How to Determine Your Customer Acquisition Cost
With the growing amount of internet-based businesses and web-focused advertising, customer acquisition cost (CAC) has become a key metric for most companies nowadays.
Only a decade ago, the best strategy to acquire new customers was to invest heavily in various marketing channels such as advertising, social media, inbound marketing, etc. The next step was to identify ways to track consumers and persuade them to become a customer based on their decision-making processes. This not only cost a ton of resources, but it also made it highly complex to calculate customer lifetime value (LTV) and return on investment (ROI).
Today, companies have the option to implement highly targeted marketing campaigns in order to monitor and nurture leads as they develop into paying customers. This allows each business to make a strategic choice based on their target market and industry. Furthermore, it allows them to compute their expenses and measure the income.
The customer acquisition cost calculator
In its simplest form, the customer acquisition cost is the price a business pays to acquire a new customer. As a formula, it would look like this:
CAC = Total sales and marketing expenses ÷ by the number of customers you acquired over a specific time period
For instance, if your company has spent $10,000 to acquire 1,000 customers in the first quarter of 2018, your CAC equals $10.
Keep in mind that CAC should not be confused with similar metrics like cost per action (CPA). In e-commerce, the CPA is the price you pay to “convince” both new and existing customers to make a purchase. CAC concerns only new customers. It also doesn’t include any customer retention costs.
Knowing and understanding your CAC is important for a number of reasons:
1. Measuring customer LTV
2. Testing, identifying, and filtering new and existing acquisition channels to determine the most suitable ones for your business
3. Segmenting customers to craft personalized campaigns based on their acquisition cost and the average income from that segment
4. Determining how much capital your business will need to survive up to the end of the payback period
Types of customer acquisition cost
Depending on the company and industry it operates in, there are a number of different ways to approach CAC. These approaches help analyze the business from multiple angles:
Direct customer acquisition cost
The sum of all costs associated with acquiring customers including marketing and sales expenses, salaries and wages, operating costs and dedicated budget. This approach can be used to analyses different sales strategies.
Indirect customer acquisition cost
Includes all the “undeclared” costs like free trial periods, setup fees, customer support, etc. There are also a number of hidden costs that need to be considered, such as coupons and promotions, publicity costs, events, conferences, etc. This approach is commonly used to compare various business models
Paid customer acquisition cost
A relatively new approach to CAC, which measures the number of customers acquired solely through paid advertising, excluding all other channels. This metric is useful for heavily advertising-focused businesses.
Full customer acquisition cost
The combination of all the above-mentioned approaches combined with all overhead costs. This final metric is the one you will need to compare with customer LTV.
Caveats and hints
It’s important to understand that CAC isn’t, and can never be, a 100% accurate figure. There are a ton of channels that businesses utilize to acquire new customers, and pinpointing which one is responsible for converting a given lead is nearly impossible.
For instance, imagine that a customer you acquired recently read a blog on your website, was referred by a number of friends through social media, received a few promotional emails, saw a bunch of advertisements and then became a subscriber.
There is no way to tell whether the person would have become a customer if some (or even one) of those events didn’t take place. Additionally, there is the issue that the marketing resources you spent on in April may influence customer acquisition in August.
There are three commonly accepted attribution models that help deal with these kinds of scenarios:
Decaying attribution credits all involved channels by assigning more credit to each successive channel. In our example, it could be something like this:
10% blog, 15% referrals, 30% emails, 45% advertising
These figures are experimental. Determining how much credit you want to give each channel is up to you.
Linear attribution divides credits among all channels equally. In our case it would be:
25% blog, 25% social media, 25% emails, 25% advertising
Last touch attribution
Last touch attribution model gives 100% credit to the last channel the customer touched before converting, ignoring the rest.
0% – blog, 0% – social media, 0% – emails, 100% – advertising.
More often than not, businesses choose to recognize the importance of multi-channel acquisition and follow the linear or decaying acquisition models. In some rare instances, last touch attribution can be useful. However, an average business is more likely to acquire a customer if they utilize (and credit) multiple channels.
Marketing is a combined effort. Each marketing channel fuels and supports the next one. Blogs reinforce emails, which reinforce PPC ads. Social media campaigns reinforce word of mouth, which reinforces referrals, etc.
How to calculate customer acquisition cost
Regardless of your attribution model, calculating CAC can seem rather complex, but it’s really not the end of the world. Here is what you need to do:
1. Calculate the cost of each customer acquisition channel
Take the costs associated with each marketing and sales channel, and add them up. Some of those costs will be easy to determine, while others may be more difficult. For instance, paid advertising is your average cost per click or impression. Social media is the time spent on developing strategies, coupons, and promotions, as well as events and PR activities. Emails will include the time you spend crafting them, plus the amount of resources it cost you to create those emails.
Again, don’t focus on achieving a 100% accurate figure – use it whenever you can, and use the average when you can’t.
2. Distribute the costs based on your attribution model
With the costs per channel at your disposal, all you have to do is simply distribute them through your attribution model and calculate the weighted cost. Let’s use the decaying attribution model from the example above:
10% blog, 15% social media, 30% emails, 45% advertising
CAC = blog costs*0.1/4 + social media costs*0.15/4 + email costs*0.3/4 + advertising costs*0.45/4
Depending on which type of CAC you want to calculate, including associated expenses will help you achieve the desired figure.
Understanding the value of CAC for different industries
Depending on your industry, the value of CAC, as well as calculation methods, will vary. In industries where the cost per product or service is low or includes pennies (like mobile apps), you will need to calculate CAC for each customer separately. For SaaS and enterprise software companies, calculating CAC based on customer groups or segments makes more sense.
If you’re targeting large enterprises, the value given by CAC isn’t that high, mainly because, more often than not, you’re dealing with just a handful of custumers. In this case, the sales cycle duration is more important, since the first customer may be difficult to acquire, but it creates a snowball effect – good referrals and reputation make acquiring new ones significantly easier.
On the other hand, for e-commerce businesses and companies selling physical goods, CAC is one of the most important metrics to keep track of, in addition to LTV and retention rate. If your business model also includes selling through distribution partners like wholesalers and retailers, you’ll have to include them into your calculations as a cost type, taking into account inventory risk (you have to purchase any unsold goods), which is how most retailers approach the matter.
Measuring and understanding customer acquisition cost isn’t simply important, it’s a necessity if you’re really serious about streamlining your sales funnel, increasing profit margins and attracting investors. Depending on your business, target audience and industry, use the information above to determine the most suitable way of approaching CAC and aim to calculate it as accurately as possible. The more precisely you can measure your efforts, the more flexibility, growth opportunities and new potential strategies you’ll have at your fingertips.