As a business is being set up, one of the things that bug the mind of the business owner is if his or her business can get enough customers to keep it afloat for a long period of time. Acquiring customers for your business is no small issue as it is what would make a difference between you staying afloat for longer, or packing up after a short while.

Customer acquisition cost (CAC) in its most simple term is the cost you are willing to pay to acquire a customer. This cost would also have you looking into the Life Time Value (LTV) of the customer you acquired; that is the amount of purchases the customer makes while he uses your services.

The cost of customer acquisition and lifetime value (LTV) of a customer are some of the most important metrics of a business. This is because your business needs to make money, and to be able to make money, you need to get a return on investment (ROI) from your marketing and sales campaigns.

This calculation tells you exactly how much value you’re making from your customers in relation to how much it cost you to acquire them. Your business would fail if the cost you spend on acquiring customers is higher than the lifetime value of your customers.

You need CAC to assess how your marketing campaigns are performing. The goal is to find the marketing channels that have both a high LTV:CAC ratio and are equally scalable. Lifetime CAC can provide a brand with a lot of valuable insights on their day-to-day operations. For instance, if lifetime CAC is increasing from period to period, then one of two things might be the cause:

Either the brand is investing more on acquisition without seeing a proportional increase in customer adoption or the brand is maintaining a constant level of acquisition spending but customers aren’t signing on at the rates they used to. Either way, an increasing lifetime customer acquisition cost signals the need for a closer look at a brand’s acquisition strategy.

A decreasing lifetime CAC is less concerning but just as curious. If a brand’s lifetime CAC is dropping they’ll want to know why. If they’re slashing the acquisition spend, customer adoption rates might not have dropped yet but could in the future.

This is the reason why customer acquisition is a big issue in business. Every business owner has to know its customer acquisition costs, how to calculate them, and the levers that drive them. Simply put, if you don’t calculate just how much it is costing you to transform that one lead into a paying client, your business may go down the drain, leaving you clueless as to why and how it happened.

Importance of Calculating Customer Acquisition Cost

Depending on your business, a customer could mean different things. For example, if you are running your business on Facebook, the cost to get a new user on the platform is your CAC. If you are Bell Mobility, the cost to acquire a new user on the network is your CAC. Calculating your customer acquisition cost comes with a lot of advantages, and some of them include;

  1. Helping to optimize your marketing campaigns and channels: if you keep your customer acquisition cost updated, it would help you optimize your marketing channels.
  2. Calculating your brand’s customer acquisition cost allows you to assess their acquisition spending at the most granular level on a per customer basis.
  3. Know which channels convert better: when marketing, a business makes use of a lot of channels, but by calculating your CAC, you would know which of your channels that perform better, and be able to put more effort in that channel.

How to calculate it

One very simple way of calculating your customer acquisition cost is by dividing all the costs spent on acquiring more customers (that is your marketing expenses) by the number of customers acquired in the period the money was spent. For example, if a company spent $100 on marketing in a year and acquired 100 customers in the same year, their CAC is $1.00.

The simple method for working out CAC is by dividing the total amount spent in marketing the product (also known as marketing campaign costs or MCC) over the total number of clients it delivered (number of customers acquired, or CA).

Where:

CAC = Cost of customer acquisition

MCC = Total marketing campaign costs related to acquisition (Not retention)

CA = Total customers acquired

That is MCC/CA = CAC

This is customer acquisition cost in its simplest form. A brand that uses the above formula will be able to easily calculate their lifetime CAC, which is a historic measure of the average cost to acquire a customer since the creation of the brand.

There is another more complex, but more accurate way of going about it, but it involves many other variables.

The complex method for calculating CAC is thus:

Where:

CAC = Cost of customer acquisition

MCC = Total marketing campaign costs related to acquisition (Not retention)

W = Wages associated with marketing and sales

S = The cost of all marketing and sales software

PS = Any additional professional services used in marketing/Sales (Designers, Consultants etc)

O = Other overheads related to marketing and sales.

CA = Total customers acquired

That is MCC+W+S+PS+O/CA = CAC

To compute the Lifetime Value of a Customer, LTV, you would look at the Gross Margin that you would expect to make from that customer over the lifetime of your relationship. Gross Margin should take into consideration any support, installation, and servicing costs.

