"Get closer than ever to your customers. So close, that you tell them what they need before they realize it themselves" – Steve Jobs.

When Steve Jobs gave this advice, did he mean businesses should spend recklessly to get closer than ever to their customers?

He didn't mean, 'You have to spend money to make money.'

While it's true that businesses occasionally spend money upfront to validate their ideas, the unit economics per customer can be fatal for your business.

That's where customer acquisition cost (CAC) comes in. It's the single most important marketing metric, preventing businesses from spending too much to acquire new customers.

CAC can be confusing, time-consuming, and perhaps a bit scary for any company thinking about using this wonder metric.

But it doesn't have to be.

In this article, we explain what the CAC metric is, how to measure it, and what steps you can take to improve it, along with some nitty-gritty details about CAC itself.

Let's get started!

What is the customer acquisition cost?

Customer acquisition cost measures how much a business incurs to acquire a new customer over a specific period of time. CAC includes the total sales and marketing costs.

Sales and marketing costs include:

• Ad spend
• Creative costs
• Employee salaries
• Technical and publishing cost
• Inventory upkeep
• Production cost

Source

‍

CAC is one of the most critical metrics because it determines your company's profitability. It compares the amount of money you spend on attracting customers to your products or services to the number of customers you gain.

For this reason, judges on the famous television reality show "Shark Tank" are keen on knowing the CAC for every business that comes knocking on their door for funding.

CAC helps measure the return on investment of efforts to grow your customer base. Calculating CAC determines your customer acquisition strategies' overall efficiency and ROI. Most businesses become scalable and profitable only when they learn to lower their CAC.

Importance of CAC

CAC highlights your return on investment, and this metric matters because as your business grows and becomes profitable, you expect a lower CAC. Here are a few reasons measuring CAC is important for every business:

It benefits a company and its investors

As mentioned above, CAC is critical for a  company and its potential investors in the following ways:

• From the company's perspective: The first involved and interested party is a marketing specialist who uses CAC to optimize the return on their advertising investment.

• From the investor's perspective: The second party includes investors like the ones on "Shark Tank," who use CAC to measure a company's profitability. It helps calculate how much investment a company requires to stay afloat. For instance, investing $0.75 million in a SaaS start-up to help them reach the target audience is only justified if it is viable enough to earn more than the invested cost in a specific period.

It optimizes your payback period

The payback period refers to the time required for recouping the funds expended in any investment to reach a break-point. When it comes to CAC, the payback period refers to the time it takes to earn back the money you spend on acquiring new customers.

Knowing your CAC helps you understand how much revenue you must generate from each customer to take the first step toward profitability.

It optimizes decision-making

CAC gives you a shortcut when making critical business decisions, helping you save on your marketing costs. For instance, if you provide a project management (PM) tool to businesses and are testing three advertisements per quarter, each advertisement might receive 1000 clicks and generate 40 new customers.

If a company focuses only on these two aspects, it might run all its advertisements for the next quarter. To gain a deeper understanding of what’s happening in the background, let’s understand the marketing expense and cost per click of every ad:

• CPC of ad one: $10
• CPC of ad two: $14
• CPC of ad three: $6

When ad three generates the same number of clicks and new customers, there’s no need to focus on ads one and two.

‍

Source

Still not convinced why you need to calculate CAC?

Read on!

Calculating and tracking CAC gives an overview of your sales team's success and evaluates your company's scalability. If your sales generate income sufficient only for retaining customers, your company will have no money to acquire new customers – a perfect recipe for your downfall.

Alternatively, if your marketing team is spending more money on prospects than it can convert into leads –you're sitting on the tip of the iceberg, with close to 80% submerged in deep, deep waters.

Tracking this 'God metric' helps companies reduce the cost of extracting money from customers, improving profit margins. You can use an improved profit margin to attract more investors who want lower CAC and higher profit margin numbers.

How to calculate customer acquisition cost

Use these steps to calculate the CAC for your business:

Alt text: How to calculate customer acquisition cost

1. Select the time period for CAC calculation

As CAC measures the amount of money you spend on acquiring new customers in a specific period, defining this 'specific period' helps narrow your search. Companies calculate CAC over one month, quarter, half-yearly or yearly, depending upon their requirements.

