Understanding Customer Acquisition Costs

One of the most important KPI’s your business needs to understand is the cost of customer acquisition (CAC) Understanding what it costs for your business to acquire a new customer can be a hard thing to do, but the results are worth the time and effort.  It can also help point you in the right direction as to where to spend your time, money and marketing efforts.

What actually is CAC?

CAC is the price you pay to acquire a new customer- essentially, it is the average cost your company needs to spend in order to acquire a customer. It is critically important to understand that CAC is not the same as cost per action (CPA). In e-commerce, CPA is the amount it takes for you to convert a customer old or new, whereas CAC is about how much it costs you to just get a new customer. CAC is about acquiring new customers whereas CPA is really the cost you are willing to invest in order to make a conversion. Can you see the difference? Obtaining your CAC can help you to scale your business, boost profits, cut costs and enhance your marketing strategies. Your CAC can also be used to determine whether your business is worth investing in.

How to Calculate CAC
The easiest way to get you CAC is to calculate all the costs spent on acquiring new customers, such as marketing and then divide it by the number of customers acquired. Say in 3 months your company spent $50,000 on marketing, sales, relevant wages, overheads and during that time you acquired 15,000 customers. This would mean that your CAC would be $3.33 This is an efficient way to start understanding how much it costs your company to recruit a customer.

This calculation is only the tip of the iceberg and can be more complex depending on different factors in your business model. Studies have found that most businesses underestimate the cost of customer acquisition because they forget to factor in time spent on social media outreach, emails, networking and sales calls.  Alongside your CAC is another very important metric – the Customer Lifetime Value (CLV).  Taking the data from above, a$3.33 CAC sounds appealing, but what if the product is only a .99 cent app,which customers are not likely to buy again? This CAC would mean the company is essentially making a massive loss due to the fact that they are investing far more than they are getting in return.

This is where CAC can become a little harder to understand. A good rule of thumb is that you want your CAC and your Customer Lifetime Value to be in a balanced ratio of 3:1 (CLV:CAC). Your CLV is essentially a prediction of the net profit that your company will make through the entire future relationship with every consumer. It is determined by averaging out the cost that each customer typically spends. There are however, plenty of that can help you easilydetermine your CLV. From this calculation you canthen determine how much revenue you are likely to generate when you spend acertain amount on marketing and whether you need to down-scale or up-scale.

CAC and Marketing

As a marketer, understanding your CAC is important to your brand but understanding your CAC for each of your marketing channels is equally crucial. Knowing which marketing campaign is providing you with the lowest and highest CAC is going to help you get a better understanding of where to allocate your marketing budget. Commence by breaking down each of your campaigns and the cost for each. When doing these calculations you may also have to factor in the time and wages spent on each campaign.  Following this, work out how many customers were acquired through each of the campaigns to determine your CAC. Once all the costs for each campaign have been broken down group them into the different channels that your company uses for example, Pay Per Click (PPC), Inbound Marketing and Events.

If you sell physical products,it may also be useful to factor in your conversions to determine how your PPC campaigns are doing relative to your marketing budget.  You may also see fit to set up software to trace your customers back to their last attribution source. This allows you to see the last channel that your customer visited before doing their first sale with your company. This gives you the ability to understand which marketing strategy is most effective. Using the previous app example,I will demonstrate what I am referring to. Say 5% of potential customers who saw an ad on Facebook ended up purchasing the app whereas, only .8% of potential customers who saw the app on an organic search (SEO) ended up purchasing the app. This would show that more of the budget could be used towards Facebook advertising instead of SEO….right?

It can be a bit more complex than that, there is no clear black and white action to take. Some marketers believe that all marketing channels work synergistic-ally, so Facebook supports SEO and vice versa. This has been proven in traditional media campaigns where having both a TV ad and a radio ad can increase conversion and acquisition rates, despite this, with e-commerce the trends are not always the same.

Determining the best way to spend your marketing budget based on the CAC for each marketing channel may seem tedious and complex, especially if you know you have a cross over with certain channels, but it can really help you to get a better understanding of your company’s potential to build revenue and profits. It truly comes down to your unique business requirements, trial and error and what your company’s philosophy is on advertising and customer acquisition.

How to Improve CAC

Decreasing your CAC should be one of the primary objectives of any marketing team. I will be going over briefly how to do this.  Establishing the perfect CAC can take some tweaking but there are ways you can improve your numbers and extract more value from your customers. Here are a few suggestions to get you started:

Conversion Metrics
Remember that on its own CAC doesn’t actually mean much, when paired with your CLV however, your CAC can mean a whole lot more.  When you increase your conversion rate on your site, you automatically improve your CAC to CLV ratio. Consider changing your landing page, mobile site, site speed and call to actions as this may drastically improve your KPI’s. Identify where you are losing customers and fix that section of your website/sales funnel and your brand is bound to see an decrease in your CAC and an increase in your CLV.

User Value
This is the ability to generate something that will engage your customers in order to keep them interested and responsive with your company.  Customer satisfaction and high audience engagement can often lead to more sales, so focus on the little things you can do to make your customers happier. This could be something like starting a blog, offering a free e-book or consultation, running competitions or surveys. You may also want to consider ways to engage your existing customers as well by offering them a weekly newsletter, discount coupons and add ons to their existing purchases.

CRM tools
Customer relationship management (CRM) software is used by nearly all successful companies and if you don’t have a platform installed, you are definitely doing your business and brand a disservice.  There are plenty of great CRM tools on the market and choosing one will really depend on your unique business needs.  When you have your software in place however, you can track all sorts of features about your customers that can help you improve retention, CLV and overall sales.

Understanding your CAC and CLV can help you to not only run a smoother and higher functioning business but it can also help you to increase your ROI.

Ash Bryant

Ash Bryant is the Founder & Director of Vivid Visuals. He is responsible for managing the kick ass team at Vivid Visuals and ensuring clients are getting the best results possible.