Customer Acquisition Cost, or CAC, measures how much an organization spends to acquire new customers. CAC – an important business metric – is the total cost of sales and marketing efforts, as well as property or equipment, needed to convince a customer to buy a product or service.
Analyzing CAC in conjunction with Lifetime Value (an estimate of how much revenue an account will bring in over its lifetime by continuing to purchase or subscribe for a longer period of time) or Monthly Recurring Revenue (the measurement of revenue generation by month) is a common way to discover whether or not a company is operating efficiently.
What is Customer Acquisition Cost (CAC)?
Customer acquisition cost (CAC) is the cost related to acquiring a new customer. In other words, CAC refers to the resources and costs incurred to acquire an additional customer. Customer acquisition cost is a key business metric that is commonly used alongside the customer lifetime value (LTV) metric to measure value generated by a new customer.
CAC, meaning customer acquisition cost, known in marketing circles as CAC, describes how much a company has to spend to get a new customer. The use of CAC marketing has risen in popularity as organizations use web analytics to make data-driven decisions. Whether they’re paying to have potential customers click on banners or investing in articles and graphic content, measuring their CAC helps companies figure out if they’re getting their money’s worth as they invest in growing their clientele.
Internet marketing methods can target specific groups of customers on a granular level. This is relatively new. Traditionally, companies had to cast a wide net with advertising, which involved aiming their marketing content at a broad segment of potential customers. The hope was that this would bring in at least some new customers. Because this approach lacks specificity, it was common for companies to see undersized returns on their marketing investments.
However, modern, targeted campaigns combined with CAC metrics can not only home in on specific groups of people but they can also tell you how much you’re spending per each new prospect to bring them on board and convert them to paying customers.
Formula for Customer Acquisition Cost
The formula for customer acquisition cost is as follows:
Where:
- Sales and marketing expenses are the advertising and marketing spend, commissions and bonuses paid, salaries of marketers and sales managers, and overhead costs related to sales and marketing over the measurement period.
- Number of new customers is the total number of acquired customers over the measurement period.
Why does CAC matter?
CAC reflects the success of your marketing and sales campaign performance. Your marketing and sales teams spend a lot of time, effort, and resources trying to find new customers and improve customer retention. Customer acquisition cost is just one important key performance metric your business must track to determine how effective your campaigns are.
Once you understand how much it costs to acquire a customer, you can begin strategizing to reduce those costs, ultimately boosting your return on investment (ROI.) For example, if you want to write a sales email that converts, you may measure the effectiveness of your campaign and A/B test different factors to identify ways to reduce that cost.It costs less to retain customers than it does to find new ones. So, while CAC is an important metric, you must take into account other factors that may contribute to your bottom line, like customer retention.
Importance of Customer Acquisition Cost
CAC is a key business metric that many businesses and investors look at. In fact, many companies end up failing due to not fully understanding their customer acquisition cost.
1. Improving return on investment- Understanding the cost to acquire new customers is crucial to analyzing marketing return on investment. For example, consider a company that uses several channels to acquire customers:By using CAC, a company is able to determine the most cost-effective way to acquire customers. In the table above, we can see that Social Media provides the lowest acquisition cost while Social Events cost the most. A company presented with this data may consider using social media marketing more to generate more customers.
2. Improving profitability and profit margin- Understanding its CAC provides a business with the ability to fully analyze the value per customer and improve its profit margins. For example, assume that the value of each customer to a business is $60.
Relating it to the example above, which channel would you choose to use? A business that does not understand CAC would adversely affect profitability by choosing to use Social Events as a channel. The channels Social Media and Posters would improve profitability for the company as the CAC is lower than the value per customer.
How customer lifetime value affects customer acquisition cost
Customer lifetime value (CLV, or sometimes LTV) is the amount your company makes from each customer during the customer’s “lifetime” of making purchases from you.
Of course, the amount of time a person remains a customer and how much they spend varies greatly among businesses and sectors, so you have to consider the factors that impact your company specifically. However, some elements of CLV are pertinent to most organizations.
- Average customer life span: This is how long the individual remains a customer.
- Rate of customer retention: The percentage of customers who buy again.
- Profit margin per customer: Expressed as a percentage, this may take into account CAC as well as other expenditures such as the overall cost of goods sold, which includes production and marketing costs, and how much it costs to run the company. To calculate the profit margin per customer, take your net income per customer, which is what each customer spends minus the CAC, then divide that number by your revenue from the customer over their lifetime with you. Multiply by 100 to get the percentage.
