Calculating a LTV:CAC ratio correctly for hardware-as-a-service (HaaS)

One of the most common metrics to evaluate the health of a subscription business is the LTV:CAC ratio (sometimes written "LTV/CAC").

The ratio is the customer lifetime value (LTV, sometimes written "CLTV") to customer acquisition cost (CAC). It is widely used to evaluate subscription businesses. The metric is important because it helps businesses understand the lifetime return multiple on go-to-market spend by comparing each customer's profitability to the cost to acquire a customer. This provides immediate insight on how to prioritize additional sales and marketing investment.

LTV:CAC is simple to calculate and use in software-as-a-service (SaaS) businesses. But in hardware-as-a-service (HaaS), the metric is often misunderstood and calculated incorrectly. So this critical metric often breaks down.  And not because the ratio is wrong, but because hardware costs are used in the wrong part of the equation!

In HaaS businesses, this mistake is unfortunately common. In this article, we explain:

1. How LTV:CAC is commonly calculated and used in SaaS businesses
2. How to calculate LTV:CAC correctly for a subscription-based hardware businesses
3. Why LTV:CAC is often calculated incorrectly when hardware is involved

The SaaS baseline: LTV/CAC is simple without hardware

In a pure SaaS business, LTV:CAC is simple. The underlying cost structure is well-separated. A standard SaaS formulation looks like this:

LTV:CAC = LTV ÷ CAC

For example, if the customer lifetime value is $32,000 and the customer acquisition cost is $10,000, then LTV:CAC is $32,000 ÷ $10,000 = 3.2x.

A higher LTV:CAC ratio is better. A LTV:CAC ratio of 3.2x means that for every $1.00 spent on sales and marketing, the business will receive $3.20 in gross margin over the lifetime of the customer.

Lifetime value (LTV) of a customer: the total gross margin a customer will generate over their lifetime

LTV is usually calculated as gross margin (monthly subscription revenue less the ongoing monthly operating costs such as hosting, support, tooling, etc.) multiplied by the expected customer lifetime.¹

LTV = Monthly gross margin × Expected customer lifetime (in months)

For example, if a customer has a monthly gross revenue of $1,000, and ongoing costs of $200 per month, then gross margin is $800/mo. If the expected customer lifetime is 40 months, then LTV is $800/mo × 40 mo = $32,000.

Customer acquisition cost (CAC): the cost to acquire a customer

CAC is usually calculated as the total sales and marketing spend required to acquire a customer.

For example, if the total sales spend to acquire a customer is $6,000, and the total marketing spend to acquire a customer is $4,000, then CAC is $6,000 + $4,000 = $10,000.

Computing LTV/CAC in a SaaS business

Following our example above, if LTV is $32,000 and CAC is $10,000, then LTV:CAC is $32,000 ÷ $10,000 = 3.2x. This is a very healthy LTV:CAC ratio for a SaaS business.

This metric provides insight for three reasons:

First, lifetime value is based on margin dollars over time. Marginal value increases as the customer lifetime grows longer, unaffected by the cost of acquiring the customer.

Second, CAC is independent of customer lifetime. The sales and marketing cost to acquire a customer does not change if that customer stays 12 months or 60 months.

Third, this means that customer lifetime appears exactly once in the formula. If expected lifetime changes, update one input and the ratio updates.

Because of this separation, SaaS operators can reason easily about LTV:CAC.

• Improve retention → increase LTV
• Improve sales efficiency → decrease CAC
• The two are independent of each other

What LTV/CAC ratio is considered healthy for a SaaS business?

The benchmark LTV:CAC ratio for a SaaS business is 3.0x or more. For SaaS businesses, these are commonly accepted ranges for LTV:CAC.

• 1.0x or below: Losing money on every customer. The business spends more to acquire a customer than it will ever earn back. This is clearly unsustainable unless there's a path to improving retention, pricing, or acquisition costs.

