Understanding Customer Acquisition Cost (CAC)

One of the reasons businesses fail is a wrong estimate of how much it will cost to acquire customers. If the cost ends up too high and exceeds the monetization of the customers, the business cannot operate sustainably.

It is essential to understand how much a customer will generate for the business, as knowing this will let us figure out our acceptable level of CAC per customer. Companies that do not fully understand their CAC can quickly end up failing.

Customer Acquisition Cost shows us the resources we need to grow sales.

This is a crucial concept, as any business can fail if it struggles to find a cost-efficient way to convert prospects into customers.

What is the Customer Acquisition Cost (CAC)?

The Customer Acquisition Cost (CAC) is a metric with growing popularity in recent years. It follows the emerging of internet businesses and improved tracking capabilities.

CAC represents the cost of finding a lead and converting them to a paying customer. It includes various expense categories like ads, marketing, sales, copywriting, publishing, design, and others.

It was harder to narrow down the audience of advertising and track them through the decision process in earlier days. Nowadays, we can create highly targeted ad campaigns and then follow every step of the conversion from a lead to a customer.

The Customer Acquisition Cost takes the total cost of sales and marketing (including salaries and benefits) and divides over the number of customers acquired.

When we calculate CAC, we exclude the production cost for goods and then compare the result to the gross margin per customer, also known as the customer’s Life-Time Value (LTV). To have a successful business model, we need the Customer Acquisition Cost to be way below the LTV per customer.

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Who Uses CAC?

External

Investors are looking at CAC as part of their evaluation of potential investment opportunities. The metric is vital for potential investors in internet tech companies, as it is an excellent indicator of the scalability potential of the business.

They look at the difference between how much it costs to get a client and how much the client generates for the company, which allows them to calculate the company’s profitability.

This allows analysts to get a feeling of the business’s potential even if the company is not yet generating significant turnover.

Internal

The marketing and operations departments within the company follow the metric to optimize the return on investment in ads (marketing ROI). It’s a crucial metric, as CAC optimizations translate to improved profitability for the company.

Customer Acquisition Cost Formula

We calculate CAC by dividing the total marketing and selling expenses over the volume of newly acquired customers.

Customer Acquisition Cost (CAC)

Selling and Marketing include various cost items. Some of those can be:

  • Creative – what we spend to create content;
  • Technology – the cost of the tools we use in our marketing and sales teams, e.g., reporting tools, autoresponders, and others;
  • Publishing – the cost of getting our message out there (reaching our audience);
  • Ad spend;
  • Salaries and benefits;
  • Inventory upkeep (warehousing and logistics).

Adjustments

The company may have made a sizeable investment in a marketing project where they do not expect an immediate return. This can be a new market entry, building up pre-launch hype for a new product, and others. Such expenses can significantly skew the CAC calculation, and it is common to adjust these out of the calculation.

Customer Acquisition Cost Analysis

Marketers aim to know the CAC metric per marketing channel. If we identify the channels with the lowest Customer Acquisition Cost, we can focus on developing them. The more we can spend within channels with low CAC, the more customers we can onboard with a fixed marketing budget.

Online businesses have access to very detailed analytics on their customers. For example, if a sale comes from an organic Google search, our SEO strategy works well.

A common approach is to average the number of clients over all channels, which can become an issue. However, this can lead to additional problems.

Imagine if we run a Facebook ad just for one day. Then our analysis becomes pointless, as it will attribute the same number of customers to each channel, including Facebook ads. This channel will have the lowest amount of expenses (only one day’s worth of ads) and will show an unrealistically low CAC value.

It becomes more challenging when we have channels that are hard to track. If we have viral video or blog posts that generate many word-of-mouth referrals, these will support our overall marketing efforts. Still, it’s harder to track their effect on Customer Acquisition Costs.

We need to model our Customer Acquisition Cost and mainly aim for two things:

  • A customer Life-Time Value of at least 3-5x of CAC;
  • CAC is recoverable within six to twelve months.

