Customer Acquisition Cost (CAC): What It Is and What It Means to Your Business

cost of customer acquisition

Small to medium-sized business owners and CEOs of large corporations alike should be keenly interested in a unique metric:  CAC , ( or Customer Acquisition Cost). CAC is one of the most important key performance indicator of a company’s financial health, and can yield several important insights into the effectiveness of sales and marketing efforts.

What exactly does CAC measure? How can you calculate CAC? Moreover, once you have a grasp of how CAC works, can you improve your CAC scores, and how? The following information will answer these and other questions.

What does Customer Acquisition Cost Measure?

CAC is basically a measure of how much, on average, it costs your company to acquire a new customer. An accurate CAC should include every single dollar spent by sales, marketing, and any other direct stakeholders within your organization in the process of converting a prospect into an actual customer.

Therefore, CAC will typically include costs such as:

  • Product cost
  • Overhead costs for in-house sales and marketing
  • Costs for outsourced sales/marketing
  • Costs of market research
  • Advertising spend
  • Software spend

It’s important to note that CAC has no correlation with generating leads, but is only viable as a measure of actual customer acquisition. CAC is an important metric for owners, executives, and investors alike, since it can paint a broad picture of how the company currently allocates sales and marketing resources, and how efficient those targeted efforts actually are.

For instance, an investor researching opportunities with the CRM software development sector can use CAC as a comparison factor between two competing firms. If one company’s CAC is much higher than the other, but both companies are generating an approximately equal revenue stream, then the investor may come to the conclusion that the firm with the lower CAC has more efficient sales and marketing processes in place, and is therefore a safer prospect.

Looking for Customer Acquisition Costs by Industry?

There are plenty of guidelines and resources about typical costs in different industry, but I would caution that they may be unreliable. If you’re in an industry that is easily disrupted, then it’s hard to compare apples to apples because different companies in the same space might have radically different cost structures. However, if you’d like to venture deeper into this topic, you might try this research report (note – this requires registration and payment) for a starting place about standards in your industry.

How Branding Affects Your Costs of Customer Acquisition

The effectiveness of your brand makes a difference on your bottom line, including your cost of acquisition. Here’s how that works. Brands that are visible, understood, consistent, relevant, and preferred to other companies in the same category acquire customers much easier and at a lower cost. Now that doesn’t preclude that a lot of time went into developing and clarifying your brand strategy, but in theory, the cost of acquisition for better brands should go down.

The rationale is that the more believable brand has all of the existing infrastructure in place to support its position, including its history. A brand that’s fighting to earn visibility and to be considered, has to invest more effort into reaching and staying connected with a customer.

How to Calculate Customer Acquisition Cost

While the details of CAC calculation can sometimes become tedious, the basic principles are relatively easy to understand and intuitive.

The first prerequisite to an accurate CAC calculation is time frame selection. You want to determine the exact time period for which you’ll be measuring CAC.

Next, you’ll need to dive into the numbers. Add up all costs associated with customer acquisition, not just sales and marketing spend.

After you’ve determined your total costs, tally the total number of customers that your company acquired in that same period of time. For instance, if you’re measuring the CAC of a specific marketing campaign, only count the new customers that came onboard during the time span of that campaign.

Once you have these two figures in hand, divide your total costs by the total number of new customers. The result will be your customer acquisition cost. You could stop at this point, having found the desired metric.

However, you probably should take one final step after determining CAC. Many companies compare their CAC to each customer’s CLV (customer lifetime value). This can provide a more balanced perspective on your CAC’s effectiveness, as well as its importance. Executives want to know how long it will take to recoup their customer acquisition costs.

Here is the CAC formula that you can use, with the costs in the numerator position:

M (marketing)  + W (wages) + S (services) + PS (professional services) + O (overhead) / CA (customers acquired) = CAC

Here’s a simple example to illustrate the process:

A PEO brokerage firm launches a month-long marketing campaign to convert leads into new customers. They spend $2,000 in marketing costs, $10,000 in wages for their sales/marketing team, $500 for related software services, and $1,500 for overhead costs. At the end of the month, they’ve acquired 5 new customers.

Thus, their CAC for that campaign would be as follows:

2,000 + 10,000 + 500 + 0 + 1,500 = $14,000

14,000/5 = $2,800

So their average cost to acquire a new customer would be $2,800.

For many companies, that CAC would be disastrous. However, let’s say that the average customer for that PEO brokerage firm generates $40,000 worth of revenue per year. In that case, the profit from each new customer acquisition would equal about $37,200, which is not too shabby. Thus, you can see that whether a particular CAC metric should be considered “good” or “bad” is dependent upon a number of different factors.

Now that you have a good idea about your costs, you can evaluate your customer acquisition cost ratio by dividing your total customer costs by your total annual sales. For more nuanced insights, divide your average costs per customer by your average annual sales per customer. You can use all of these snapshot metrics to measure the trends in your business and figure out whether or not your costs are increasing or decreasing. Are you investing enough in acquisition?

