In the past, marketing campaigns and sales strategies adopted a shotgun-like approach – spraying tactics all over the place to see what hit. And while plenty of successful companies used this method to build the foundation for highly successful campaigns, it was an extremely “hit or miss” approach. It was also difficult (if not impossible) to accurately measure.
Fast forward to the internet age and most modern companies – regardless of size, industry or niche – have access to tools and systems that allow them to implement highly-targeted campaigns that zero in on very specific customers. Not only that, but they can measure their results to understand precisely what’s happening on the ground floor.
One of the favorite measurements is something called Customer Acquisition Cost, or CAC. And if you want to gain more clarity into the efficacy of your own marketing, advertising, and growth strategies, we’d highly recommend learning more about your own CAC, so that you can optimize it for greater profitability.
Customer acquisition cost is basically a measurement that analyzes the total cost of taking the lead, turning them into a prospect, and ultimately transforming that prospect into a customer. In other words, it’s the total cost of taking someone who has no relationship with your brand and getting them to spend money. It compares the total amount of money spent on attracting customers over a period compared to the number of customers onboarded.
Businesses and investors alike want to see customer acquisition costs be as low as possible. The lower the cost, the higher the profitability – it’s as simple as that.
So how do you calculate CAC?
The basic equation looks like this:
CAC = (total cost of sales + total cost of marketing) / (# of customers acquired)
Here’s an illustration:
CAC = ($10,000 spent) / (100 customers acquired) = $100 per customer
The formula is simple enough to understand. There are only two variables, and the second one (# of customers acquired) is dead-simple to calculate. But in order to get an accurate output, you have to be sure you’re including everything in the total cost of sales and marketing.
Every business model is different, but here are some expenses that typically go into this equation:
Depending on the sales and digital marketing strategies you use, there may be other expenses to add; however, this is a pretty decent place to start.
The biggest key with CAC is to determine what time period you’ll use. It’s helpful to track your CAC over time, so that you can study trends. Most businesses choose monthly, quarterly, or annual periods. If you’re just starting out, we’d recommend monthly or quarterly.
You may find it helpful to look at an example to better understand CAC and why it matters. So let’s use a fictional company, which we’ll call the Acme Coffee Mug Company.
The Acme coffee mug company sells trendy coffee mugs through an ecommerce store. They’ve built a nice little niche for themselves and have seen their volume of sales really take off over the past 18 months.
Over the previous month, the company spent $3,000 on sales and marketing, while generating 1,000 new sales. This means their CAC is $3.
For some companies, a $3 CAC would be amazing. (If it only took Apple $3 to get someone to purchase a $2,000 computer, they’d be elated.) But for the Acme Coffee Mug Company, we need to dig a little deeper to understand what this means for their bottom line.
On average, mugs sell for $10. But that’s at a 100 percent markup. In other words, they’re only making $5 after they account for purchasing the inventory and printing the designs. Then if you take away the $3 CAC, they’re really only bringing in $2 net per mug.
Sure, they’re profitable, but they’re going through a lot of effort to generate $2 in revenue. Before calculating CAC, they probably thought they were doing better than they actually are. But now that they understand the total cost, they can begin looking for opportunities to improve the bottom line.
The first thing the Acme Coffee Mug Company should do is look for ways to increase the average transaction size for customers. See, the CAC remains the same regardless of whether the customer purchases one mug or a dozen mugs. So if they can get people to spend more (either up front or over time), it automatically increases their profitability.
A $3 CAC isn’t great if you’re only making $5 per mug. But it’s pretty darn incredible if you’re generating $60 per customer. This speaks to the importance of (a) lowering customer acquisition cost while (b) increasing customer lifetime value (CLV). Find a way to pull both levers at the same time and amazing things will happen.
Technically speaking, calculating CAC does nothing for you. It’s simply a measurement. The biggest thing is what you do with it. And once you understand CAC, the mission becomes clear: Get it lower.
Sometimes it’s helpful to understand what other businesses within your space are doing. And while we don’t recommend accepting these figures as gospel truth, here are some very basic CAC averages by industry:
This gives you an idea of how variable CAC can be from one business to the next. Perspective is everything – don’t lose sight of what industry you’re in and what the CLV is.
Whether you already have a fairly healthy CAC, or you’re losing money, it’s always wise to consider ways to improve this metric. Here are a few specific ways you can lower your customer acquisition cost and increase profitability:
When you think about it, 99.9 percent of your customer acquisition cost is spent getting a customer to your product/service landing page. At this point, you’re on the one-yard line – you just have to push the nose of the football into the end zone. If you have a high bounce rate on your sales page, it’s absolutely tanking your CAC. The smartest thing you can do is increase sales page conversion rate.
Optimizing a sales page conversion rate is all about measuring the number, observing behavior, and making smart tweaks that reduce friction while increasing perceived value. Here are a few suggestions:
You’ll never regret any investment you make in optimizing your sales page conversion rate. Done well, you can dramatically lower costs by increasing the number of prospects who become customers.
If you’re acquiring a lot of your customers via advertising, you’ll find better ad targeting to be a simple way to lower costs and improve CAC. And in terms of laser-focused targeting, no platform comes close to matching the power of Facebook.
If you’re working with limited data, but want to experiment with better targeting right away, you can try using the Audience Insights feature to refine your approach. Here’s how this method works:
This is just one strategy. There are countless techniques you can use to narrow targeting and find the right audience (which will dramatically lower your advertising costs and bring CAC down).
For many companies, salaries, wages, and employment-related expenses are the beefiest line items on the expense sheet. The leaner you can get in this area, the lower your CAC will be. One solution is to outsource.
Outsourcing offers a number of benefits, but cost savings are the most noteworthy. When you outsource tasks like content creation, graphic design, link building services, PPC ad management, and even conversion rate optimization, you’re able to maintain a leaner team. This brings costs down and, assuming there’s no drop off in customers acquired, dramatically lowers your CAC.
Once you have a loyal base of customers, you can try creating a referral program that rewards existing customers for onboarding new customers. You can provide discounts, coupons, free products, or any combination of perks. This is an inexpensive and effortless way to add new customers.
Don’t underestimate the value of using customer relationship management (CRM) software. Every successful company is using a CRM – don’t try to be the exception. These simple solutions make easy work of tracking customers, automating follow-up, calculating costs, and capturing loyalty. If nothing else, it’ll improve the accuracy of your CAC numbers.
As mentioned above, the CAC is only one metric. It’s also helpful to measure CLV and other marketing ratios to determine your level of success. And when you compare the two, you get something known as the CLV:CAC Ratio.
To understand this ratio, which is basically (CLV) / CAC, let’s use Netflix as an example.
Netflix reportedly has a customer lifetime value of $226.40 per customer and an acquisition cost of $11.32. If you take $226.40 (CLV) and divide it by $11.32 (CAC), you get a ratio of 20:1. In other words, they’re getting a 20X return per customer.
At first, a 20X return may seem impossible for your business – particularly if you aren’t in a subscription-based model – but that’s a shortsighted way of looking at things. There are companies out there who make 200X returns. It’s all about how you optimize your CAC and respect the importance of CLV.
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