What is LTV:CAC Ratio?
The LTV:CAC ratio compares customer lifetime value to customer acquisition cost, indicating whether your unit economics are sustainable. A ratio of 3:1 means customers generate three dollars of lifetime value for every dollar spent acquiring them the standard benchmark for healthy SaaS businesses.
This metric is the primary unit economics test for subscription and recurring revenue models. It answers the fundamental question: "Does the long-term value of customers justify what we spend to acquire them?" Without a satisfactory LTV:CAC ratio, growth destroys value rather than creating it.
Why It Matters
Investors and acquirers scrutinize LTV:CAC ratio as a leading indicator of business health. Ratios below 3:1 suggest unsustainable economics; ratios above 5:1 may indicate underinvestment in growth. The 3:1 to 5:1 sweet spot indicates efficient acquisition without excessive spending.
LTV:CAC also guides strategic decisions about pricing, marketing investment, and customer segmentation. Segments with strong ratios justify increased spend; weak ratios signal need for pricing changes, qualification tightening, or service model adjustments.
Benchmarks
- Healthy ratio: 3:1 to 5:1 indicates sustainable unit economics
- Below 3:1: Unit economics problems; acquisition costs too high or LTV too low
- Above 5:1: May indicate underinvestment in growth; could afford to spend more acquiring
- Payback period: LTV should be recovered within 12-18 months for healthy economics
Best Practices
1. Calculate by segment and channel - Aggregate ratios hide important variation. Calculate LTV:CAC by acquisition source, customer segment, and plan tier to identify what's working and what isn't.
2. Consider payback period alongside ratio - A 4:1 ratio is meaningless if payback takes 5 years. For SaaS, target CAC recovery within 12-18 months even with strong LTV:CAC.
3. Use gross margin, not revenue - LTV should reflect gross margin after direct costs. Using revenue inflates the ratio and masks economic reality.
4. Monitor trends, not just snapshots - Is your ratio improving or declining over time? Rising ratios indicate improving economics; declining ratios signal competitive pressure or execution problems.
5. Balance ratio with growth rate - Premium ratios (5:1+) with slow growth may indicate insufficient ambition. Aggressive growth often temporarily depresses ratios as you spend ahead of optimization.
Common Mistakes
- Using revenue LTV instead of gross margin, overstating ratio
- Ignoring payback period; 4:1 over 5 years isn't healthy
- Calculating at aggregate level only, missing segment differences
- Over-optimizing ratio at expense of growth opportunities
- Not accounting for time value of money in long payback scenarios
Key Takeaways
- LTV:CAC ratio is the primary test of sustainable unit economics
- 3:1 is minimum threshold; 3:1 to 5:1 represents healthy range
- Gross margin LTV, not revenue, should be used in calculations
- Payback period matters alongside ratio; target 12-18 month recovery
- Segment-level analysis reveals where economics are strongest/weakest
