The short version is this: Many have been taught to focus on LTV/CAC ratio and if that number is substantively larger than 1 said entrepreneur feels great. That can be a trap for three primary reasons:
- Payback period may be long even if LTV/CAC is large, and having a long payback period requires you to be able to raise capital to fund this deficit period. So if you’re able to raise easily no problem. If you can’t raise — you’re dead. End of story. No matter what you were taught about this fucking ratio. So I spend an inordinate amount of time with entrepreneurs focused on payback.
- LTV is imprecise. In product business it is often measured over multiple purchases and assumptions are made about the repeat rates, and in the enterprise or services world, LTV can be based on churn rates, which are notoriously hard to predict in an early-stage business. Poorly calculated LTVs can become BVs (bankruptcy values).
- CAC is often measured incorrectly and often doesn’t capture the true costs of acquisition. And even when calculated correctly often CAC’s are assumed to be constant but of course, they’re not. If you acquire 10 customers a month at $100 per customer and this scales to 100 customers at the same price you may make assumptions about 1,000 customers that don’t hold. The reality of CAC is both that when you scale your acquisition “channel,” costs usually go up plus when you find a great channel others notice it and drive up the costs as they compete with you in that channel.