Customer Acquisition Cost (CAC)

 What is customer acquisition cost (CAC)? 

Customer acquisition cost (CAC) is a measurement used to determine how efficient an organization's marketing efforts are. It measures the total cost an organization spends on sales, marketing, and equipment to acquire new customers. 

The use of Customer acquisition cost has risen in popularity with the rise of the internet. As organizations use web analytics to make decisions, the use of CAC increases because it helps companies figure out if they're getting their money's worth as they invest in new clients.

CAC is commonly used alongside customer lifetime value (CLV), the metric used to measure the value generated by a new customer. Analyzing it in conjunction with lifetime value or monthly recurring revenue allows businesses to gauge whether or not they are operating efficiently. 

Organizations can use this measurement to increase their:

• Return on investment
• Increase profitability
• reduce spending on new customers.

Increasing ROI and profitability while reducing costs leads to an overall more efficient business.

This metric is highly important because businesses want to make sure they are operating at the most optimal efficiency level. No company wants to spend more than they need to acquire customers, so tracking its acquisition cost is vital. 

You can track these costs in several ways. Making sure the cost per customer is lower than the customer lifetime value is the most important. Having a higher cost per customer acquisition than customer lifetime value leads to a negative profit.

Keeping track of social media advertisements, collecting customer email information, and keeping tabs on the recovery rate of your acquisition spending are also great ways to benchmark customer acquisition costs. 

To improve your cost per customer acquisition, you can do many things. Collecting customer feedback, improving value, and establishing customer relationships are all ways to improve it, but the main focus should be on retaining customers. 

A returning customer is much less expensive than a new one. 

Understanding Customer Acquisition Cost (CAC)

An acquisition cost is an amount paid for a fixed asset. In the case of the customer acquisition cost, the asset being paid for is the customer. The most common costs spent to acquire customers are internet marketing methods, sales tactics, and advertisements. 

Internet marketing methods today are very specific compared to traditional advertisements run by companies. Traditional ads would cast wide net advertising, which often left their marketing efforts reaching a broader audience rather than a specific target audience.

This approach lacked specificity, so it was common for companies to see diminishing returns on their marketing investments.

This is where customer acquisition cost comes into play. With new Internet marketing methods, it allows companies to measure exactly how much they spent on their marketing efforts compared to the exact amount of customers they brought in.

Measuring these monetary factors allows companies to track their efficiency and see what is working and what isn’t. 

Companies can use the information gathered from analyzing CAC to change their marketing methods and reduce the money spent on customer acquisition. This is one of the best ways to increase the efficiency of a business. 

Businesses should analyze their cost of customer acquisition for a few reasons.

A company might be spending too much on advertising when they don’t need to, or it might be gaining a majority of its customers from an underutilized marketing effort. They also could be losing profits because customers are not returning at a high enough rate.

A company needs to know exactly where its customers are coming from so they can use the marketing tactic that brings in the most customers. 

Every company should at least keep an eye on CAC so it doesn’t get unreasonable. No company should spend $1,000 on a customer with a lifetime value (LTV) of $500 because that would result in a loss of $500. 

How do you calculate CAC?

Cost per customer acquisition can be calculated as the sales and marketing expenses divided by the number of new customers.

There is a simple way and a complex way to calculate this.

A)The simple method

Divide the total marketing costs to acquire new customers by the total number of customers acquired in a defined period.

CAC = MCC / CA

• MCC = total marketing cost for acquiring customers (not regular customers) 

• CA = total customers acquired 

B) The thorough method

This method includes costs such as sales and marketing wages, software costs for sales marketing, and all additional professional services such as designers, consultants, etc., as well as other overhead costs. 

CAC = MCC + W + S + PS + O / CA

• MCC = total marketing cost for acquiring customers

• W = wages connected with sales associated software cost 

• S = all the marketing and sales associated software costs (inc. E-commerce-Platform, automated marketing, A/B testing, analytics, etc.) 

• PS = every additional professional service in marketing/sales (Designer, consultant, etc.) 