How to Improve Your CAC

First of all, understanding CAC means breaking down your customers by segment, product lines or other factors. All customers are not acquired at equal cost. Perhaps you may now wonder if and how CAC can be improved. There are several ways in which you can improve a baseline CAC metric, including.

Improve your Audience Targeting

Segmenting and refining your target audience profile and buyer personas will help you create more targeted and relevant content and positioning. Better targeting means less wasted investment on positions, customers and other promotional costs that aren’t priorities.

Boosting onsite conversion metrics

If you optimize your website’s performance, and convert more customers, then your CAC score will inevitably improve. Small changes in conversions can yield big results on your bottom line. Want to see how that works? Try our inbound marketing calculator and see the results for yourself.

Increase your customers’ CLV

So many companies fall into the trap of pursuing new customers at the cost of keeping old ones. However, a focus on customer retention will help you to enhance the value of your current customers, and increase your revenue stream from users loyal to your brand.

Use a CRM system

Customer relationship management can help streamline your sales and marketing processes, which in turn will lead to more conversions.

Reallocate resources for increased efficiency

Sometimes minor tweaks can be made to your current sales/marketing infrastructure in order to reduce costs and boost effectiveness. This will also improve your CAC.

CAC is a vital metric in determining your company’s performance. Understanding it and using it as a guideline in your decision making process will help you to keep costs down, generate more revenue, and enjoy sustainable business growth.

How To Calculate Customer Lifetime Value to Drive Strategic Decisions

One of the biggest challenges that marketers face is justifying their investments. How much should your business spend to acquire a new customer? If you spend too much, you’ll eventually go out of business. If you don’t invest enough, you might be missing opportunities to grow – much to the delight of your better-informed competitors. The stakes associated navigating this dilemma are pretty high. Forecasting future cash flows by calculating customer lifetime value is an essential practice in figuring out how to invest in your ideal customer. The lifetime value of a customer calculation is an essential, “Executive Metric” for managing your business.

Your investment in acquiring a new customer, like any investment, should be less than the value that a single customer returns to your business. But how do you determine what value a customer will bring to your business in the future? This brings us to one of the most important executive KPI’s (key performance indicators), Customer Lifetime Value or CLV (Try Our Online CLV Calculator). Just as it sounds, CLV is a powerful measure that estimates the future value of a typical customer over an average customer relationship lifespan. Improving CLV can make a big difference on the bottom line, but first, you need to have some visibility into the various factors that influence the measure.

At the most basic level, CLV can be calculated by determining an average customer’s cash flows (or profits) over the lifetime of your business relationship, less the costs to borrow money to invest in your business and the initial costs to acquire the customer. Let’s assume that an average donut-buying customer spends, on average, about $10.00 per transaction (averaging the purchases of many customers) and the average profit margin over food costs are 80% (yes, 80%). Let’s use historical data to measure how frequently an average customer visits the donut shop (twice a month) and the average lifespan of the relationship (3 years).

The average customer, using the most basic CLV calculation is worth $576. That’s a lot of donuts.

If you want to take things a step further, you can also include two other important factors, a) the average retention rate, and b) the current discount rate or the average cost of capital. These measures will help you understand today’s value of a typical customer.

Variables:

  1. Average Purchase Cycle: e.g Daily, Weekly, Monthly, Yearly
  2. Average transaction value
  3. Average number of transactions per purchase cycle
  4. Average lifespan of customer Years
  5. Average retention rate = % of customers you retain each purchase cycle
  6. Average profit margin
  7. Current discount rate. This varies between 8% and 15%, but you can use 10% to start.

Formulas

Simple: a (365, or 52, or 12, or 1) x b x c x d
Advanced CLV: Above Answer x (e / 1+g-e) – less costs to acquire.

customer lifetime value CLV

 

Key benefits of understanding your customer lifetime value

Market Segmentation

You can determine which customer groups are more profitable and adjust your investments, priorities, and strategies accordingly.

Marketing Investments

You can optimize your acquisition strategies to leverage the ones that drive the most profitable business. That doesn’t necessarily mean the lowest costs, but the combination of factors that lead to the optimum number of new, profitable customers without over OR under investing.

Product Development

Enhancements to your offering, inclusive of products and services, may result in increased retention and expanded purchase volume. Pricing is also an important factor. Optimizing your product assortment or perceived value might command higher prices with the right segments.

Finance

What kind of difference would it make in the profitability of your customers to be able to borrow at a highly competitive rate?

Calculate Customer Lifetime Value Online

Measuring and continuously monitoring CLV can help business owners evaluate financial performance, relative to their acquisition costs. Understanding the different metrics that contribute to your CLV can provide valuable insights about strategies and priorities that can help justify your marketing investments and make an impact on your bottom line. To get started, download the CLV resource guide, and try our online CLV calculator.