It’s easy to get caught up in bringing in new customers any way you can, regardless of the time and expense. However, for a company to grow, you need a balance between the cost it takes to acquire a new customer while still making a profit. There’s a name for this: customer acquisition cost or CAC.
Successful companies know the importance of CAC and how to balance that cost with the customer Lifetime Value (LTV). Let’s take a look at how to determine customer acquisition cost, it’s importance, and how to use this insight to grow your business and increase your revenue.
What is Customer Acquisition Cost (CAC)?
Customer acquisition cost refers to the total marketing and sales cost needed to attract a new customer over a specific amount of time. What is included in customer acquisition costs? Accurate CACs should include:
- Creative costs
- Ad spend
- Publishing costs
- Production costs
- Technical costs
- Inventory upkeep
Each of these factors will help you calculate a more accurate and helpful CAC. Additionally, this value can show you whether you need to increase or decrease CAC costs for better sales, marketing, and customer service tactics.
Why is CAC Important?
The goal of any business, whether it be a startup or not, is to make money. If your CAC is too high, your ROI will be low. For startups, this can be particularly dangerous and can lead to a failed business. Additionally, this value allows you to:
- Analyze channels to see which are producing the most value and which could be improved.
- Optimize your payback period so you can earn back money after acquiring a new customer more quickly.
- Track and improve your CAC so you can earn a higher profit.
How to Calculate CAC
Calculating your company’s CAC is done by taking the cost of sales and marketing and dividing that number by the number of new customers acquired. Your final total will be the overall cost of acquiring a new customer. The average customer acquisition cost will vary by industry and can be as little as $7 (travel industry) or as high as $400 (technology/software industry). You can calculate this number by hand or by using a customer acquisition calculator online.
However, there are a few factors you’ll want to include in this basic formula to get a more accurate CAC. These include:
- Determining who qualifies as a new customer. Does a returning customer count as new? What is the time period of someone seeing your company’s touchpoints and them becoming a new customer? Take these time periods into account as it can help you get a more accurate CAC.
- Ensuring you include all expenses in your marketing and sales costs. As previously mentioned, ensure you account for salaries, bonuses, and the cost for new tools.
What is a Good CAC to LTV Ratio?
Another metric to consider when calculating your CAC cost is a customer’s lifetime value (LTV). This term refers to the amount of revenue a customer will bring to your business during their relationship with your company. How is LTV calculated? You’ll need to know a few variables before you can determine your company’s LTV, such as:
- Average order value (AOV)
- Purchase frequency
- Customer lifespan
- Profit margin
With this information, you can then calculate LTV by multiplying customer value by customer lifespan. This number will give you an idea of how much profit you can expect to earn from a customer during their relationship with you.
Your CAC to LTV ratio will show you overall customer worth and how much it costs to retain them. However, it’s important that this ratio be balanced. If it’s too low, like 1:1, you’re spending just as much money attracting customers as you are retaining them. Too high of a ratio, like 5:1, means you’re not spending enough to attract new customers and may need to rethink your strategies. A good CAC to LTV ratio should be 3:1, meaning the value of your customers is three times higher the cost of acquiring them.
Understanding your company’s CAC will show you where you can improve your sales and marketing techniques, how valuable your current customers are, and what the overall health of your business looks like. Maintaining a healthy CAC can be the difference between taking your business to the next level or remaining stagnant. Take the time to calculate this number–you’ll be surprised at the valuable insight you’ll gain.