Cost Per Acquisition (“CPA”) defines the amount of money it takes through advertising, to attract a customer and get the said customer to purchase an item. It measures the costs in advertising to convert one person from a visitor to a paying customer. Advertisers prefer this approach to marketing because they only pay when the desired outcome is achieved; the desired outcome being when a customer makes a purchase of a particular item.

Cost Per Lead (“CPL”) is an advertising pricing model, where the advertiser only pays when an interested customer signs up for the interested offer through a web form or phone call that can be tracked. No payment is made by the advertiser for visitors who only click or call on the offer and don’t sign up. A lead may include contact information, a sign up and some demographic information; unlike an acquisition it’s typically a non-cash conversion event. It may consist of as little as an email address, or many details, which determine the difficulty and cost of running such a program. CPL marketing enables advertisers to make consistent returns on the money spent advertising online. In a tough economy like we’re experiencing, it is not surprising that CPL advertising has grown explosively. It’s a popular inbound marketing technique among marketers.

Customer Lifetime Value (“LTV”) is the expected profit that you will realize from sales to a particular customer during their lifetime doing business with you. Roughly defined, LTV is the projected revenue that a customer will generate during their lifetime. Customer behavior changes over time and these gradual changes are known as the customer life cycle. It can be an absolute calculation over a customer’s life or relative calculation using a customer’s life cycle. For example, if a customer buys a product for two years and then doesn’t for at least one year then the life cycle of that customer is generally considered 2 years.

How does CPA relate to LTV?

LTV of a customer in theory represents how much they are worth, and therefore how much an advertiser should be willing to pay to form a relationship with them. It can then be used to evaluate the optimal CPA for that customer as well. If it costs $3 to acquire a new customer (CPA = $3) and that client’s lifetime value is $100 (LTV = $100), then the client is presumably profitable (at 3% of the total revenue they will produce) and acquisition of additional clients at that CPA is advisable.

How to calculate CPA and LTV?

If the average customer you acquire through advertising buys for 4 years, then stops for at least 1 year. We can define the life cycle and hence the life time of that customer as 4 years. If during that 4 years, the average customer makes 10 purchases and the profit per one unit purchased is $5 then the client’s lifetime value will be calculated as shown below that should work (note: the calculations used in this article are extremely basic for the purposes of explaining the overall concepts, and further analysis can and should be done to develop precise calculations. For the purposes of this article and for many smaller businesses that don’t have large databases of information, these basic calculations can server as a good guide) :

If that average customer then refers 5 other customers, the maximum cost of acquisition of a new customer should be 5 x $50 = $250 in order to break even. That would be the maximum you should be willing to pay to acquire a single customer. However, you want to maintain profitability, so further analysis should be done to determine what a reasonable CPA should be to provide you a specific profit margin.

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Calculating the LTV of a customer will help a business owner manage customer relationship as an asset, scrutinize the impact of marketing investments and their value. Hence, help him or her work towards optimizing allocation of resources for marketing in order to achieve the greatest return on investment.