• O = other overheads associated with marketing and sales

• CA = total customers acquired

In short, if an organization spent $500 on marketing expenditures in a year, and brought in 500 customers, then their cost per acquisition is $1.

On the other hand, if a different organization spent $500 on marketing expenditures in a year but only brought in 250 customers, then their cost is $2. 

The organization with the $1 cost per acquisition has a more effective marketing approach.

A lower CAC is always better because you have to spend less money to acquire customers, which makes a business more efficient.

Calculating the cost to acquire customers can be pretty simple, but there can be a lot of factors that need to be taken into consideration when adding up expenditures. To ensure you fully understand this process, we will look at a more in-depth example. 

Example of cAC for coffee company

Let’s take a hypothetical coffee company, for example. The company is a local coffee shop and uses these four tactics to gain both young and old customers: 

• Social media campaigns

• Sales and marketing manager 

• Newspaper ads 

• Pay-per-click advertising 

The company decides to track its spending on new customers over the course of a whole year. By the end of the year, they will use the simple method of calculating the cost to acquire customers by adding up all their costs and dividing by the number of new customers. 

The coffee company uses a spreadsheet to calculate the total cost per customer at the end of the year. The sheet looks like this: 

Their customer acquisition cost came out to $37.95 because that is the cost of all marketing expenses divided by the number of new customers acquired in the given period.

In order to understand the meaning of the $37.95 figure, one must look at the overall context and each expense by itself. For example, if the average customer spends $7 at this coffee shop, then they would have to visit the shop five more times for the store to make a profit on them.

Since most coffee drinkers purchase coffee almost every day, this is a pretty good cost of acquisition. Customers will likely spend much more than $37.95 in a year if they are avid coffee drinkers, so the company will make a decent profit on these customers. 

However, not all customers will be returning customers. The coffee shop can still lose money if a majority of customers do not return, so they should still focus on reducing CAC. 

To fully understand any cost per acquisition number, it is helpful to compare it with the customer lifetime value (LVT). 

Customer lifetime value 

Customer Lifetime Value (CLV or LTV) is the amount your company makes from a customer during their “lifetime” as a customer (the amount of time that they make purchases from you). 

The CLV of customers varies widely depending on the business and sector, but some elements are shared across all organizations. 

These important elements are average customer lifespan, rate of customer retention, profit margin per customer, average lifetime spending, and average gross margin per customer.

1. Average customer lifespan: How long the individual remains a customer.

2. Rate of customer retention: The rate of returning customers (buy more than once).

3. Profit margin per customer: The net income per customer, divided by the revenue produced by the customer over their lifetime with you.

4. The average amount each person spends over their lifetime as a customer: Calculated by adding up what each customer spends in their lifetime and dividing that number by the number of customers

5. Average gross margin per customer: Profit margin per customer over their lifetime, divided by 100 and multiplied by how much they spend during their lifetime

Example of CLV

Let's take a hypothetical plumbing business, for example. The plumbing business provides all standard plumbing services but has extremely good customer service and customer relationships.

The business' numbers are as follows.

• CAC is $40 per customer

• The average customer stays with the business for ten years

• The profit per customer is 20%

• The average amount spent by each customer over their lifetime is $5,000

• The average gross margin per customer is .2 x $5,000 = $1,000. This is the CLV of a customer of the plumbing business. 

How CLV relates to cost per acquisition:  

For a plumbing service, a customer cost of acquisition of $40 seems mildly expensive, especially if they have a lot of customers. 

For this specific plumbing service, however, the customer's average lifetime of 10 years is very high. This leads to a high CLV, which ultimately makes the high cost per customer worth it.

A customer acquisition cost by itself is almost always meaningless if you have nothing to compare it to. The plumbing business' cost of acquisition of $40 means nothing significant until you know what a customer's CLV is. 

A successful business always has a smaller cost per customer than customer's lifetime value. 

Importance of customer acquisition cost

CAC is a key business metric that many businesses look at to understand if their operations are efficient. It also allows businesses to determine the resources they need to attract new customers. Not understanding your customer cost will likely lead to failure in a business.