We have to validate our numbers as soon as possible in the business life cycle. Good ones will make it easier to get funding, while bad ones may indicate we don’t have a viable business idea.

When we look into Customer Acquisition Cost, we need to consider the following factors that may affect the metric:

  • Sales cycle length;
  • Company maturity;
  • Customer lifespan;
  • Sales frequency;
  • Sales value.

CAC is a helpful metric to calibrate our growth strategy and focus our ad investment on the most beneficial marketing channels.

Return on Investment (ROI)

It’s beneficial to understand the cost to acquire new customers if we want to analyze marketing Return on Investment properly. CAC helps businesses to find the most cost-effective channel for customer acquisition.

Improving the CAC

In reality, we can continually improve our marketing campaigns, increase customer loyalty and satisfaction, and get more value out of each customer. There are a few things we can do to improve our company’s Customer Acquisition Costs:

Enhance the Value for our customers

One way is to improve our products and offerings. We can increase customer satisfaction by providing better customer support. Once we achieve better customer satisfaction, this will lead to a higher retention rate.

Improve the on-site conversion metrics

We can gain a lot by improving our landing page, load speeds, and mobile experience. Another beneficial exercise is to perform A/B split testing on various features and track which convert better. The main goal here is to reduce the rate of shopping cart abandonment.

Use a Customer Relationship Management (CRM) system

CRM systems leverage actual sales data to take the guesswork out of business decisions. Their ultimate goal is to improve customer acquisition and retention.

Another way to improve CAC is to implement a customer referral program. We can also strive to decrease the sales cycle to increase the number of times we turn over sales in a given period.

Example

To illustrate the importance of analyzing our Customer Acquisition Cost, we will look at a simple example.

Here we have a summary of our spending and newly acquired customers per marketing channel:

We can go ahead and calculate the CAC metric for each channel:

Looking at the Customer Acquisition Cost, it appears Facebook Ads is our best-performing marketing channel. It takes €10.35 on average to convert a client from ads on Facebook, compared to €20.48 on Linkedin and €14.81 from our blog posts.

However, if we go one step further and add the average Life Time Value of a customer within each channel, we get the following:

We can now see that sales we make through advertising on Facebook are also the lowest.

If we calculate the difference between the CAC and LTV per Marketing Channel, we will get our average profitability:

Now that we have added the LTV and profitability details, we have a more holistic view of our CAC. We can see that although Facebook Ads have the lowest CAC, it is Blog Posts that are most profitable within our Marketing Channels.

It is also worth mentioning that our LTV is not in the preferred range of 3-5x CAC. This is not always a bad sign, but we need to look into options to optimize our CAC spending or improve LTV per client through upselling campaigns, referral incentives, and others.

Conclusion

Customer Acquisition Cost (CAC) is an essential metric for both company management and investors. It can show us whether the business can be and remain profitable in the long run.

We can use CAC to allocate resources and funds to different marketing channels to improve customer retention. It is crucial in the profitability analysis of the company.

If we manage to reduce the Customer Acquisition Cost, we are spending more efficiently and should see improvement in the profit margin.

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Dobromir Dikov

FCCA, FMVA

Hi! I am a finance professional with 10+ years of experience in audit, controlling, reporting, financial analysis and modeling. I am excited to delve deep into specifics of various industries, where I can identify the best solutions for clients I work with.

In my spare time, I am into skiing, hiking and running. I am also active on Instagram and YouTube, where I try different ways to express my creative side.

The information and views set out in this publication are those of the author(s) and do not necessarily reflect the official opinion of Magnimetrics. Neither Magnimetrics nor any person acting on their behalf may be held responsible for the use which may be made of the information contained herein. The information in this article is for educational purposes only and should not be treated as professional advice. Magnimetrics and the author of this publication accept no responsibility for any damages or losses sustained in the result of using the information presented in the publication.

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