Have you ever considered how much your company spends to obtain a single customer? If you’re not calculating customer acquisition cost (CAC) you may be reading the signals all wrong. Even when business seems to be booming, if it’s costing you more to attract that business than what you get in return, you are in an untenable position that doesn’t often end well.
Case in point—many new companies throw every resource they have into customer acquisition without considering the cost or effort involved. But if you want to operate profitably, you need to know what it costs to achieve your goal.
This article will provide detailed steps for calculating CAC. We will also explore strategies to reduce CAC and discuss the importance of reducing customer churn. Implementing these tactics will help you lower customer acquisition costs, achieve a higher return on investment (ROI), and achieve sustainable growth.
So get ready to rip off those blinders as we dive deep into CAC and learn how to use it to your advantage.
What is Customer Acquisition Cost (CAC)?
The Cost of Customer Acquisition (CAC) looks at every cost that goes into gaining a new customer. It accounts for every effort you make to attract new business, the sum total of your marketing, sales, software, salaries, commissions, incentives, and even the overhead on your physical office space.
Ideally, you’ll want to weigh your CAC against customer lifetime value (CLV) to ensure you’re generating customers profitably.
But what does CAC success look like? A low CAC means your sales and marketing efforts are healthy and working in your favor, but there’s definitely a sweet spot. Spend too little and you might be missing opportunities. Spend too much and you’re in the red.
The trick is to find the right balance. Generally speaking, your CLV should be 3x your CAC (or 3:1). However, CAC/CLV ratio benchmarks will vary by industry. More on this later!
How to Calculate CAC
Calculating CAC is simple! First, you’ll need to establish a timeframe to measure (e.g. monthly, quarterly, or annually).
The standard customer acquisition cost formula is:
CAC = Cost of sales & marketing ÷ number of customers acquired
For example, let’s say your company spends $250,000 on sales and $150,000 on marketing in a year. During that period, you acquired 1000 new customers.
(250,000+150,000) ÷ 1000 = 400
It costs you $400 to acquire one new customer.
Simple enough, right? Where it gets sticky is deciding what goes into your sales and marketing numbers. You need these to be accurate, or the numbers will be meaningless. Consider the following expenses:
- Advertising
- Trade shows
- Employee salaries
- Software (marketing automation, chatbots, etc.)
- Creative
- Production costs (video production, third-party vendors, etc.)
- Customer service
- Product demos
- Promotions
Calculating Customer Lifetime Value (CLV)
Customer lifetime value (CLV) is the amount a customer is likely to spend over the course of their relationship with you. Here’s the formula to calculate CLV:
CLV = (ARPA x Gross Margin) ÷ Churn Rate
Here are some important terms you’ll need to understand to calculate CLV:
- Average Revenue Per Account (ARPA): this is the average revenue you collect from each customer during a given period of time.
- Gross Margin: this is the percentage of revenue that remains after accounting for cost of goods sold (COGS).
- Churn Rate: this is the percentage of customers who stop using your product or service within a given period of time.
For example, let’s say you make $100 in revenue from each customer each month. Let’s assume that gross margins are 80%. And, let’s say that 1% of your customers churn each month on average. We can use the following formula to calculation CLV:
CLV = ($100 x 80%) ÷ 5% = $1,600
Why CAC is Important
Calculating CAC is vital to profitability. A low CAC indicates the company is gaining new business without overspending, which is a cozy place to be.
Here are a few reasons why CAC is important:
- Informs marketing spend. CAC can also be measured per channel, giving you an idea of where to focus your marketing dollars.
- Informs pricing. Ideally, you’ll want revenue to cover your costs. CAC gives you a gauge of how your products and services should be priced.
- It gives you something to compare to CLV. Your CAC should be lower than your CLV. Both numbers are essential to understand your company’s financial health.
- Provides a benchmark. Your CAC can be compared to average industry benchmarks to gauge business performance.
CAC can also highlight problems with your sales funnels. Those problems could be anything from flawed messaging to poor audience segmentation, inadequate content, or lack of brand awareness. New companies often have a higher CAC because of the latter; strategies should then be tailored to raise awareness and authority to support future efforts.
