Many SaaS businesses use the ratio of customer lifetime value (CLTV) to customer acquisition cost (CAC) to measure their sales efficiency.  The higher the CLTV/CAC ratio, the greater the value the business creates for every dollar of sales and marketing spend.  Of course, CEOs and especially investors are not interested solely in the absolute value of this metric—they also want to know how their businesses, portfolio companies, or potential investments stack up against their peers.

The conventional wisdom is that SaaS companies should aspire to a CLTV/CAC ratio of 3 or higher.  But the reality is that most businesses do not achieve that aspiration.  We used our proprietary SaaS Radar database of company metrics to calculate the CLTV/CAC ratio for a sample of 40 companies.  The results are shown in the histogram below:

As this chart shows, a plurality of SaaS companies have a CLTV/CAC ratio of between 1 and 3.  And while the mean CLTV/CAC ratio in our sample was 3.4, the median was only 2.8.  Most companies therefore appear to fall on the other side of the conventional wisdom.

That said, we share the popular skepticism over CLTV/CAC’s effectiveness as a metric.  Calculating this metric poses challenges and it can be susceptible to wild swings that might not be representative of the health of the underlying business.  Computing customer lifetime value requires companies to make assumptions about their customers’ lifecycles that often are not grounded in data.  Even when they are data-driven, the data used for the estimate is historical rather than forward looking, and may change significantly depending on the company’s product cycle and sales strategies.  Alternatively, companies compute CLTV by dividing their monthly recurring revenue (MRR) by their churn rate.  While this approach may be preferable because churn is easily calculated at a snapshot in time, small changes in churn can result in large swings in CLTV, particularly at low churn rates.

Although it’s true that the metric does correlate with growth rate—in our sample, those companies with a CLTV/CAC above 3 grew at an average annual rate of 42%, while those at 3 or below grew slower—28% per year on average—we don’t believe that SaaS health can be boiled down to a single KPI.  As we will detail in forthcoming research, we think that these businesses should be judged through a more holistic series of metrics that provide insight into specific operational levers that SaaS companies can use to optimize their growth and profitability.

Article By - Ryan Janssen Posted May 31