Virtual Banks: Understanding Lifetime Value and Customer Acquisition Cost

The virtual bank market is booming across regions. Just in Hong Kong, eight virtual banks have opened their doors to attract customers with special deposit products or reward schemes. To help banks define their customer acquisition strategy to maximise the return in investment, Synpulse has conducted a research and will publish its findings. In this first article, we introduce a key metric with two data sets – Lifetime Value (LTV) and Customer Acquisition Cost (CAC).

The emergence of innovative business models in the digital banking landscape

Most market players offer free account opening to attract new-to-bank customers. For enhanced services such as overseas spending or ATM withdrawals, banks like ZA and Mox adopt a transaction-based model. Others, including Revolut and Monzo, launched a segmented subscription structure that is typically split into different categories such as standard, plus, premium, metal.

Virtual banks generally have three commonly observed profit drivers: transaction charges, commission on value-adding services, and subscription fees. For virtual banks to boost their profitability, it’s key to have customers who frequently engage in credit transactions, purchase value-adding products like insurance and invoicing tools or subscribe to monthly premium services.

At the same time, virtual banks need to keep a close eye on their costs. For most industry players, the costs revolve around physical servicing, interest on clients’ deposits and rewards, and referral bonuses. With large virtual bank Monzo shutting its referral bonus program due to high expenses and low customer value, virtual banks should pay close attention to whether they are maximising profits by attracting high-value clientele while mitigating client acquisition and retention costs.

The importance of understanding LTV and CAC

Before looking into attracting the right clientele, it is essential to understand two data sets: Lifetime Value – or LTV, and Customer Acquisition Cost – or CAC.

Lifetime Value

The concept of LTV is key to banks as it effectively measures the lifetime value of each customer to the bank. While there are many permutations to its calculation, a good definition would be:

LTV = (Average Annual Revenue — Costs to Serve) x (Customer Retention Period)

For example, Client A has to pay $120 in the annual subscription fee, and $80 in miscellaneous fees. The bank must fork out $100 for interest on deposits and $20 on promotions to continuously engage with the customer. Assuming Client A stays with the bank for 5 years, the LTV for Client A would therefore amount to:

[(120+80) — (100+20)] x 5 = $400

High LTV signifies a high-value clientele. In order to enhance profitability, banks need to position themselves to attract high LTV customers.

Customer Acquisition Cost

CAC on the other hand, measures the cost to acquire a new customer:

CAC = (Cost of Sales + Cost of Marketing) / (Number of New Customers Acquired)

In a digital bank context, with the absence of physical branches and relationship managers, CAC is largely attributed to referral scheme, rewards and digital marketing efforts, e.g., social media, blogs, chat-bots, videos and search engine.

LTV/CAC: The key metric for virtual banks

For challenger banks, the LTV/CAC metric is more effective than traditional ones such as cost-to-income. It takes into account the approximate time the client might stay with the bank and the client acquisition cost.

While the time a client spends with the bank and the acquisition costs may not be critical to traditional banks given their strong and long market presence with the large customer base, they’re key measures for virtual banks that are in their expansion phase. Virtual banks also encounter the challenge of encouraging their customers to use them as their main banking partner and not just see them as their second or third banking partner which is price-sensitive yet replaceable.

As a general rule of thumb, a LTV/CAC between one and three is a signal of healthy customer profitability. It indicates the bank’s acquisition strategy is effective in attracting the highest value clientele possible per unit acquisition cost. On the other hand, a LTV/CAC that is too high may indicate the bank is not allocating enough resources towards customer acquisition and banks may miss out on other customers that could create value.

It is recommended for banks to make use of the LTV/CAC ratio as a health indicator of their customer acquisition strategy, and to keep it within an optimal range according to their value proposition.

Synpulse can be your partner in identifying an ideal LTV/CAC range, and assisting you in building an effective customer proposition that maximises the values from your existing users.

What’s next?

This article is the first part of a research series on Synpulse’s deep-dive into leading virtual banks by analysing their customer acquisition strategy and propositions. Look out for the vibrant market outlook and insights.

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