Customer acquisition cost is a critical metric because it tells you how much you're truly spending to acquire a customer. After you read this, you should be able to calculate your CAC and then get to the more interesting job of optimizing it.
The simplified CAC formula is:
CAC = total marketing spend / # of new customers
The common CAC formula is too simplistic
The problem with the above formula is that it’s way too simple. In reality, your expense to acquire new customers is more than just a marketing spend. The money spent on marketing resources (full-time, freelancers or your own time) and other overheads such as rent, hosting, tool subscription should also be accounted for. You risk severely underestimating your CAC if you only consider marketing or ad spend as your cost.
To calculate CAC accurately, use the guide below to ensure you're counting everything you need to in your cost.
How do I know if my CAC is good enough?
When you have a more accurate CAC number, the question most people have is “ Is my CAC good or bad?”. Lets assume there are two businesses A and B, A calculates a CAC of $10 and B calculates a CAC of $100. Which one is better?
That was a trick question, the answer is it's impossible to tell. Let's try that question again with one more data point. Business A has a CAC of $10 and their average customer spends $8, B has a CAC of $100 and their average customer spends $350. Hopefully this makes it clear that CAC being good or bad is the wrong question.
That was a contrived example but in reality CACs do vary significantly. For instance, a B2B business can spend up to $264 while a travel company can have a CAC as low as $7 .
Make sure each customer’s total purchase value is higher than what you spend to acquire them
Acquiring paying customers is only half of the equation, you also need to make sure each customer’s total purchase is higher than what you spend to acquire them. This is known as customer lifetime value (LTV) which we'll discuss in a subsequent post.
A more pressing question becomes how does your CAC compare to LTV
Since CAC varies by your business goal and business you’re in, a more pressing question becomes how does your CAC compare to LTV and what you should do if your CAC is too high? If your CAC:LTV is 1:1, you are losing money every time you bring a new customer. Generally a good ratio is 1:3 or higher. When the ratio becomes too high, you might be underspending in marketing.
Calculate your customer LTV to know on average how much your customers are worth and compare it to your CAC. Is your CAC acceptable?
What can you do to reduce CAC?
If you find your CAC to be high, don’t fret. There’s a lot you can do to bring it down. But first, understand the cause of your high CAC. Do this by going back to the CAC formula and break it down. To decrease CAC, you can either lower your overall sales and marketing cost or increase the number of new customers. Tip: it's often easier to control your costs than it is to magically find new customers.
The secret is to segment wherever you can and isolate the quickest way to reduce your CAC with the least impact to your business. Some potential ideas:
- To lower your marketing cost, can you shift your budget to channels that convert better than others?
- Can you invest in marketing automation to reduce human effort?
- To increase number of new customers, can you identify patterns in your customer groups, say by age, where they are from, devices they use, or when they usually buy from you?
For each factor within the CAC formula, slice and dice each factor to understand what are the biggest contributors to your CAC and reduce/increase it as appropriate.
Tips on reducing your CAC
Below are some tips to reduce acquisition cost, the key to success though is relentless testing. Use the diagram to derive some ideas to lower your CAC then use A/B testing to methodically experiment with those ideas and see the results.
Simplify decision making by focusing on the right metrics
There are tons of metrics you can look at when evaluating your paid marketing efforts. The trick is to know which ones actually matter so you know what to to focus on. At DataCue, we want to automate these kinds of analysis so you're no longer looking at endless metrics and getting a head start on fixing issues.