Customer Acquisition Cost
Customer acquisition cost (CAC) is the amount of money a company spends to get a new customer.
What is customer acquisition cost?
Customer Acquisition Cost (CAC) is calculated by dividing all the Sales and Marketing costs involved to acquire a new customer within a certain timeframe. To get your customer acquisition cost (CAC), divide all sales and marketing costs by the number of customers acquired over a given time period.
CAC is an important metric for growing companies to determine profitability and efficiency.
CAC formula:
The formula for CAC calculation is:
CAC = (total cost of sales and marketing) / (# of customers acquired)
For example,
if you spend $36,000 to acquire 1000 customers, your CAC is $36.
CAC = ($36,000 spent) / (1000 customers) = $36 per customer
Why is understanding your CAC so important?
CAC is a lever that businesses can adjust to help them meet their goals and, depending on their strategy, be a source of competitive advantage.
Let’s dive in and take a look at the 3 main reasons why measuring CAC is important for your business.
Simplify decision making In its simplest form, CAC tells us how much it costs us to attract new customers but if we take a closer look we see that it also provides a mechanism by which to simplify our decision-making process. \
It helps optimise marketing and sales activities to focus on customer lifetime value (LTV) It is easy to get distracted and focus solely on trying to achieve the lowest CAC possible but it is important to remember that costs are not all bad. Let’s take a look at our example again.
Determining and optimising your payback period Most analysis of customer acquisition cost ends with the LTV/CAC ratio which doesn’t paint the complete picture. There is a third element that needs to be considered: the payback period.
Calculating customer acquisition cost
Reducing CAC is one of the ways to earn more from your business. To do it, you need to know how much you spend on customer acquisition.
Now let’s have a look at the ways to calculate CAC.
There are two methods: basic and complex. The basic formula shows an approximate CAC, as it doesn’t include a lot of expenses. The complex formula includes overhead costs, such as using professional services, sales and marketing wages, software costs, and other costs that are not incurred in marketing. Use a complex method to get a more exact result and draw informed conclusions.
Basic formula This formula allows you to determine the approximate customer acquisition cost for a certain period of time. You can calculate the total marketing cost for acquiring new customers (MCC) and the total number of customers acquired (CA) — divide the first number by the second one.
CAC = MCC / CA
For example, you have spent 3000$ (MCC) on marketing for the last three months and acquired 100 customers (CA). So, your CAC for the last three months is 30$ (3000/100).
However, you spent much more on customer acquisition than you invested in your ad campaign budget. You cannot ignore the salaries of your employees, premium subscriptions they need to use, and other expenses. These spendings often significantly affect the real CAC.
It is reasonable to calculate CAC for each channel. Different channels require different expenses, and they can give different profits. To take this into account, you need to use a complex formula.
Complex formula : To calculate CAC, add MCC, wages connected with sales and marketing (W), marketing and sales associated software cost (S), professional services (PS), and other overheads (O), and then divide the result by CA. Don’t forget that you should use all metrics from the same period.
CAC = (MCC + W + S + PS + O) / CA
Let’s look at an example. You still have spent 3000$ on marketing (MCC), but you have also spent 200$ on wages connected with sales and marketing (W), 100$ on marketing and sales associated software cost (S), 300$ on professional services (PS), and 100$ on other overheads (O). Your company has acquired 100 customers, so your CAC is 37$ (3700/100).
Calculate CAC for different channels, and compare the results. You’ll see where you spend less money on acquiring one customer and will be able to make changes to your marketing strategy.
If you think that your company’s customer acquisition cost is too high, there are effective ways to reduce it and earn more from your business.
How to Improve Customer Acquisition Cost
There are a few different ways to improve customer acquisition costs to bring that LTV: CAC ratio closer to 3:1. Here are a few strategies to work towards:
Invest in conversion rate optimization (CRO): Make sure it's simple and straightforward for visitors to convert into leads or for leads to convert into customers and make purchases on your site. Optimize your site for mobile form submissions and shopping, test website copy to make sure it's as clear as possible, and try to create a touchless sales process so your visitors can buy from you 24/7.
Add value: Increase customer value by giving customers what’s valuable to them. Collect customer feedback, and whether it's a product fix, a new feature, or a complementary product offering, do your best to give customers what they're asking for to make them stick around longer.
Implement a customer referral program: If your customer refers you to a warm lead from their network who is already interested in learning about your product or service, their particular CAC will be $0 if they convert. These "free" customers will lower your CAC over time, so build a customer referral program your customers want to participate in.
Streamline your sales cycle: Decrease the length of a typical sales cycle to increase the number of sales you can influence over the course of a year. Use CRM and prospecting tools to connect with more qualified leads more effectively.
How customer lifetime value affects customer acquisition cost
Customer lifetime value (CLV, or sometimes LTV) is the amount your company makes from each customer during the customer’s “lifetime” of making purchases from you.
Of course, the amount of time a person remains a customer and how much they spend varies greatly among businesses and sectors, so you have to consider the factors that impact your company specifically. However, some elements of CLV are pertinent to most organizations.
Average customer life span: This is how long the individual remains a customer.
Rate of customer retention: The percentage of customers who buy again.
Profit margin per customer: Expressed as a percentage, this may take into account CAC as well as other expenditures such as the overall cost of goods sold, which includes production and marketing costs, and how much it costs to run the company. To calculate the profit margin per customer, take your net income per customer, which is what each customer spends minus the CAC, then divide that number by your revenue from the customer over their lifetime with you. Multiply by 100 to get the percentage.
The average amount each person spends over their lifetime as a customer: This is a simple calculation: Add up what each customer spends over their lifetime and divide it by the number of customers.
Average gross margin per customer: This can be calculated for a finite time period, such as a year, or according to the customer’s life span. In the case of a life span calculation, take the profit margin per customer over their lifetime, divide it by 100, and multiply that by how much they spend during their lifetime.
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