• 1.5x to 2.0x: Break-even to marginal. The business is barely covering acquisition costs. This leaves no room for other operating expenses (R&D, G&A, overhead) and no path to profitability without significant improvement.

• 2.0x to 3.0x: Workable but tight. The business generates some return on customer acquisition, but the margin for error is thin. Most operators in this range are focused on improving retention or reducing CAC.

• 3.0x to 4.0x: Healthy. This is the target range for most subscription businesses. There's enough margin to cover operating expenses and generate profit. Sales and marketing spend is productive. This is the range most investors look for.

• 4.0x or above: Strong. The business has efficient acquisition and strong retention. The company may be leaving market share on the table. It is worth examining whether there's room to invest more aggressively in growth.

Note: For hardware-as-a-service businesses, the benchmarks are different!

How to calculate LTV/CAC correctly in a subscription-based hardware business

For hardware-as-a-service or hardware-enabled SaaS businesses, LTV:CAC is calculated the same as in a regular SaaS business. The important difference is that hardware costs have to be included in gross margin if the business is running subscription HaaS.

Adding hardware costs into LTV/CAC for hardware subscriptions

The standard LTV:CAC formula remains the same:

LTV:CAC = LTV ÷ CAC

The important difference is that the cost of hardware has to be accounted for in gross margin.

Lifetime value (LTV) of a customer: the total gross margin a customer will generate over their lifetime (same as SaaS, but be sure to account for hardware costs!)

For example, if hardware costs $15,000 and has a lifetime of 60 months, then the allocated depreciation is $250 per month.

Gross margin is now calculated as monthly subscription revenue, less ongoing software costs (hosting, support, tooling, etc.), less hardware costs (amortized over the expected hardware lifetime).

Monthly gross margin = Monthly subscription revenue - ongoing software costs - amortized hardware costs

LTV is still calculated as:

LTV = Monthly gross margin × Expected customer lifetime (in months)

For example, if a customer has a monthly gross revenue of $1,000, and ongoing software costs of $200 per month, with hardware costs of $250 per month, then gross margin is $550/mo. If the expected customer lifetime is 40 months, then LTV is $550/mo × 40 mo = $22,000.

This mirrors how customers actually consume resources over time.

Customer acquisition cost (CAC): the cost to acquire a customer (same as SaaS)

CAC is still calculated as the total sales and marketing spend required to acquire a customer. CAC does not include hardware costs, because hardware is not a customer acquisition cost.

For example, if the total sales spend to acquire a customer is $5,000, and the total marketing spend to acquire a customer is $5,000, then CAC is $10,000.

Pulling LTV/CAC together for hardware subscriptions

Following our example above, if LTV is $22,000 and CAC is $10,000, then LTV:CAC is $22,000 ÷ $10,000 = 2.2x. The math is the same, but the inputs are different for HaaS so the result is different. However, this is still a very healthy LTV:CAC ratio for a HaaS business.

What LTV:CAC ratio is considered healthy for a HaaS business?

When hardware costs are correctly included in gross margin, HaaS companies naturally have lower LTV:CAC ratios than SaaS companies. This is expected. It reflects the structural difference in gross margins between the two models.

SaaS companies typically have 70-90% gross margins. Subscription HaaS companies with hardware depreciation included often have 40-60% gross margins. This depends a lot on the hardware business model and the cost structure of the business.

Lower gross margin means lower LTV, which means a lower LTV:CAC ratio for the same CAC. For example, a SaaS business with 80% margins and LTV:CAC of 3.0x would turn into 1.9x as HaaS business with 50% margins. A SaaS business with 80% margins and LTV:CAC of 4.0x would be equivalent to a 2.5x HaaS business with 50% margins.

The LTV:CAC benchmarks below are for HaaS businesses:

• 1.0x or below: Unsustainable. The business loses money on every customer. Requires immediate improvement in pricing, retention, or acquisition efficiency.

• 1.0x to 1.5x: Break-even but marginal. The business covers acquisition costs but doesn't leave room for operating expenses. Common in early-stage HaaS companies still optimizing pricing or hardware costs. Not fundable at scale.

