What is Customer Acquisition Cost and How do You Calculate it?
Customer acquisition cost is a business metric that has really been gaining a lot of popularity recently. This is the cost that is associated with actually convincing a customer to buy a product or service.
The cost in question is incurred by the organization or business in order to convince the client that they should work with them.
The customer acquisition cost comprises of the product cost and the cost involved in marketing, research, and accessibility.
This metric is very important as it helps a company calculate how important a customer is to it. It also helps it to calculate the resulting ROI of an acquisition.
It is important for a business to know each customer valuation so they know how much of its resources they should spend on a customer so as to be profitable.
These allocated resources are what we refer to as cost per customer acquisition. The customer acquisition is often expressed as a ratio where you divide the sum of customer acquisition cost (CAC) by the number of new customers that have been acquired by a business resulting from their customer acquisition efforts.
Who is Customer Acquisition Cost Metric Important to?
There are two major parties that are very concerned with the customer acquisition cost and these are the investors and companies.
The investors we are talking about are the early investors who are still searching for a good internet technology company to work with.
They usually determine a company’s profitability by looking at the difference between how much money can be extracted from customers and also how much money was used in the extracting process.
Most investors are concerned with the current relationship and not future promises of making an improvement on the metric unless the company can justify this.
A company’s internal operations or marketing specialist is the other interested party when it comes to the customer acquisition cost metric.
The specialists use this metric to maximize the return on the company’s investments. This means that the less the cost of extracting money from customers the greater the profit of the company will be.
In general, the investors want to provide the company with needed resources while partners are more interested in the growth of the company and the company can really use the improved profit margins to actually pass the value to their customers so as to get a greater market position.
How To Come Up With Your Customer Acquisition Cost
CAC is basically calculated by dividing all the cost spent on marketing by the number of customers acquired during the period the money was spent.
For example, if a company spends $500 in a year and they acquired 200 customers in that same year, their customer acquisition cost will be $2.5.
There are some factors in this metric that you should be aware of before going ahead to apply it.
For example, you may get a company that has made some investment in marketing that may not expect to see results until a later time. These may include investments in a new region or early stage SEO.
This is a very rare situation but when it occurs it may cloud the relationship when calculating CAC.
You should perform multiple variations so as to account for these kinds of situations. We will give you examples of how to calculate the CAC in both its simple and pragmatic forms. The first example is a company with a poor metric while the second example is a company with a great metric.
Let us take an example of a fictional e-commerce company that sells baby food products. This company spent $150000 on advertising in the past month and the marketing team claims that 15000 new orders were placed.
This example suggests that the company has a CAC of $10 which is a ridiculous figure.
If this was the CAC for a motor selling company then it would have been a great metric as it would mean that they are spending a lot less than they are earning from their customers.
While the calculation above is quick we have not factored in a couple of things, for example, what if the customers make more than one purchase from this company over their lifetime or if they choose to buy all their baby food from this company and nowhere else.
In this case, you need to calculate your customer lifetime value (CLV). You can get a CLV calculator from the internet which is very easy to use. This will help you know what the CAC means to your company.
In this example, we will consider a company that offers an online financial management system to other companies.
The cost for the distribution of this software is fairly low since it is cloud-based and the target customers require very little support.
This company will be able to retain their customers due to the fact that they had to upload all the information required to the server which takes a bit of time and effort.
The company in our example has been able to work its way up on the search engine results page.
This company also has an expert support team that is working for minimum wage as they are working from their call stations or even homes.
This company has a steady supply of new customers which only requires spending $2 per customer who will give them a lifetime value of maybe $2000. The following is how the calculation will be done.
• The total cost for new customer sales support call centers: $1,000,000/year
• The total cost paid to strategic alliance partners for each customer $1
• Total monthly spend on search engine optimization $20,000/year
• Total number of new customers generated in one year 1,020,000
• The customer acquisition cost will be
• ($1,020,000/total number of new customers) +$1 per customer = $2
In the above example, the company has already calculated its CLV and found it to be $2000. They now know that by making a $2 investment they will have a turnover of $2000.
This will attract both the investors and also show the marketing team that there is an effective system in place which will generate more customers.
Customer Acquisition Cost Per Marketing Channel
It is important to get to know the CAC for each of your marketing channels so as to know which channels require the least CAC and where you need to double down on investment.
The more money you can allocate on your lower CAC channels the more customers you can get for a fixed budget amount.
For you to do this, you need to break down your spreadsheet into the different marketing channels you have. Gather the receipts for your marketing expenses for the year and add them up by channels.
Once you know how much you are spending on each marketing channel you have, you can be able to apply a simple formula and assume that each channel is performing and bringing in the same number of customers.
The only problem with this method is that you won’t easily know which channel is responsible for which customers.
If you are an e-commerce company that sells physical products it will be easier for you to know which pay-per-click ads are performing better than the rest of your marketing strategies.
There are tools such as Landerapp which allow you to trace your paying customers back to their last attribution source.
This will allow you to see the last marketing channel the customer visited before committing to a sale. You will be able to know which marketing efforts are performing well so you can double your efforts in them.
How You Can Improve Your Customer Acquisition Cost
We all want to have companies that have great CAC like the company in our second example.
It’s a fact that we can improve on advertising campaigns and make them more effective. You can also make an effort to improve the customer loyalty so as to reap more value from them.
You can improve your CAC by doing the following:
• Setting up goals on Google Analytics
• Performing A/B tests with new checkout systems so as to reduce the number of cart abandonment
• Improving your website landing page
• Improve the speed of your site
• Make your site mobile optimized
• You can improve your site’s user value by generating something that would be considered pleasing by the users
• You should implement customer relationship management (CRM) system
If you didn’t know what cost per customer acquisition I hope you have now gotten a clear picture of what it is.
It is one of the most important metrics in an online business platform. You should make sure that you calculate the CAC for your company so you are able to know that the investments you have are actually profitable to your business.
This will also guide you on what audience you should target for your products/services. The calculation process is very simple and you can get tools on the internet to help you as well.