Customer payback period
The customer payback period (CAC payback period) is the time it takes for the margin from a customer's purchases to cover the cost of acquiring them. The shorter it is, the faster the money put into advertising returns to circulation.
In plain words
The general concept of a payback period is the time an investment takes to recover its initial cost, that is, to reach break-even; all else equal, a short period is better (Wikipedia). For an online store, the "investment" is CAC, the cost of acquiring a customer, and the return is the margin from their orders.
This complements LTV: LTV over three years can look great, but ads today are paid for with today's money. a16z calls the ratio of LTV to CAC, calculated on gross margin, a good way to assess CAC payback and manage ad spending (a16z).
Formula
Payback (months) = CAC ÷ monthly margin per customer
Or cumulatively: add up the margin from all of a cohort's orders month by month until the sum exceeds the acquisition cost. The general method works the same way: cumulative cash flow is added up period by period until it turns positive (Wikipedia).
Example (illustrative numbers)
The numbers are made up for the example. A pet supplies store: CAC UAH 450, the first order brings UAH 1,200 in revenue and 25% margin, that is UAH 300.
- After the first order: 300 − 450 = −150 UAH.
- A second order two months later adds another 300 UAH: the total is +150 UAH.
Payback is about 2 months. Had there been no repeat purchases, the customer would never have paid back.
Limits of the method
Wikipedia names the main weaknesses of payback: it ignores the time value of money, disregards cash flows after the payback point, does not account for risk and gives no universal threshold for "good or bad" (Wikipedia). So it is used together with LTV, not instead of it.
Common mistakes
- Calculating payback on revenue rather than margin.
- Taking the average across all customers. Buyers from different channels pay back differently, so calculate by cohorts.
- Ignoring returns and cash on delivery orders that were never collected.
- Counting on repeat purchases that are not in the data.
FAQ
What is the customer payback period? The time it takes for a customer to return to the store the cost of acquiring them.
How do I calculate CAC payback? Divide CAC by the customer's monthly margin, or add up the cohort's margin month by month until it exceeds the cost.
What payback period counts as normal? There is no universal norm. It all depends on your ad budget and how fast repeat purchases come.
How is payback different from LTV? LTV shows the customer's total value; payback shows how fast they return the investment.
Related terms
- CAC (customer acquisition cost)
- LTV (customer lifetime value)
- Cohort analysis
- Unit economics of an online store
Sources
- Wikipedia. Payback period — en.wikipedia.org/wiki/Payback_period
- a16z. 16 Startup Metrics — a16z.com/16-startup-metrics
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