{"id":22762,"date":"2023-12-26T13:28:37","date_gmt":"2020-05-14T12:02:00","guid":{"rendered":"https:\/\/www.bloomreach.com\/library\/retail-math-the-most-important-formula-in-online-retail"},"modified":"2024-09-17T10:17:52","modified_gmt":"2024-09-17T10:17:52","slug":"retail-math-the-most-important-formula-in-online-retail","status":"publish","type":"library","link":"https:\/\/www.bloomreach.com\/en\/blog\/retail-math-the-most-important-formula-in-online-retail","title":{"rendered":"Retail Math: The Most Important Formula in Online Retail"},"content":{"rendered":"

As a decision maker at a digital commerce<\/a> company, there\u2019s all sorts of retail math formulas you have to do to make sure everything is running as it should be (average inventory formula, retail markup calculation, average unit retail, etc). But there\u2019s one retail math formula in particular that can best predict the success or failure of your company. The holy grail of retail math. <\/strong>This article will show you how to use it.<\/p>\n

What is the Online Retail Formula?<\/p>\n

The online retail math formula describes the ratio of your customer acquisition cost (CAC) to your <\/strong>Customer Lifetime Value<\/strong><\/a> (LTV).<\/strong> At its simplest, you want your formula to look like this:<\/p>\n

\"Retail<\/p>\n

Keep your customer acquisition cost (CAC) below your customer lifetime value (LTV).<\/strong><\/p>\n

Which makes sense; that\u2019s basic retail math. Of course, you want to pay less for your customers than you make from them. The tricky part is breaking the formula down, and using the insights you gain in an actionable way. <\/strong>First, let\u2019s discuss why you should care about this formula, then we\u2019ll break the formula down to examine the parts.<\/p>\n

Why is the Online Retail Formula Important?<\/h3>\n

You can have a rough idea of what you spend and what you make back without having to do the retail math, but there are tangible reasons to sit down and make this formula work for your business.<\/p>\n

Business & Marketing Reasons for the Online Retail Formula<\/h4>\n

The online retail formula isn\u2019t just a matter of figuring out if your CAC is lower than your LTV. The difference between your CAC and LTV will inform you of how you should adjust your marketing spending.<\/strong><\/p>\n

The larger your business grows, the more important the retail math formula becomes; you won\u2019t always be able to use rough estimates. Once you start looking into how large and how quickly you can scale, you will want to know if, and by how much, you can increase your acquisition spending without going into the red.<\/p>\n

On the opposite end of that, you might find out that your CAC is too much lower than your LTV, meaning you aren\u2019t spending enough on your customers.<\/strong><\/p>\n

\u201cThe ideal CAC:LTV ratio is different for every industry, but the comfortable range is between 1:3 and 1:5. A ratio of 1:6+ is even better.\u201c<\/strong> 1:6 and up means your customer loyalty program is working brilliantly, your customer experience is near perfect, and overall you\u2019ve honed and optimized your site just right.<\/p>\n

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Hugh Kimber<\/a><\/strong> | General Manager EMEA and Emerging Markets<\/a><\/p>\n

However, if your LTV is way higher than your CAC, it could indicate that you aren\u2019t spending enough on your customers. And if you aren\u2019t spending enough, your competitors will.<\/em><\/p>\n<\/div>\n

You should also consider that LTV is based on the average customer. If Apple started selling items that only 1% of the population could afford, their average LTV would be enormous; probably much higher than its CAC. However, it would be because the target group is smaller;  not because they\u2019re making more money.<\/p>\n

Deeper Reasons for the Online Retail Formula<\/h4>\n

Solving this formula for your business gives you more than your CAC:LTV ratio. The variables you\u2019ll need to define as you start piecing it together (Cost Per Visit, Gross Margin, Frequency, etc.) are valuable to be aware of as well.<\/p>\n

The process of solving this formula will change the way you look at your business, leading to a more customer-centric model for this customer-centric market.<\/strong><\/p>\n

Breaking Down the Online Retail Formula<\/h3>\n

There are five Key Performance Indicators (KPIs) successful ecommerce companies look at to determine CAC and LTV:<\/p>\n

\"Online<\/p>\n

Customer Acquisition Cost:<\/p>\n