Customer Acquisition Cost : What Is It? and How Do You Calculate It?
The ultimate goal of every business venture is to develop products and offer services to serve the needs of its customers. As a result, businesses must develop working strategies to help them retain their existing customers and gain valuable new customers.
Sadly, with every new customer comes more business expenses, as written by Bernd Zipper in a post – “it is at least five times more expensive to acquire a new customer than it costs to retain an existing one.”
We all know that to get something of value, you have to work hard for it, only that this comes with a little more cost for marketers and salespeople who need to build their customer base to increase sales and grow the company.
In the words of Regenia Gagnier that “human wants are insatiable,” a business’s desires and goals are also endless. Regardless of the amount of money (revenue) a company generates from its current customers, there will always be a need to look out for more customers to expand its revenue.
How do businesses get their new customers? What expenses and costs are involved in acquiring customers? How do they measure this and keep the costs at a minimum? And what strategies are in place to generate the best revenue from every new customer?
Now, this is the part where customer acquisition cost (CAC) calculation becomes extremely important.
In this article, we will be sharing valuable information on what customer acquisition cost (CAC) is? How you can calculate customer acquisition cost and other important factors.
Table of Content
- What is customer acquisition cost (CAC)?
- Why is customer acquisition cost important?
- How is customer acquisition cost (CAC) calculated?
- Customer lifetime value (CLV) and Customer acquisition cost (CAC)
- Components of customer acquisition costs?
- How to improve customer acquisition costs?
- Customer acquisition cost FAQs
What is customer acquisition cost (CAC)?
Customer acquisition cost (CAC) is a business metric that measures the amount of money a company spends to acquire new customers. The emergence of internet companies and web-based marketing and advertising campaigns has contributed to the rise in the calculation of customer acquisition costs.
According to a business policy by the United States Small Business Administration, companies that make less than $5 million a year should allocate between 7% and 8% of their total revenue to marketing campaigns. What this means is if your company generates revenue of $500,000, $35,000 to $40,000 of your income should go into your marketing and advertising campaigns.
So if you are going to spend $35,000 to $40,000 in marketing and ads to acquire new customers, you have to ensure that the money is well spent and managed properly to increase your profit margin, which is where your customer acquisition cost calculation comes in.
Customer acquisition cost tracks the progress and the total amount of money spent on getting a customer with a focus on their journey from a lead to a customer. Customer acquisition cost is critical to help you keep a record of your investments and to ensure that you make the right decisions for your revenue and business growth.
Customer acquisition costs should generally include advertising costs, the marketer’s salary, sales costs, etc., divided by the number of customers acquired.
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Why is customer acquisition cost important?
Customer acquisition cost is crucial to building profitable and scalable businesses. It gives business leaders, marketers, and sales reps a look into the cost incurred in acquiring a customer and guides them on how to spend to get the best results.
If you wish to build your customer base, increase sales and monitor your business performance, you should calculate your CAC.
Aside from this, customer acquisition costs can help you achieve the following;
1. Make data-driven decisions
CAC is instrumental in important decision-making. When you can monitor the money spent on your marketing and sales activities to acquire customers, you can make data-driven decisions on what and where you should spend your money to get the best results.
2. Optimize sales and marketing efforts to get CLV
CAC guides the marketing and sales team activities to optimize the CLV to CAC ratio. In simple words, this means that by calculating your customer acquisition cost, you can estimate the monetary value you would get from every newly acquired customer. So if you spend $5 on marketing, you should make $15 in return.
3. CAC Shows the payback period
CAC can show you how long it can take to get back the money spent on the business, especially when your business is still new.
4. CAC shows the financial health of the business
CAC will show you your business’s financial performance and condition over an estimated period. To calculate your business profit, add your CAC from the previous months, and subtract the projected revenue.
How is customer acquisition cost (CAC) calculated?
To calculate customer acquisition cost (CAC), you add up the cost associated with acquiring new customers – the total amount you have spent on sales and marketing activities and divide it by the number of customers you gained. You can calculate CAC within a specific period, usually in fiscal quarters or annually.
CAC formula = Total sales and marketing expenses/number of new customers acquired
For example, if a company spends $10,000 on marketing and sales in a year and gains 1,000 new customers, the CAC would be $10,000 of marketing and sales expenses divided by 1,000 customers, which equals $10. That way, you have been able to spend $10 per customer.
