Your business may acquire new customers and grow, but what's that growth costing you? How do you measure whether that growth is healthy for your business in the long run?
To get a true picture of your growth, you need to look at your customer acquisition cost (CAC). CAC is a useful metric that helps you analyze whether you’re getting your money's worth in getting new customers.
Understanding customer acquisition cost is important for efficient budget allocation and increased revenue generation. This guide will discuss how to calculate CAC and 6 easy ways to reduce it.
Table of contents
What is customer acquisition cost?
Customer acquisition cost (CAC) is a metric that measures the cost of acquiring new customers for a business. It helps you calculate marketing and sales costs your business incurred on an average to acquire new customers.
Why does CAC matter?
Here's why acquisition cost matters:
• Analyze your most profitable ad channel
If you are using different channels to run ads - social media, Google ads, email marketing ads, etc., it’s important for you to know which ad drives the most customers.
You can calculate the cost for different ads by dividing the money spent on each channel by the number of customers acquired.
For example, let's calculate customer acquisition cost for each channel with this example.
| Channel | Customer acquired | Money spent | CAC (money spent/customer acquired) |
|---|---|---|---|
| Social media ads | 50 | 1000$ | 20$ |
| Email marketing ads | 80 | 800$ | 10$ |
| Paid ads | 100 | 1800$ | 18$ |
It's evident that paid ads are getting you the most customers, costing you twice as much as the other two channels.
In contrast, email ads seem the most efficient use of resources as you are getting 80 customers at the lowest cost among the three channels.
But to get a true picture, you need to compute the customer lifetime value (CLV) to understand the revenue generation potential of each customer. We will be discussing CAC in relation to CLV later in this guide.
Related guide: How to Create Engaging Display Ads to Acquire More Customers
• Identify areas of improvement and optimization
As CAC takes into account both the marketing and sales cost, you can analyze where your budget is getting spent and whether you are getting the expected return or not. It will also help you identify areas of improvement to acquire more customers at a lower cost.
• Help investors understand the profitability
CAC helps investors understand the profitability of the business over time. They use CAC to determine how much revenue your company generates from the given resources.
How to calculate customer acquisition costs?
The formula to calculate customer acquisition cost is:
CAC = (Total marketing cost + Total sales cost) / Number of customers acquired
Let's assume you spent $50000 on marketing and $20000 on sales in Q3 and acquired 700 new customers.
So, the cost of marketing + sales will be 50000$ + 20000$ = 70000$
The number of customers acquired is 700.
Putting these values in the CAC formula, we get → 70000/700 = 100$
Your CAC for that quarter is $100, meaning you spent $100 acquiring a single customer in Q3.
The CAC formula seems pretty simple, but there are additional costs within the marketing and sales category that you need to calculate your business's acquisition costs accurately.
Costs to include while calculating CAC
The costs you incur on your marketing and sales strategy will vary depending upon your industry, product/services, target audience, etc. The most common costs are discussed below:
Ad spends: Total money spent running paid ad campaigns on different marketing channels.
Marketers and sales team salary: Salary paid to employees working in the marketing and sales department.
Technical cost: Cost of all the softwares and technology you use to operate your day to day business activities. For instance, analytics tool price.
Production cost: Cost incurred while producing content.
Publishing cost: Cost involved in publishing and distributing the content.
Inventory upkeep: Cost of maintaining and updating your products or services.
Related guide: How to Create a Successful Customer Acquisition Strategy to Grow Your Business
Factors affecting customer acquisition cost
There are many factors at play that you’ve to consider when calculating CAC:
Business duration: If you are a newly established business in a particular industry, your CAC might be higher. Setting up your marketing tactics to generate brand awareness takes a huge upfront investment and time.
Business diversification: If your business is thinking of venturing out in a new line of product/service, then CAC might be higher due to new stuff to augment the diversification.
Marketing ads channel: Cost of acquiring new customers varies depending on which marketing ads you are using. For instance, email marketing advertising might be less costlier than Google paid ads.
Seasonality: Seasonality refers to holidays and peak seasons such as Christmas, Halloween, etc. Such festivities can significantly impact how you acquire customers. The tactics you use during such a season might vary from the rest of the year.
Role of customer lifetime value in CAC
Now, how do you ascertain whether or not your CAC is good or bad?
One way is to look at the customer lifetime value or the revenue you get from each customer during their time with your business.
Let us understand this with a hypothetical example.
You are running three different paid ad campaigns to acquire new customers. We assume you didn’t incur any additional cost other than the paid ad cost.
| Metrics | Ad 1 | Ad 2 | Ad 3 |
|---|---|---|---|
| Customers acquired | 30 | 20 | 15 |
| Clicks | 5000 | 10000 | 2500 |
| CPC | 6$ | 4$ | 9$ |
| Cost (Clicks X CPC) | 30000$ | 40000$ | 22500$ |
| CAC (cost/customers acquired) | 1000$ | 2000$ | 1500$ |
From this calculation, it's evident that Ad 1 is getting you the best return on your investment compared to other ads. But, this calculation doesn't give you the true picture.
