What Is Customer Acquisition Cost?
Lord knows we love an acronym in the world of marketing. If you don’t know your CPCs from your PPCs from your LTVs this little growth universe of ours can seem like a proper linguistic labyrinth.
So let’s do something about it, shall we?
This blog is all about Customer Acquisition Cost (CAC). Arguably, the single most important measurable in the world of marketing. It’s vital for budgeting, financial planning, investment decisions and marketing strategy decisions. We’re going to discuss what Customer Acquisition Cost is, what it isn’t, how to use it, and how to reduce it.
What Is Customer Acquisition Cost and how do I calculate it?
Customer acquisition cost is, trying not to be obvious, the cost a company pays to acquire each new customer.
It’s a pretty simple formula: CAC = total marketing cost for acquiring new customers / total new customers acquired in a given period of time.
For example, if you spent £1000 on marketing in a quarter and you acquired 100 new customers, your CAC is £10. That seems pretty simple, right? There are a couple of important things to keep an eye on though:
1. Time period. It’s worth thinking about the time period you use to calculate your CAC. There are two main factors to consider:
- Make it long enough to account for your sales cycle. How long does it take for a new customer to make a buying decision? It could be that you have an ecommerce product which generates a very fast impression > click > purchase cycle. Or you may have a product which customers ruminate on for a few months before making a buying decision. The timeframe you apply should be longer than your average sales cycle.
- Make it short enough to be relevant. For example, you may have launched a long time ago and your product, creative, positioning, targeting or market conditions may have changed since then. In which case, if your time frame is too long your CAC won’t be a fair representation of your current situation.
2. Total marketing cost. It’s very important to point out that ‘total marketing cost for acquiring new customers’ does not just mean the amount you have spent on media to acquire customers. For example, if you only use Facebook advertising, it is not simply your Facebook advertising spend divided by the number of new customers acquired. You should include all marketing and sales costs including what you’ve spent on tools, creative, consultants and even staff. When it includes staff salaries CAC is sometimes referred to as ‘loaded CAC’.
For CAC to be as useful as possible, you really need to include as many of your sales as marketing costs as you can. That way you’ll get a realistic figure. If you shy away from including any marketing costs in the calculation, your CAC will appear lower than it already is. This may lead you to making poor financial or marketing decisions.
What is the difference between customer acquisition cost and cost per acquisition (CPA)?
CAC and CPA are related metrics, and sometimes they are used interchangeably. But strictly speaking, they should be used to describe two different things:
Customer acquisition cost = cost per new customer acquisitionCost per acquisition = cost per any other kind of acquisition. Eg – newsletter sign up, registration, lead, Twitter follower. Any other user action that can be considered an ‘acquisition’ but is not quite a new customer.
CAC is a more important metric, but CPA can be very useful too depending on the sector, product and campaign objectives.
What is customer acquisition cost used for?
Customer acquisition cost is one of the most important metrics a business can track. It is relevant for financial planning, marketing spend, investment decisions and hiring decisions.
It is most commonly used in conjunction with Lifetime Customer Value (LTV). This is the measure of financial value a customer is worth to your business over their entire lifetime of interactions with you. To represent a lifetime, most businesses use 1, 3 or 5 years – but for start-ups without historical data, this can be tricky. You’ll have to calculate LTV based on average churn/renewal rates (if you’re a subscription-based business) or repurchase rates (if you sell individual products).
Typically, we divide LTV by your CAC to generate your ratio of LTV to CAC. For example, if you have an LTV of £300 and a CAC of £150 your ratio is 2.
When doing financial planning or budgeting, you’ll need to know what ratio your business needs to generate in order to remain profitable. In the above example, if your product costs £50 to manufacture and distribute, that ratio of 2 could be acceptable – you’re still generating a profit after all costs. If your product costs £150 or more to manufacture or distribute, you’re going to have to improve that ratio either by reducing CAC or raising LTV (or changing your business model).
We have created a tool to help businesses use this ratio to calculate a marketing budget.
How do I reduce customer acquisition cost?
Ah, the question on everybody’s lips. It’s one of the most difficult things to do and also one of the most important.
There are so many factors that go into your CAC – from your advertising creative, to your channel selection, to your website design. The best place to start is to look at your marketing funnel, and use a bottom-up approach to reducing CAC.
That means starting with the last stages of the user journey: the checkout experience, the product listings, the website or app design. If you have major problems here, it’s like having holes in the sides of your funnel – customers will be leaving the process too much, and anything you spend to top up the funnel will just generate more wastage. So start off by plugging the holes – do testing, research and use experts to improve these parts of the funnel.
Next, look at your creative and messaging. Is it a fair representation of what the product is? Is it enticing, relevant and interesting to your target audience? Do you need to get in an expert designer or creative agency to improve your creative assets?
After that, look at your channel selection. Are you using the right marketing channels, where your target audience spends time? Are you using the right experts to manage those channels?
If you have done all of the above and you still can’t get your CAC down to a sustainable level, it’s time to think at a higher level of strategy. Is your target audience right? Is your proposition one that will appeal to them?
And finally – it’s not always possible to make drastic reductions in your CAC. You could make marginal gains, but if that’s still not enough you might need to look at ways to raise your LTV with more expensive products, better customer relationship management (CRM, another acronym!) or a different business model.
If you want help reducing CAC, raising LTV, or both – talk to us.
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