This is basically the general metric, but there are certain things you need to know about when using this metric. Some channels need a bit more time to produce results, and as such, they may not provide the most accurate picture while calculating the CAC. For example, if a company invests in SEO in a new geography, it’ll be a while before they actually start ranking well enough to acquire customers. While such cases definitely exist, they are quite rare.

Calculating your CAC per Channel

It is highly recommended that you know how much it takes to acquire customers from each channel you are using to acquire customers. If you know which channels bring customers with a lower CAC, you can start allocating more budgets to those channels to bring your overall CAC down. This way you can obtain more customers, especially if you are working with a small budget.

To be able to calculate your CAC per channel, it is helpful to have a spreadsheet as this would help you have a clear view of all of your channels and what they cost. This way, you can have clear visibility over which channels are bringing customers at a lower cost.

While it is easy to calculate your customer acquisition cost per channel if you run an online business, it may not be so for a service oriented business because customers don’t always go through the desired routine. For example, if you are running a tattoo parlor, if a customer finds you by clicking on your search ad, but decides to visit your store instead of calling you, it could be difficult to trace the source of that conversion. Yes, you could ask the customer how they found you, but the answer might not reflect the direct answer.

How to reduce CAC

If after your calculations you found out that your CAC is too high and/or you are not able to afford it, there are indeed strategies you can employ to reduce it.

  1. Offer free trials: If you are a SAAS company, see if you can offer a free trial to new customers. This way, customers can try out your product and decide to cancel if they think it is not the right fit for their needs. This can also help improve your churn rate.
  2. Key into referral programs: referrals are a good way to gain steady customers from your old customers. If you can have a steady flow of referrals from existing customers, you can reduce your Customer Acquisition Cost by a huge margin. For example, if you spend $50 to acquire a customer and that customer brings two more customers to sign up for your services, your overall CAC will be $16.67 as a result.
  3. Always be on the lookout for free advert channels: running adverts can gulp a lot of money. One way to go around this is to find channels that would provide you these services free of charge. One way to do this is to get featured in publications. This may be a bit tricky, but you can start by having a regular guest column on a popular blog or publication. Collaborations are another great way of getting great results without investing a much capital.
  4. Optimize your conversion rate: if customers do come to your website, but they do not take any of your desired action like making a purchase, requesting a service, installing your app etc., then you should work on improving your conversion rate. This can be particularly important for e-commerce sites that may lose sales despite receiving a high volume of traffic. The first step to take here is to make sure that your website is user-friendly. Afterwards, you can set up goals on Google Analytics, A/B test your copy and call to action, and implement abandoned shopping cart emails to improve your conversion rate.
  5. Identify your target niche and ideal buyer personas: The success of inbound marketers often relies on the quality of content that they offer to the client. Having an in-depth knowledge of who your potential clients are, what they want and when they want it is crucial to developing the perfect content that can entice them to close a deal with you.

Common mistakes entrepreneur make when calculating CAC

  1. Removing salaries from the calculation: the salaries of people who work in marketing and sales also make up your CAC. A lot of business owners make the mistake of not including them. This includes not just the individual contributors who are 100% dedicated to marketing/sales, but also those (often times managers) who spend part of their time on marketing/sales. A CAC number with salaries included is often referred to as “Fully Loaded CAC.” This means that the CAC is more complete.
  2. Not including marketing overhead: Similar to the mistake of not including salaries, you need to include the overhead (rent, equipment, etc.) allocated to those employees working on marketing sales.
  3. Exclusion of money spent on tools: a lot of tools are required for the success of any marketing endeavor. Most businesses are using more than ten tools to operate their marketing and sales machine. These tools can add up in cost and need to be included in the expenses of your CAC calculation.

Conclusion

As an entrepreneur who plans on starting a business, you should never ignore your (CAC). The earlier you work on this, the better for your business and finances. You should equally know that if your business is going to be able to acquire customers for less, and if you would be able to get good value from your customers, way better than the money you spent to acquire them, then you have to constantly keep abreast with your CAC.