In determining whether paid advertising is viable for your business we need to understand your Customer Acquisition Costs (CAC). The simple way to do this is to add up the quarterly sales and marketing expenses for a company and divide that by the number of new customers acquired in the quarter. But how do we know if the CAC is worth it? 

To answer this question, we need to look at the Customer Lifetime Value (LTV), which is calculated by (Annual Recurring Revenue x Gross Margin) ÷ (% Churn + Discount Rate). As a general rule: if LTV is 3X or greater than CAC, that’s a good sign that the business model is working.

If the LTV is close to or less than CAC, then something is out of balance; it suggests the company is spending more money to acquire customers than it generates in profits over the customer’s lifetime. This could be because the company hasn’t figured how to effectively monetize its customers. Or that customers are leaving before they’ve spent enough money to cover the costs to acquire them. Or that the company isn’t effectively scaling its customer acquisition costs. 

And then there’s “Churn“, which is the ultimate measure of customer satisfaction. There are two types of churn: customer churn and revenue churn, however for our calculator we are simply concerned with Customer churn. Customer churn is the % of total customers who churned in a given month or year. Low churn means happy customers; high churn means they head for the exits fast. For this reason, we look at the churn relative to the rate of new customer additions. It tells us how leaky your bucket is: as long as the hole (churn) is small, you can keep the bucket full by adding more water (customers) than is draining out.

Churn is perhaps most important to forward growth outlook — especially as the need to replace lost business greatly increases at scale.

There are several ways that a company can offset or overcome churn: add new customers at a faster and faster pace; have “negative churn” (which happens when expansion revenue is larger than the revenue lost from churned customers), and reduce churn itself — that is, retain customers! This is why marketing, sales, and customer management functions are so crucial.