Not only does the measurement allow businesses to gauge how much they need to spend to acquire customers, but it also allows them to improve the business as a whole. Customer acquisition cost helps a business improve two things: 

1. Return on investment (ROI): An indicator of the profitability of an investment relative to the amount invested. It can help determine if the business should change or keep its marketing strategy to improve its return on investment. 

2. Profitability: Understanding the cost of acquisition per customer allows a business to analyze the value per customer and increase profit margins by utilizing the marketing strategy that has the lowest cost. 

For example, if they spent $1000 on pay-per-click advertising and gained 400 customers from it, their CAC is $2.5.

On the other hand, if they spent $500 on social media advertising but gained 500 customers, their cost per customer is $1.

They should use more social media marketing because it has a lower acquisition cost.

Return on investment and profitability are some of the most important factors that organizations need to focus on improving. Cost per customer acquisition is a useful tool for improving these factors, so it is highly important for all organizations trying to maximize profits. 

In addition to maximizing profits, analyzing the cost per customer helps businesses reduce costs. 

By analyzing different marketing strategies and determining which strategy provided the firm with customers with the lowest acquisition cost, the firm can focus more heavily on that specific strategy.

The combination of maximizing profits and reducing costs leads to an overall increase in efficiency, which is why customer acquisition cost is such an important metric for businesses to utilize. 

How to improve/reduce your CAC

It is clear that CAC is an important metric for businesses to utilize, but how can you improve it? 

There are multiple strategies that a business can use to reduce these costs per customer acquisition. These are some of the best ways:

1. Improve on-site conversion metrics: Make sure that it is simple for customers to purchase your product once they are on your website. Converting potential leads into customers is the number one factor that drives customer acquisition.

2. Enhance value: Increase value for customers by giving customers what is valuable to them. Listen to customer feedback and complaints and deliver what the customer wants, whether it's a new product update, new service, or a small product fix.

3. Implement customer relationship management (CRM): A CRM platform can help you keep track of customers. You can also manage email lists and ad campaigns to reach your customer base to keep them coming back easily.

4. Engage customers early: The earlier you engage a customer with your product, the lower your acquisition cost per customer will be.

5. Keep them coming back: The ultimate step to reduce acquisition costs. All of the methods listed above aim to achieve this step. Returning customers is much less expensive than acquiring a new one. 

To improve your cost per customer acquisition, you have to know how to measure it. To keep a benchmark of your CAC, you'll want to keep your measurables simple and easy to interpret by doing these things: 

• Make sure your CAC is lower than the average lifetime value of your customers. You want to profit from your customers, so you need to ensure that each customer produces more money than you have to spend to acquire them.

• Try to make back your CAC in a year at most. You want to make back the money you spent as fast as possible, but to make sure your business remains profitable, aim to recover your money in less than a year. 

• Keep track of social media marketing. If certain content is being shared more than others, it is doing a good job. Keep track of this and only pay for content that is likely to be shared, so it brings in more potential customers. 

• Collect customer email addresses and contact information when they sign up for your website. You can use this information to measure how long it takes to generate leads. Collecting customer emails can bring in leads for several months or more. Compare that with other forms of marketing to determine its effectiveness. 

Conclusion

A business cannot make informed decisions or predict how profitable it will be in the long run without knowing how much it costs to bring in new customers. 

• CAC, when combined with CLV, is an effective way to measure how efficient an organization is at acquiring customers. It allows businesses to assess what each customer costs in the short term and analyze how much each customer produces in the long term. 
• The measurement allows companies to have a full view of how much they make from each conversion. It also helps keep track of conversion rates and how much it costs to obtain a higher customer conversion rate. 
• Businesses can use it to allocate funds towards strategic marketing campaigns that bring in customers at the lowest cost. 
• Customer acquisition costs can be easily calculated by adding the cost of sales and the cost of marketing and dividing by the number of new customers acquired. 
• It can be benchmarked by comparing it with the average CLV, keeping track of social media shares, and collecting customer email information. 

Overall, the customer acquisition cost is one of the most important metrics to keep track of to keep your business profitable. 

Researched & Authored by Nick

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