Acquiring more customers at less cost doesn't imply that you'll be able to generate higher revenue. To ascertain that, you need to look at CAC in relation to the customer's lifetime value.
Once you have the CLV, you need to divide it with CAC to get a LTV:CAC. This ratio will help you determine whether the customer you are acquiring will generate more revenue than they cost.
The industry consensus on an ideal LTV:CAC ratio for SaaS businesses seems to be between 3:1 and 4:1. So, you must strive to keep your LTV:CAC ratio within these standards.
Here we have used a hypothetical scenario to calculate LTV:CAC.
| - | Ad 1 | Ad 2 | Ad 3 |
|---|---|---|---|
| Customer acquired | 30 | 20 | 15 |
| CAC | 1000$ | 2000$ | 1500$ |
| Average order value (AOV) | $50 | $100 | $80 |
| Average order frequency | 3 times | 4 times | 2 times |
| Average customer retention in months | 10 month | 20 month | 15 month |
| CLV (AOV X Frequency X Lifetime) | 1500$ | 8000$ | 2400$ |
| LTV:CAC | 1.5:1 | 4:1 | 0.16:1 |
Without considering LTV, Ad 1 seems the right option, but after LTV, it seems Ad 2 is a more efficient investment as the customer acquired will generate more revenue over time. Besides, LTV:CAC falls under the standard ratio of 4:1.
If you can monetize your customers at a higher rate than the cost to acquire them, your marketing and sales efforts are probably going in the right direction.
To know more about customer lifetime value you can read our guide - Understanding Customer Lifetime Value and 7 Proven Ways to Increase it
How to reduce customer acquisition costs?
As a business, your aim should be to acquire more customers with low cost and higher lifetime value and to achieve that goal, here are 6 tactics you can use:
1. Target users with re-engagement emails
Email marketing is the second most used channel by 81% of marketers to acquire customers.
Not every prospect who visits your site will end up converting. So to convert these prospects into customers, you need to engage them using their interaction and behavioral data.
One way to do this is to send re-engagement emails such as cart abandonment emails to target users who added items in their cart but didn't checkout.
To ensure that you get users to take action, you can use AMP emails that allow users to complete the purchase within their cart.
Why does AMP work?
Because AMP email allow users to complete the action without leaving their inbox. Thus, removing the friction in the checkout process.
Check out our interactive cart abandonment email template
2. Create FAQs and help guides
Add FAQs on your website that answer users' most common queries. You can list all the common sales questions that arise during the sales process and answer them as FAQs.
It will help reduce the objections that users have about your product/services and encourage them to take action.
Besides, try including a help section on your site to help users resolve any issue they might face on their own.
3. Tailor website per different customers
Making your website's content personalized is one of the best tactics to create a more humanized experience for users. When you tailor content to individual users, you go a step beyond and talk to them personally - resolve specific pain points and create more relevant content.
As you target different users with more relevant and valuable content, you can acquire more customers likely to last longer, thus increasing LTV and reducing the overall acquiring cost.
4. Try a customer referral program
A customer referral program incentivizes current customers to share your product/services in their social circle. If someone from their referral becomes your customer, they get freebies and other benefits.
Referral programs work as people's word of mouth recommendations work as social proof for a product/service and help build credibility among prospective users. Such referrals give a push to prospective warm leads by resolving their doubts. Hence, in such cases, your CAC virtually equates to zero.
Related guide: Get People Talking About You Using Word of Mouth Marketing
5. Setup live chat options
Live chat allows users to communicate with your team directly if they have any issues navigating your website or using your product/services. Such conversational marketing tactics allow you to engage with the customer throughout their lifecycle stage and help convert leads into customers.
6. Optimize your website for conversions
To attract customers; you need to optimize your website to give users a good experience and convey your value proposition clearly.
You should run a website audit, dig into your marketing analytics tools and analyze your site's performance. Here are some of the vital metrics you should look at:
Does your website load fast on mobile and desktop?
Is your website responsive to different devices?
Is your landing page optimized for conversions?
Where do users drop off the most?
These metrics will offer insights into what is working and where you need to improve. Once you have the data, you can A/B test different variations of your website pages. A/B testing offers you data-driven insights that you can use to identify the optimal versions that generate higher conversions.
To know more about A/B testing, you can read our guide - A Complete Guide to Perform A/B Testing.
Conclusion
As you are playing the long term game, you need to think and plan in such a way that helps you achieve your goals. When analyzed with CLV, customer acquisition costs can unlock actionable insights to maximize your marketing ROI.
With our email journey builder, you can set up email drip campaigns and target leads at the right time to convert them into paying customers and lower your CAC. Sign up on Mailmodo today to send interactive AMP email campaigns and remove friction in your conversion process.
What you should do next
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