Customer Acquisition Costs

Customer Acquisition Cost (“CAC”) is a metric that has been growing in use among Internet businesses. It’s a metric that can make or break your start-up.

However, we find that many ‘traditional businesses’ fail to measure CAC, giving them limited insight as to whether they are acquiring customers profitably.

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In this video, Rowan shares how to calculate your CAC, why it’s important and how you can improve your results.

In assessing the viability of your business model, there are two metrics you need to consider. One is customer lifetime value, which we’ve covered in a previous video, and the other one is the cost of customer acquisition, which we’ll cover now.

As the name suggests, Customer Acquisition Costs are the costs your business incurs in acquiring a new customer.

How do you calculate this?

Take the customer acquisition cost for a given period and divide it by the number of new customers for that period. cac

What is contained in these customer acquisition costs?

Customer Acquisition Costs are all expenses incurred in acquiring/winning new customers. These include:

  • Wages for your sales and marketing team;
  • Digital advertising expenses like pay-per-click (“PPC”) or Search Engine Optimisation (“SEO”);
  • Expenses for events and trade shows; and
  • Any other expenses to do with onboarding the customer.

The formula calculates a ‘per unit cost’ of acquiring a customer over a period. Typically this is on a monthly or quarterly basis. 

Example:

ex1

Why is customer acquisition cost important?

Measuring CAC is a crucial metric to measure as it helps business owners understand the profitability of marketing and sales efforts.

If you have multiple channels of acquiring new customers, it is important that you assess which channel is the most profitable for your business. Having CAC data allows you to analyse the profitability per channel so you can assess whether you should;

  • Double down on the most efficient channel and/or;
  • Improve the less profitable ones, or scrap them altogether.

Example:

ex2

Based on the example above, Inbound is the most efficient Customer Acquisition channel, with unit CAC of $313 per customer. The least efficient channel is Outbound sales, with a unit CAC of $800 per customer. The management team should, therefore, understand why Inbound is the most efficient channel and consider redirecting their marketing and sales spend from Outbound sales to Inbound.

Customer Acquisition Cost to Customer Lifetime Value ratio

Now that you’ve calculated your cost of Customer Acquisition, you can now compare this to your Customer Lifetime Value.

Click here to understand how to calculate your Customer Lifetime Value.

Understanding the ratio of CAC and CLV is important to understand if the customers you’re acquiring are profitable. If your CAC is higher than your CLV, you’re losing money.

If you are in this category, you have a failing business model.

A poorly balanced business model (ie. losing money):

model1

A well-balanced business model requires that CAC is significantly less than CLV.

A well-balanced business model:

model2

We’ve got some figures here to act as a benchmark to assist you with understanding if you’re acquiring customers profitably.

. ltv

If LTV:CAC ratio is one-to-one (1:1), as a whole, as a new business, you’re losing money.

The sweet spot to target is that three-to-one (3:1). If you’re acquiring customers at this rate, you should be happy.

If you’re acquiring customers above three-to-one, and you’re acquiring customers at a very profitable rate.

How to lower your Customer Acquisition Costs

If you’re not acquiring customers at an efficient rate, the question begs, how do you lower it?

There are two main methods which we focus on.

1/ Analyse your Customer Acquisition Channels

Having CAC data allows you to analyse the profitability per channel so you can assess whether you should;

  • Double down on the most efficient channel and/or;
  • Improve the less profitable ones, or scrap them altogether.

Understand which are the most effective channels of acquiring customers and double down on them.

2/ Focus on Customer Success

The other method, which we see under utilised despite being the most important one, is customer success.

For those new to the term, Customer Success is the function at a company responsible for managing the customer relationship and is responsible and accountable for that customer’s success. The role can be varied, but the role is typically focused on long-term value generation to the customer.

By having a great customer success team, an organisation ensures their current customers are so happy that they’re willing to refer you more customers.