• 1.5x to 2.0x: Workable but tight. The business generates meaningful return on acquisition spend. Many healthy HaaS businesses operate in this range, especially those with higher hardware costs or shorter hardware lifespans. Investors will want to see a path to 2x+.

• 2.0x to 3.0x: Healthy. This is the target range for mature HaaS businesses. There's enough margin to cover operating expenses and generate profit. This is the range most investors look for in capital-intensive subscription models.

• 3.0x or above: Strong. The business has efficient acquisition and/or strong retention. Worth examining whether there's room to invest more aggressively in growth. You may be leaving market share on the table.

How hardware subscription LTV/CAC compares to conventional SaaS LTV/CAC

In SaaS, the 3x LTV:CAC benchmark exists to manage cash flow (payback), manage risk (capital), and optimize long-term profitability (operating margins). This is because below-the-line operating expenses (R&D, G&A, support) typically consume 50-60% of revenue for a SaaS company. Gross margin must cover CAC and leave room for profit, which would typically be around 20% of revenue at scale.

In HaaS, hardware costs are already deducted from revenue to calculate gross margin. The remaining margin has the same job (cover operating expenses and leave room for profit) but the starting number is smaller. However, hardware operating expenses tend to be lower than SaaS operating expenses, so the ratio is still healthy. A typical hardware-as-a-service business might have a 30-40% operating expense ratio, and around a 10% operating margin.

This has significant implications for how we benchmark the valuation of HaaS businesses.

What does a SaaS LTV/CAC ratio imply for a similar HaaS business?

Based on our understanding of how SaaS and HaaS businesses operate, we can map what "conventional" SaaS LTV:CAC ratios imply for a "similar" HaaS business.

We break this down by SaaS margin and HaaS margin to get a more granular understanding of what we're benchmarking.

Benchmarking a conventional SaaS company LTV:CAC ratio of 3.0

For example: to benchmark against a SaaS company with 80% margins and an LTV:CAC ratio of 3.0x, a HaaS company with 50% margins would expect an LTV:CAC ratio of 1.9x.

Benchmarking a conventional SaaS company LTV:CAC ratio of 4.0

For example: to benchmark against a SaaS company with 80% margins and an LTV:CAC ratio of 4.0x, a HaaS company with 50% margins would expect an LTV:CAC ratio of 2.5x.

Benchmarking a conventional SaaS company LTV:CAC ratio of 5.0

For example: to benchmark against a SaaS company with 80% margins and an LTV:CAC ratio of 5.0x, a HaaS company with 50% margins would expect an LTV:CAC ratio of 3.1x.

Why LTV/CAC is often calculated incorrectly when hardware is involved

Many new HaaS businesses calculate LTV:CAC incorrectly because of the hardware component. This is a common mistake that can result in misleading conclusions about the health of a business. This happens because subscription hardware is often mistaken as an acquisition cost (part of CAC), rather than a gross margin expense (part of LTV).

Key mistake: Treating hardware as an acquisition cost

The mistake is trying to load the cost of hardware into customer acquisition cost. This is what it looks like to calculate LTV:CAC incorrectly:

• LTV = (revenue - non-hardware COGS) × expected customer lifetime
• Hardware acquisition cost = (hardware cost ÷ hardware economic life) × expected customer lifetime
• Total CAC = sales CAC + hardware acquisition cost

At first glance, this seems reasonable! The customer "requires" a certain amount of hardware, so it gets added to CAC. However, this is a mistake because it completely changes the meaning of LTV:CAC.

The problem shows up when you change assumptions. The root cause is that the expected customer lifetime now appears twice in the equation (once in LTV and once in CAC). This is a big problem because it means that the LTV:CAC ratio is no longer a predictable ratio.

An incorrect example: treating hardware as an acquisition cost

Assume the same facts as above: customer revenue is $1,000/mo, non-hardware COGS are $200/mo. Customer lifetime is 40 months. Hardware cost is $15,000, and hardware economic life is 60 months. Total sales & marketing CAC is $10,000.

