From: alexhormozi
The LTV to CAC ratio is considered the single most important metric for understanding a business’s foundational economic unit and its potential for scaling [02:27:29]. If only one metric about a business could be known, this would be it [02:25:51].
Defining LTV and CAC
- Lifetime Value (LTV): This represents the total amount of gross profit a business makes from a customer over the entire duration of their relationship with the business [02:27:07].
- To calculate gross profit, subtract the cost of goods sold (COGS) from the revenue [02:30:17]. For services, COGS is the labor cost; for widgets, it’s the cost of the widget plus shipping [02:30:24].
- A broad stroke estimation of LTV can be made by dividing the total gross profit from customers over the last year by the total number of customers acquired in that year [02:30:11]. This often underestimates LTV, especially for recurring revenue businesses, which is preferred for a safer estimation [02:30:46].
- Customer Acquisition Cost (CAC): This is the all-in cost to acquire a customer, encompassing sales, marketing, software, and every other expense incurred to get someone to pay [02:27:15].
The LTV to CAC ratio simply shows how much money it costs to make more money [02:27:25].
Importance for Business Scaling
A high LTV to CAC ratio is crucial for scaling business operations profitably [02:27:32].
“The total amount of money made off of X number of sales calls… Here’s the sweet spot where I sell the most amount of units at The Highest Potential price” [03:30:42]
Dominating the Market
- Outbidding Competition: Paid advertising operates as an auction for attention [09:22:18]. Businesses with a higher LTV can afford to spend more to acquire a customer than their competitors [09:17:34]. This ability to outbid others can create an “ethical monopoly” [09:28:13].
- Customer Lifetime Value (LTV) Advantage: The core principle is to build a business that makes more money from every customer than anyone else, enabling higher spending to acquire customers [09:38:09].
Optimal Ratio for Growth
- A rule of thumb suggests an LTV to CAC ratio of at least 3 to 1 [02:28:25]. This means for every dollar spent acquiring a customer, the business should generate at least three dollars in gross profit.
- Smaller ratios, such as 30:1 up to 200:1, have resulted in significant wealth creation [02:29:13].
Real-world Examples
- Bow Manufacturing Business: For a bow manufacturer, if leads cost 100. If the average gross profit on a bow is $500, the LTV to CAC ratio is 5:1, indicating a profitable model [02:35:05].
- Starbucks: Starbucks reportedly achieves an LTV of approximately 500 per customer, and still achieve a 28:1 return on investment, which explains their massive scaling in locations [02:50:00].
- Personal Business Experience: The speaker’s success with Gym Launch, sold for $46 million, stemmed from high LTV to CAC ratios, sometimes reaching 30:1 to 200:1 [02:50:50]. These high ratios enable rapid, aggressive investment into customer acquisition, as wealth is often made in short, punctuated periods [02:53:50].
Optimizing for Efficiency
While advertising should be optimized “front to back” (focusing on headlines, hooks, etc. to maximize initial engagement) [01:17:15], the overall business should be optimized “back to front” [01:14:44].
- Back-End Optimization (LTV): Increasing the amount of money made per customer (LTV) directly impacts how much can be spent on the front end (CAC) [01:14:49]. Improving LTV allows for a larger budget to acquire new customers, even as acquisition becomes less efficient at massive scale [01:19:20].
- Front-End Optimization (CAC): While back-end improvements fund the front, maximizing the efficiency of initial advertising efforts (e.g., improving Click-Through Rates from 1% to 4% for a 4x increase in throughput) is critical [02:39:53].
The ability to maintain profitability even as the LTV to CAC ratio potentially drops (e.g., from 20:1 initially to 5:1 at scale) signifies effective leverage and efficiency in scaling a business [01:19:42]. The primary goal is to increase absolute return on investment, not just relative return [03:00:01].
“The CAC to LTV ratio gives me an indication how much room I have to blow this thing out of the water” [03:04:04]
In essence, a superior LTV to CAC ratio provides the leverage to outspend competitors, attract more customers, and achieve substantial growth.