Customer Acquisition Cost
Customer acquisition cost is a measurement of the resources that you invest in converting a single customer.
Any marketer is happy when they see soaring growth rates. This is a strong indicator that their efforts are working. However, it can be easy to forget to factor in the sales and marketing expenses involved in securing such growth rates.
Without factoring these costs in, or without understanding these expenses in the context of product-market fit, you risk spending far more than you gain from these conversions. This is why measuring your customer acquisition cost is so important.
In this article, we discuss how to calculate your customer acquisition cost, as well as its importance to your overall business strategy.
Table of contents
- What is Customer Acquisition Cost?
- How do you Calculate Customer Acquisition Cost?
- Why is the Customer Acquisition Cost Important?
- How Do You Reduce Your Customer Acquisition Cost?
- Customer Acquisition Cost: Optimizing Growth For Maximum Profit
What is Customer Acquisition Cost?
As the name suggests, the customer acquisition cost (CAC) is a measure of the resource expenditure involved in acquiring a new customer. In this case, it can also be defined as the sales and marketing spend required to convince a single customer to do business with you.
How do you Calculate Customer Acquisition Cost?
The simplest way to calculate your cost of customer acquisition involves three figures:
- CAC: The Customer Acquisition Cost itself
- AC: Number of newly acquired customers over a given period
- MC: Sales and marketing costs
Once you’ve determined these, what you then need to do is divide your total sales and marketing spend by the total number of paying customers acquired over a given period.
The customer acquisition cost formula is:
CAC = MC / AC
It’s fairly trivial to get the number of acquired customers over a certain time, so the more difficult part here is getting the sales and marketing costs pinned down. You want to include:
- Salaries of marketing and sales employees
- Recurring and one-off expenses involved in equipment and software for sales and marketing
- Cost of any consultancy services for sales and marketing
- Overhead costs, such as payment processing fees
Here’s a quick example. Let’s say over the course of one month, you acquired 10 customers.
Your total sales and marketing spend over that one-month period was $1000.
$1000 divided by 10 customers produces a CAC of $100 per customer.
Why is the Customer Acquisition Cost Important?
Customer acquisition cost is a sobering figure for any growth-focused business strategy. Spending large amounts of money and effort on sales and marketing can definitely generate impressive growth. However, without CAC to temper your expectations, you may end up spending more than you make.
Customer acquisition cost is almost always measured against customer lifetime value. After all, if your CAC is higher than the value of each customer, then your company is spending more in getting your customers through the door than what you stand to earn from them.
Think of each customer as becoming an expense the instant they’re converted. At this point, you need to consider how much they give you in revenue every month and estimate how long you’ll be serving them.
Let’s take the above example and say you’ve just landed a new customer. Because your CAC is $100, you can think of them as having cost you $100 to convert.
Now, they start paying for a subscription worth $25 per month. In this way, they “pay back” the cost of their CAC. Once the value they’ve given has exceeded their CAC, they start generating profit for your business. At $25 per month, that means they’ll “pay off” their CAC after four months and start earning you actual profit.
However, you also need to consider how long the average customer will keep paying for your services. If your customers typically stay with you for a year, that’s a (simplified) customer lifetime value (CLV) of:
CLV = $25 * 12 months = $300.
According to ProfitWell’s Jordan McBride, a good CAC is a maximum of 33% of the customer lifetime value. In this example, the CAC of $100 is a perfect 33% of the $300 customer lifetime value, making this a relatively ideal scenario.
How Do You Reduce Your Customer Acquisition Cost?
Obviously, the lower your CAC, the more profit you stand to make from each customer you convert.
Reducing your customer acquisition cost is based on two factors: The number of acquired customers, and the amount you spend on sales and marketing. Therefore, optimizing both of these figures is key to reducing your CAC. Here are a few steps to help you out.
1. Improve Your Audience Targeting
It’s important to focus your marketing efforts on audiences who are likely to buy your products. This is especially true if you’re working within a small niche. Reduce or stop your marketing efforts aimed at segments that have a lower chance of converting, and focus on reaching the people who most accurately resemble your buyer persona.
By doing this, you can both reduce your marketing costs and increase the number of potential paying customers you reach.
2. Revisit Your Sales Funnel
Your sales funnel is the key to converting your leads into paying customers. To reduce your CAC, you need to analyze each stage of the funnel and determine where and why people are dropping out of a purchase journey. By targeting these reasons and optimizing your funnel accordingly, you can increase your conversions and reduce the time each customer spends going down the funnel, both of which contribute to a lower CAC.
3. Develop a Retargeting Strategy
People may choose not to complete the customer journey for many reasons. Luckily, in many cases, all they need is a carefully retargeted push or another impression to get them back on track.
In fact, research indicates that retargeted customers are 70% more likely to convert. Get information about why leads go cold and retarget them to entice them back into your funnel if you want to successfully retarget them and increase your conversion rates.
Customer Acquisition Cost: Optimizing Growth For Maximum Profit
In isolation, growth isn’t the be-all, end-all of your company’s success. You want to use multiple metrics, including customer acquisition cost and customer lifetime value, to inform your growth efforts and make the best decisions for your business.