• LTV = ($1,000/mo - $200/mo) × 40 mo = $32,000
• Hardware acquisition cost = ($15,000 ÷ 60 mo) × 40 mo = $10,000
• Total CAC = $10,000 + $10,000 = $20,000

Now LTV:CAC looks like this: $32,000 ÷ $20,000 = 1.6x

This is an incorrect LTV:CAC ratio because the expected customer lifetime is being accounted for in both the LTV and the CAC. This means that if you change the expected customer lifetime, it will affect both the LTV and the CAC, so the LTV:CAC ratio will not change predictably.

The decisive test: what happens when customer lifetime changes?

A correct LTV:CAC model should be "self contained" with respect to customer lifetime. This means that if you change the expected customer lifetime, it should only affect the customer lifetime value (customer LTV). It should not affect the acquisition cost of acquiring a customer (CAC).

Changing customer lifetime using the correct LTV:CAC formula for HaaS

From our correct example above:

• Customer monthly gross revenue was $1,000, ongoing software costs were $200 per month, and hardware costs were $250 per month, so gross margin was $550/mo. The expected customer lifetime was 40 months, so LTV was $22,000.
• Customer acquisition cost was $10,000.
• LTV:CAC was $22,000 ÷ $10,000 = 2.2x.

Now we improve retention, so our customer lifetime increases to 50 months:

• LTV should increase to $550/mo × 50 mo = $27,500. Customer lifetime has gone up by 25%, and customer lifetime gross margin has increased by 25%! This is expected.
• Customer acquisition cost is the same. It should still be $10,000. This is expected.
• So LTV:CAC increases to $27,500 ÷ $10,000 = 2.75x. (Note: this is a 25% increase in LTV:CAC, which is what we would expect!)

This shows that a correct LTV:CAC model is "self contained" with respect to customer lifetime. We change one number and the LTV:CAC ratio changes predictably. The metric is simple and clear. This makes it very useful.

Changing customer lifetime using the wrong LTV/CAC formula for HaaS

From our incorrect example above:

• LTV = ($1,000/mo - $200/mo) × 40 mo = $32,000
• Hardware acquisition cost = ($15,000 ÷ 60 mo) × 40 mo = $10,000
• Total CAC = $10,000 + $10,000 = $20,000

Now you improve retention and expected customer lifetime from 40 months to 50 months:

• LTV should increase to $800/mo × 50 mo = $40,000. Customer lifetime has gone up by 25%, and customer lifetime gross margin has increased by 25%. This is expected!
• Hardware acquisition cost increases to ($15,000 ÷ 60 mo) × 50 mo = $12,500. Our customer lifetime has gone up by 25%, so the hardware component of acquiring the customer has increased by 25%. This is confusing.
• Total CAC goes up to $10,000 + $12,500 = $22,500. Our customer lifetime has gone up by 25%, and now the total cost of acquiring a customer has increased by 12.5%. This doesn't make sense.
• Now LTV:CAC looks like this: $40,000 ÷ $22,500 = 1.78x. Our customer lifetime has gone up by 25%,, and our LTV:CAC ratio has increased by 11.1%! This is not only unexpected, but it is entirely incorrect!

This shows how an incorrect LTV:CAC model is not "self contained" with respect to customer lifetime. We change one number and the LTV:CAC ratio changes unexpectedly. The metric is not simple and it is not clear. This makes it very difficult to use.

1. LTV calculations in SaaS companies sometime ignore ongoing operating costs and just use top-line revenue instead of gross margin. This is gives an inaccurate number, but it makes LTV:CAC appear higher. So companies sometimes use this formulation to make their metrics seem stronger.

With SaaS margins of 80%+, ignoring COGS makes less of an impact. For a device-based or equipment-based company, where gross margins are lower, using top-line revenue instead of gross margin makes the ratio effectively useless.