In the business world, counting costs is all part of the game, there's no way around it. Whether it's the cost of paper clips, replacing chairs or buying new computers, every dime you spend can make or break your bottom line. Some of these costs are easy to calculate but others... not so much.
The cost of customer acquisition (COCA) or more commonly known as the customer acquisition cost (CAC) falls into the "not-so-easy to calculate" category because the process involves more than just reading the price tag.
Whether you're a business owner, a marketing agency or a B2C company looking to better inform your clients, the more you know about CAC and how to calculate it, the better off you'll be!
Okay, I know what you're thinking... it's hard enough to keep up with all the business acronyms and now they expect me to learn a formula to go with it?? But stop worrying, that's why we're here!
Let's First Start Off With... What is CAC?
For understanding’s sake, the customer acquisition cost is simply how much it costs your company to acquire new customers over a set period of time. This can include (but isn't limited to) the cost of marketing, research, incentives, website development and manpower. Basically any expense you use to convince new customers to purchase your product/service.
You'd be surprised at the number of people in the business world who still ignore CAC or don't know what it is or where to begin. A simple word of advice: if you want to position your company for profitability... don't ignore your CAC.
Being aware of your business's CAC can help you determine the profitability of your organization and can help you measure whether your business is on track to meeting its goals. It will also help you decide when and how to revamp your company’s marketing strategies.
The Magic CAC Formula
If you understand basic mathematics, determining your customer acquisition cost is a cut and dry process. You simply add up all the costs associated with your marketing and sales program over a specific amount of time (usually a year) and divide that total by the number of new customers you reel in within the same time span.
For instance, if your marketing and sales-related costs are $20,000 for the year and you managed to pull in 200 new customers, your CAC would equal $100.
$20,000/200 = $100 per customer
CAC vs. LTV
Since money is a finite resource, economics dictates that your CAC should be significantly lower than the lifetime value of the customer (LTV). After all, what sense does it make to spend $100 acquiring a customer if your ROI per patron ends up being less?
So how do we go from discussing CAC to LTV, you ask?
In business, lifetime value and customer acquisition costs are interwoven. The lifetime value for each buyer is the amount of gross or “raw” revenue you expect to earn from each customer throughout their relationship with your company. If your LTV is higher than your CAC, your business will go caput.
So how do you know if your CAC and LTV are on the right track with regard to helping your company meet its profitability goals? You guessed it! More math.
The LTV Formula
To get a general idea of your LTV, divide your net profit by the total number of buyers you have over a set time span. Your net profit is simply the profit that’s left after all of your expenses are paid.
Remember, anytime you’re calculating CAC, you only consider customers that are new to your business. When you’re determining the LTV, you have to consider all of the customers who buy from your business in the same time span.
For instance, if your net profit is $100,000 and you had 1,000 customers that year, your LTV would equal $100 per person.
$100,000/1000 = $100 per customer
Ideally, your lifetime value should be 3 to 4 times higher than your customer acquisition cost. Anything less could jeopardize your company’s health.
Reeling in Out-of-Control CAC
If your business is strictly online, you have more flexibility with regard to customer acquisition cost. Online setups have the ability to gain steam and cause the cost of customer acquisition to decrease, making it possible for them to level out over time. The reason why the CAC can decline is that marketing efforts from previous years can start to reach a larger audience and lead to an uptick in sales.
However, if you have a brick-and-mortar company and your customers need humans to fulfill their needs, your CAC is not likely to budge until you make changes to the way you do business.
In the math examples above, the CAC and LTV are equal, which means you can do one of two things: Lower your customer acquisition cost or increase the lifetime value of your customers.
Increasing LTV
You can increase LTV by boosting the amount of money each customer spends. This means beefing up efforts to retain existing customers so they can buy from you more often. You can also increase the LTV by convincing many of your one-offs to increase their purchases. Putting more resources into building long-term relationships with your clients is the ideal way to accomplish these goals.
Keep in mind that unless you have a product/service customers use frequently or you offer multiple products to complement purchases, turning existing customers into repeat buyers can be difficult. Even if you turn them into repeat patrons, they may not buy from you often enough to put a dent in your LTV.
For Example:
If you’re in the concrete finishing business, the patios and sidewalks you pour can last for 15 to 20 years. So customers are likely to use the service once, maybe twice in their lifetimes. With a business of this nature, there is limited value in pouring additional money into building repeat clients.
When it comes to balancing your LTV to CAC ratio there is certainly value in customer retention. Just remember, this method works best when it’s combined with systems that can yield long-term results.
Lowering CAC
There are multiple ways to lower the cost of customer acquisition but many businesses take the obvious route and reduce their marketing budgets. On the surface, this seems like the logical thing to do, but in the long-run, it can backfire. If you slash your marketing budget by a third, you run the risk of bringing in fewer customers. In the end, you will still have the same problem... an out-of control customer acquisition cost.
A more viable way to balance the cost is to reevaluate how you spend your marketing dollars. If you take a minute to crunch the numbers, you can easily figure out which marketing channels are most effective.
For Example:
You may find that inbound marketing reels in more customers than your radio adverts. Now you can cut back on radio advertising and re-channel the money to online venues. You will still have the same marketing budget, you'll just be using the money in a smarter way.
Another way you can lower the CAC is to encourage your existing clients to refer your services to others. Even if patrons can’t use your services often, they can certainly recommend you to friends and acquaintances.
In addition, don’t count social media platforms out. These platforms can broaden your reach, build brand awareness and help you get more mileage out of your marketing budget. The more people know about your business, the more likely they are to seek you out when they want to buy products. The more products you sell, the lower your CAC will drop.
Did we miss anything important? Let us know in the comments below!