A customer lifetime value (CLV) is a business metric that measures the total amount of money or revenue a customer can bring to a business over a specific period.
CLV helps business leaders, salespeople and marketers understand their customers to develop strategies that will help them maximize their revenue while they remain as customers.
To calculate and keep track of the money you spend to acquire new customers, it’s important that you also calculate the customer lifetime value to understand the worth of the customers you are investing in. Consider the following elements to calculate your customer lifetime value;
1. Average purchase value
Average purchase value is the value of every product or service sold in a specific period, usually a year. You calculate this by dividing total revenue by the number of purchases.
2. Average Purchase Frequency rate
The average purchase frequency rate is the number of times a customer buys from you and the consistency of purchase – every three days of the week or once in three months. You calculate this by dividing the number of purchases by the number of unique customers.
3. Customer retention rate
Customer retention rate is the percentage of customers who buy again – repeat buyers.
4. Average customer lifespan
The average customer lifespan is how long an individual remains a customer. This is derived by calculating the sum of customer lifespans divided by the number of customers. Find the detailed guide about what is gross revenue? and gross sales vs net sales.
5. Average customer value
You calculate the average customer value by multiplying the average purchase value by the average purchase frequency.
To calculate your customer lifetime value, you will multiply customer value by the average customer lifespan. You must understand that calculating the above gives you an estimate of how much revenue your average customer will generate during their time of business relationship with your company.
A CLV to CAC (CLV: CAC) ratio is necessary for marketers, sales teams, and customer service reps to get insight into their spending. The CLV: CAC ratio shows you how much you expect to generate from a customer to the amount the business is spending to acquire the customer.
It is highly recommended that you create the right CLV and CAC balance to ensure that you are not overspending on the wrong customers. The approved CLV to CAC ratio for successful companies is 3:1 – your customer value must be three times more than the cost of acquiring them.
A lower rate like 2:5 would mean that you are spending more than the value of customers, while a ratio of 5:1 indicates that the money budgeted for your marketing efforts is not enough to attract paying customers. Also, check out the related guides, B2B sales, SaaS sales and tech sales.
Components of customer acquisition costs?
Since the aim of calculating customer acquisition cost is to measure the amount you spend on acquiring customers, you must include the right elements in the calculation.
What should be in your customer acquisition cost (CAC) calculation?
CAC calculation should include the following;
1. Marketing costs
To get an accurate average customer acquisition cost, Your marketing cost should include the following;
Cost of display advertising: this should include the total cost spent on all advertising – digital (on social media, apps, and the internet) and traditional (TV, radio, and product activations). Advertising is one of the oldest and most effective methods of acquiring customers and increasing brand awareness and customer loyalty.
Cost of search engine marketing: this should include all the money spent on google analytics and other cost incurred to improve the business visibility on search engines.
Cost of affiliate marketing: this should include all the money spent on affiliate programs – getting affiliates and incentives or discounts introduced to boost sales.
Cost of social media marketing: This should include all the money spent on social media ads, content creation – videos, articles, editorials, or advertorials, and the cost of running social media channels.
2. Sales costs
CAC should include the total amount of money spent by the sales team on all sales activities – customer relationship management, sales tracking, cold calling, hosting events, data research, customer emails, customer follow-ups, prototyping, and sales team training.
The sales team is undoubtedly one of the most valuable teams in an organization, without them, it would be impossible to generate revenue. Consider all the costs of the above sales activities to get accurate customer acquisition costs.
3. Employee Salaries
Consider all salaries, wages, and incentives paid to your employees in the cost acquisition costs (CAC). Ensure you include all full-time staff, part-time staff, contacts staff, and freelancers.
4. Technical Costs
Technical costs refer to the cost of technology and software that your sales, marketing, and customer service teams use to acquire customers. Technical expenses should include the cost of reporting tools, lead generation and tracking software, sales software, CRMs, productivity tools, email and outreach software, social selling, data analysis tools, web conferencing, and collaborative tools.
5. Cost of production
Production cost refers to the cost of developing marketing and sales content. CAC should factor in all the expenses incurred to create high-quality marketing and sales content – video, text, images, ad designs, and posters to target the potential customers. For example, if you need to buy a tripod to shoot your marketing videos, consider the cost of the tripod and other money spent to create the video.
6. Inventory upkeep
The inventory cost refers to the money you will be spending to run and maintain your products. For example, if you are a software company that sells software, your inventory cost is the money you spend to update the software, improve user experience, and fix bugs.
