Explainer: From CAC to AOV, what DTC’s hottest buzzwords really mean
As direct-to-consumer brands have come to dominate the new retail landscape, they’ve also brought into sharper focus new vocabulary.
Many of these terms — CAC, LTV, AOV — are important for any retail company, regardless of whether or not they sell directly through their website or not. But they’ve become increasingly important to DTC companies, particularly the ones who have taken on venture capital funding. They have to prove to investors that they can acquire enough customers, and do it at a cost-effective rates, to justify receiving funding that values them at tens of millions of dollars. Each one may rely on a slightly different set of KPIs to do so, depending on their business model.
“Most of [these DTC brands] take so much funding that their only one goal is to return the funding, so they have to scramble and acquire customers as fast as possible so that they can raise another round, and then raise another round,” said Nik Sharma, the former head of DTC for VaynerMedia and now an independent strategist.
CAC: Customer acquisition costs
Wholesale businesses acquired new customers by selling their products through retailers like Nordstrom or Foot Locker; DTC businesses acquire their customers by getting them to buy products directly from their website. In order to make potential new customers aware that their website and their products exist, DTC brands have to spend money on advertising.
They rely on CAC to figure out whether or not their advertising is effective in getting them new customers — which is generally calculated by taking a brand’s marketing expenses in a given period of time, and diving it by the number of new customers acquired.
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“The more expensive your customer acquisition costs are, the less margin you have to pull profits from or reinvest into your business,” said Marco Marandiz, a DTC brand consultant.
According to Sharma, many DTC brands only use performance marketing spend — which includes investments in bottom-of-the-funnel marketing channels like Facebook and Google — to calculate CAC. Others may include brand marketing spend, which can include investments in public relations and events. Brand marketing investments typically prioritize KPIs like brand awareness over acquiring customers as quickly as possible, but because it may influence new customers to buy at a later period of time, some DTC brands will include it in their CAC model.
CPA: Cost per action
Purchases from new customers aren’t the only metric DTC brands will need to track in order to figure out how they can better allocate their marketing spend. Most brands will also track cost per action, which is the amount of performance marketing spend divided by the number of desired actions driven. What action(s) brands want to track will vary depending on the brand’s business model, and what type of product it sells.
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A brand that requires customers to take a quiz before signing up — like customizable vitamin or hair care companies — may want to track how much on average marketing spend it takes for them to get a potential new customer to take the quiz. A brand that is investing heavily in video advertising may want to track cost per video views.
“Whether [a customer] ended up on a product age or a cart page or a checkout page or an order confirmation page — those all mean completely different things back to the brand,” Sharma said.
AOV: Average order value
Average order value refers to the amount of money a customer typically spends each time they purchase with a company. AOV is a metric that all retail and e-commerce companies track. But it’s especially important to DTC brands in order to figure out whether their CAC is too high. If their CAC is average than their AOV, it’s a sign that they likely need to find less expensive ways to get new customers.
LTV: Lifetime value
One way that DTC brands can justify having a CAC that’s higher than their AOV is if they have an exceptionally high lifetime value, or LTV. It refers to the amount that a company projects a customer will spend with them over time, once they’ve been acquired. Because it’s a projection of future spending activity, there’s no one set way to determine LTV. Companies will typically factor in metrics like AOV and frequency of purchase when calculating LTV.
LTV is particularly important to subscription-based companies. Customers might only spend $50 with a subscription company the first time they purchase from them. But, if they are part of a monthly subscription service that customers typically stick with for two years, then they have an LTV of $1,200. Some companies will view that as a green light to spend more than $50 to acquire that customer.
ROAS: Return on advertising spend
ROAS is another way that companies try to gauge how effective their advertising is in getting people as many people to buy as much from them as possible. The term refers to the amount of money a company spends on an advertising campaign or channel, divided by the amount of revenue the company has determined that channel or campaign brought in. Unlike CAC, it accounts for the revenue brought in by both old and new customers.
Like CAC, what a company constitutes as “advertising spend” can vary on the company. Some companies may take into account advertising agency fees, while others do not, according to Marandiz.
“If you are looking at an agency that [requires] a $5,000 management fee plus 10% on ad spend…it’s a big deal when you’re only spending $10,000 or $20,000 per month on ads,” Marandiz said.
Churn
Churn is another metric that’s particularly important to subscription-based companies. It refers to the percentage of customers a company loses on average within a given period of time, like on a quarterly or monthly basis. Churn is typically calculated by dividing the number of customers who canceled by the total number of customers.
As with any other metric, DTC brands who rely on churn have found ways to make that rate look as low as possible. Richie Siegel, the founder and lead analyst of retail consulting firm Loose Threads, said in an email that some companies “will only report on early cohorts, which are usually more promising since they are comprised of early adopters who are more open to trying new products and services.”
Additionally, how “good” of a churn rate is depends on both how many customers a company loses, and how many customers in total a company has. For example, investors will probably look more favorably on a company that has a churn rate of 3% and a subscriber base of 100,000, compared to a company that has a churn rate of 1% but a subscriber base of only 10,000.
“It’s important to think about why a company is sharing the selective info they are and what is missing, and only then can you start to get a good picture of reality,” Siegel wrote.