How to Reduce Your CAC
Improving CAC to achieve that magic 3:1 ratio can be accomplished with a combination of process optimization, analysis, and prioritizing a customer-focused approach. When you can give your customers what they want the way they want it, they’ll come back. Tighten up your sales and marketing strategy, focus on channels that deliver the most value, and automate processes to the extent you can while still staying in touch with customer preferences.
Here are ten solid strategies you can implement to reduce CAC.
1. Engage customers early.
Provide a positive customer experience from the first interaction, and customers will be more likely to return. Think about your customers and the problems they are trying to solve—and give them a frictionless solution to do just that.
2. Focus on your most profitable sales and marketing channels.
Use data-driven insights to identify your highest-performing sales and marketing channels. Focusing your time and effort on what’s serving you best increases revenue, reduces cost and effort, and will reliably reduce your CAC.
3. Offer a superior user experience.
User experience is everything. From your website to the products and services you sell, customers expect a seamless, frictionless journey from end to end. An outdated website or a clunky, complicated product leads to frustration and may force customers to choose a competitor.
4. A/B Testing.
A/B testing should be an integral component of your marketing efforts. From landing pages to emails to ad copy, not all creative will resonate with your audience. Experimentation and judicious testing is the best way to learn what hits home, drives conversions, and lowers CAC.
5. Customer segmentation.
Most marketing software and modern CRMs enable detailed segmentation, allowing you to target multiple buyer personas at specific stages of engagement with your sales funnel. The more targeted and relevant your message is, the more likely they will engage. To accomplish this, focus on your most profitable customer segments and ideal buyer profiles.
6. Prioritize customer service.
Customer service is often the defining difference between brands. Being responsive, attentive, empathetic, and delivering on your promises builds trust and respect—both essential to long-term loyalty. Chatbots help to answer common queries immediately, while dedicated, well-trained customer support ensures timely response and shows that you respect your customers’ time.
7. Measure constantly.
Analytics deliver detailed insights on various data that matter to your CAC. Page visits, time spent on page, click-throughs, video views, bounce rate, email opens, and ad engagement are just a few of the SEO and marketing metrics you can track. Customer surveys also provide immediate insight into customer sentiment and can be presented while on your site, after they’ve completed a purchase, or following a customer service engagement. These metrics are critical to determine what you’re doing right and what aspects of the customer journey might need attention.
8. Minimize customer churn.
Eventually, people stop buying from you. Your churn rate is the number of customers that drop off over a set timeframe. Consequentially, your CAC and churn rate are intrinsically connected. By reducing your churn rate, you’ll reduce your CAC. To accomplish this, you’ll need to know why churn occurs. The simplest way is to engage with your customers on all channels. Ideally, you should try to do this directly, on the phone. Social media and live chat are also helpful if your customers prefer that. Exit surveys are just taking the lazy way out, and many customers will ignore them, leaving you no wiser about why they left. The fact is, most customers leave because they think you don’t care about them. You’d be surprised what a few minutes on the phone can do for a relationship.
9. Reputation management.
Customers today are discerning about who they do business with. Ethics and public sentiment matter; fortunately, there is plenty you can do to maintain your good name. While reputation management may not often be mentioned in the context of CAC, it’s good business because it ensures your public-facing brand is viewed favorably. Brands with a good reputation are more appealing to new customers and may be the tipping point between you and a competitor. Focus on your reputation, and you’ll build credibility, which leads to trust, customer satisfaction, and loyalty.
10. Automate.
Automation accelerates processes, reduces errors, and maintains consistency across the organization. Sales and marketing automation helps keep your funnel full, nurtures leads, reduces costs, and improves productivity. Your sales team will be able to spend more time on high-value, qualified leads and less on dead-end prospects. Automation ensures leads don’t fall through the cracks while sparing lots of resources. Optimizing time and effort translates to happier employees, happier customers, and, consequentially, lower CAC.
Final Thoughts
Calculating CAC, knowing your CAC/CLV ratio, and monitoring, analyzing, and optimizing your acquisition strategy are excellent ways to ensure customer satisfaction, profitability, and sustainable growth. Make CAC a part of your company’s DNA and you’ll always be on the leading edge.