What should not be included in your customer acquisition costs?
Not all cost should be included in your CAC, some of these includes;
1. Marketing expenses that are not related to customer acquisition
You should not include marketing expenses like the cost of branding, logo, and PR and customer contests – giveaways, holiday gifts, etc., that are not related to acquiring customers.
2. Other costs that are not related to customer acquisition
You should not include expenses like travel costs that do not relate to the customer acquired, expenses incurred to create customer success stories, cost of training customers, or credit card and payment processing fees.
In a nutshell, you should only include costs that are related to customer acquisition to gean accurate CAC.
How to improve customer acquisition cost (CAC)?
The significance of CAC to your business is to show that you are not overspending to acquire new customers. As a result, we have compiled five (5) ways you can improve your customer acquisition cost (CAC).
1. Invest in conversion rate optimization (CRO)
Conversion rate optimization is the process of increasing the percentage of website visitors or mobile app users to complete the desired goal of a website or app. To improve your CAC, you need to ensure that you improve your website is functional and runs smoothly when your potential customers visit your website.
You can achieve this by improving the following;
- Optimize your highest-performing blog posts to boost conversion.
- Develop value-driven content that can provide real value to your potential customers.
- Include a call to action (CTAs) in your blog posts.
- Include user-generated content like social proof, customer success stories, and reviews to drive customer growth.
The overall idea of CRO is to create a better customer experience and give prospects a reason to become paying customers.
2. Create engaging and meaningful content
Content creation is crucial to business growth and lead generation. Another effective means of improving your CAC is by creating informative, educative, engaging content that adds value to your customers.
By creating engaging content, you will be able to connect with your audience on a deeper level and help them become aware and appreciative of your products or service. I believe you must have seen marketing content that resonates with you, your needs, and your pain points. That is the idea of this, engaging and value-packed content will always bring back your customers.
If you are looking to improve your content creation strategy, consider doing the following;
- Create and use the right keywords – long-tail keywords to boost organic traffic and brand awareness.
- Up your search engine optimization (SEO) game to increase your chances of getting the right customers.
- Promote your content to widen your reach and attract new customers.
- Finally, measure your content performance to identify your strengths and weaknesses and work on them accordingly.
3. Automate your sales and marketing activities
Technology has done well for us by providing newer and advanced tools that can be used to perform some of the sales and marketing tasks. It can be very challenging for marketers to understand which content to create, track content performance, and understand where and how to find customers. However, with advanced software, you can automate the tasks to get better results.
Similarly, for the sales team, instead of manually compiling email addresses, sending emails, and doing follow-ups, you can automate them to save you stress and help you work better.
Consider the following options;
- Use of Chatbots to improve customer engagement and manage customer service.
- Send automated personalized emails to your mailing list to give you more to focus on other demanding tasks.
- Use social media automation tools to schedule social media posts, content consistency, and increase your social presence.
4. Create an Affiliate Program
An effective way to ensure you’re not spending too much to gain new customers is by creating an affiliate program. Through an affiliate program, you can get affiliates that will help you get customers and engage with them to sell your product or service on your behalf while earning a commission per customer.
5. Introduce a customer referral program
Another effective means of improving your customer acquisition cost is by implementing a customer referral program where your existing customers can refer a friend, colleague, or family to buy from you while they accrue their loyalty points to buy a product or win a gift.
A referral program will help you gain “free” customers that are likely to introduce other new customers to you. It’s smart and super cost-effective to get new customers through referral programs.
Customer Acquisition Cost (CAC) FAQs
1. What is customer acquisition cost?
CAC is the total cost a business invest in convincing a potential customer to buy a product or service.
2. What costs are part of the total customer acquisition cost?
Sales and marketing costs, employee salaries, inventory upkeep, cost of production, and technical costs should be included when calculating CAC.
3. How does customer acquisition (CAC) cost differ from customer lifetime value (CLV)?
Customer acquisition cost is the total amount spent to get new customers while customer lifetime value is the total amount of revenue expected from a customer over the period they are a company’s customer.
In conclusion
Customer acquisition cost (CAC) is the average cost of acquiring a new customer. It measures the total amount of money – marketing and sales expenses, salaries, technical costs, production costs, etc., that a business spends to get new customers.
CAC helps monitor sales and marketing performance and spending culture and improves a company’s decision-making process to help it grow and generate revenue.
