and that profitability is "anemic if the time to recover CAC extends beyond 12 months" (forEntrepreneurs). A small business without investor money usually needs a shorter wait than a funded startup, because every dollar tied up in acquisition is a dollar not available for stock or payroll.

Making both halves honest

The ratio is only as good as its inputs, and both are easy to flatter. On the LTV side, use gross profit rather than revenue, and base it on real repeat orders (customer lifetime value guide). On the CAC side, include agency fees, software, staff time and discounts, not just ad spend, and count only genuinely new paying customers (customer acquisition cost guide).

Improving retention is often the cheapest way to lift the ratio. A 2014 Harvard Business Review article noted that acquiring a new customer is anywhere from five to 25 times more expensive than retaining an existing one. Every extra repeat order raises LTV without raising CAC.

Calculate the ratio by channel when you can. A channel with a cheap CAC but customers who never return can look better than it is, while a pricier channel that brings loyal buyers may be your best investment. Matrix ROI, from Smith App Studio, lines up uploaded ad-platform exports with your Stripe payments, so you can see verified sales next to what each channel cost.