- Average amount each person spends over their lifetime as a customer: This is a simple calculation: Add up what each customer spends over their lifetime and divide it by the number of customers.
- Average gross margin per customer: This can be calculated for a finite time period, such as a year, or according to the customer’s life span. In the case of a life span calculation, take the profit margin per customer over their lifetime, divide it by 100, and multiply that by how much they spend during their lifetime.
Factors affecting customer acquisition cost
When calculating CAC, it’s important to consider the business context in which the numbers are gleaned. For example, if you’re just breaking into a new market, your CAC may be higher because it often takes a greater up-front investment to get your marketing rolling in a new area.
Also, newer companies that have to hire marketing staff or existing companies that decide to augment their current marketing efforts with new people or technologies may have significantly higher CACs.
To illustrate, suppose a boutique sneaker company, YourKicks, has already established a market in New York City. To obtain its position in the boutique sneaker segment of metropolitan New York, it used social media, pay-per-click advertising, and several strategic partnerships with retailers who would sell their sneakers. At this point, with their marketing up and running in New York City, their CAC is $10 per new customer.
When YourKicks decides to target the Los Angeles market, some of their marketing efforts will require very little extra investment, while others will demand significant cash. For instance, the pay-per-click costs may be similar in Los Angeles and New York City, so that item in the CAC calculation may not change much. However, a Los Angeles-specific social media campaign will take significant time and human capital as they ramp it up. Also, acquiring new retail partners may involve heavy up-front investments in travel, meals, and other costs associated with landing each account. Therefore, the CAC for Los Angeles will be higher than what they are currently paying in New York City.
When factored into the overall costs of operation, the Los Angeles CAC may significantly impact the total CAC. But because this investment is necessary, it would be wrong to assume the Los Angeles market “costs too much,” at least until the number of new customers and sales revenues become comparable to New York’s
How can you improve your customer acquisition cost?
To lower your CAC, you should work on converting leads and prospects to paying customers, upping the value of what customers get, and using a customer relationship management (CRM) platform to stay engaged with your audience.
- Boost lead conversion rate: You can use Google Analytics to see things like how often customers abandon their shopping carts after adding an item. You can take a close look at how fast your webpages load and think about ways to make your landing pages more engaging if your website visitors are leaving without clicking through to other pages. You should also check how your site looks on mobile devices and how smoothly the checkout process works for buyers. Making all these experiences better for the customer will lead to more conversions.
- Add value to your offering: The value users perceive from your products and services is subjective, so adding features similar companies have implemented may not have the desired effect. Your customer retention strategy depends on your ability to determine what gets your customers excited about buying your products. This is best done by highlighting the importance of customer service throughout your organization. You can also spend time interacting with customers—using surveys or emails—to figure out what would best fit their needs. You can even study statistics such as your customer retention rates and more subjective feedback from the customer reviews you get. If you notice correlations, improving one may boost the other.
- Use a CRM system: A CRM platform can help you keep track of new customers, their movements through the marketing funnel, and how much they buy, including when and where, loyalty programs, and more. You can also use it to manage email lists and campaigns such as promotions, seasonal email advertising, and drip campaigns, which periodically send emails containing compelling content.
How can you benchmark customer acquisition cost?
- ou need to bring in more money than you are spending on your CAC. While this may seem like it goes without saying, it gets more complicated as you factor in things like CLV and customer profit margins. A “low” monetization in the short term may look better over the long term.
- Try to recover your CAC in less than a year. Ideally, you want to earn at least as much as your acquisition cost from each customer by the time a calendar year passes.
- With social media marketing, track the number of shares. People only share content they value. If the content you’re paying for is bringing in customers and is being shared more than content you’ve previously produced, it’s doing its job.
- Use gated content and track how long it generates leads. Gate content is content a customer can only access by giving you their email address or other contact information. Strong gated content can bring in leads for several months or more. Compare that with subsequent content to gauge the effectiveness of your investment.
FAQs
How does Customer Acquisition Cost relate to Return on Investment (ROI)?
CAC and ROI are interconnected. By understanding CAC, businesses can assess the effectiveness of their marketing and sales efforts, helping them make informed decisions to maximize ROI.
Can CAC be different for different customer segments?
Yes, CAC can vary based on the marketing channels, target demographics, and the type of customers a business is trying to acquire. It’s important to analyze CAC for different segments to optimize strategies.
How does CAC differ from Customer Lifetime Value (CLV)?
While CAC focuses on the cost of acquiring a customer, Customer Lifetime Value (CLV) looks at the total revenue a business can expect from a customer throughout their relationship. Understanding both metrics is essential for overall business strategy.
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