2. Determine sales and marketing spend and the total number of customers

Calculate sales and marketing expenses by incorporating ad spending, creative costs, employee salaries, technical and publishing costs, inventory upkeep, and production cost. In addition, determine the number of new customers you acquired during the period you chose in step 1.

3. Calculate the CAC

Next, divide the sales and marketing spending by the new customers acquired during the period. The formula for calculating CAC is:

For instance, a software company spends $30,000 on sales and $50,000 on marketing and generates 400 customers in one quarter.

The CAC of the software company = (30,000 + 50,000) /400 = $200

Tracking CAC -  A notoriously challenging task

The CAC formula sounds simple when you look at it for the first time, involving only simple addition and division.

A pretty basic formula to work with, requiring elementary-level skills. But is it so?

When you start compiling the data, things start to get complicated.

The data you feed into the CAC system is scattered everywhere and lives in disparate systems. 

For instance, the salaries of your marketing team members lie with the human resource department (HR), your enterprise resource planning (ERP) houses the advertising spend, and your customer counts live in your customer relationship management (CRM). 

Phew! There’s more!

To accurately calculate CAC, you need to factor in even your indirect costs, such as the travel cost of sales representatives meeting with customers, software tools used by sales and marketing teams to engage customers, and the hardware tools required for the smooth running of any business. 

While these costs live deep in your ERP, it’s often combined with a myriad of other costs, making it notoriously challenging to know the cost involved in calculating CAC. 

Sadly for businesses, no magic tool aggregates and compiles this data from different places - it’s a people-powered metric.

So, understanding all the costs involved in calculating CAC is imperative for businesses looking to make decisions based on the data a company collects.

Types of cost to include in your CAC

Your sales and marketing spend include the following costs:

Ad spend

Ad spend represents the money you’re spending on your advertisements. Spending money on advertisements reaps desired results such as increased customer engagement, enhanced organic traffic to websites, and increased sales. 

Alternatively, for your marketing ads to work, it’s essential to build an emotional connection with your audience. To test whether you’re channeling your funds in the right direction, evaluate the effectiveness of your ads by calculating the revenue generated by these ads and dividing it by the amount you spend on running them on various digital platforms.

Creative costs

Creative costs represent your spending on creating content for your blogs and social media channels. It includes publishers and agency fees and the cost of hiring new employees to complete operational tasks. 

Employee salaries

When you treat your employees like an investment, they always pay back and help you achieve business goals. That’s why salaries and bonuses paid to your customer-facing team fall in the marketing and sales spending category. 

When you invest in dedicated employees, you strike a gold mine, but it’s getting too expensive, and your CAC increases. Instead of laying off employees, equip your team with the right tools to boost workplace productivity and significantly reduce employee salaries.

Technical and publishing costs

The technical cost represents the software your sales and marketing team uses to acquire customers. For instance, using a CRM to track and monitor the customer lifecycle.

Publishing costs refer to the money you spend on your marketing campaign. For instance, the cost you incur purchasing a spot in a magazine or newspaper for your brand. 

Inventory upkeep

Irrespective of whether you’re a SaaS or a product-based business, you continuously spend money to maintain and optimize your existing products. For businesses dealing with products, inventory upkeep can be storage fees and utility bills. But, for a SaaS business, this cost includes money you spend on updating and releasing software patches for better functionality.

Production cost

Production cost is the cost your business earns by creating content. For instance, for writing content, you require a laptop or desktop; for shooting a product video, you purchase a camera and its accessories. These costs would form a significant part of your sales and marketing spending, especially if you hire vendors to produce your website or blog122 content.

What is CAC per marketing channel?

Knowing the CAC per marketing channel is what most marketers crave. You can double your marketing spending by knowing the channel with the lowest CAC. 

The more marketing budget you allocate for lowering CAC, the more customers you acquire. 

Here is the CAC per marketing channel:

1. Television

Like every other marketing channel, television marketing has unique pros and cons. While it gives your business exposure to reach a wide audience, it’s one of the most expensive marketing channels. 

• Production cost of TV ad: $100,000 to $8 million
• 30-second ad on a local TV: $104,735

These costs might vary depending on when and where your ads run and the types of ads you create.

With less than half of the money you spend on TV advertisements, you can create an effective YouTube ad and post it to your social media channels.

Calculating CAC

For calculating the CAC, you need to determine how many customers you acquire per TV advertisement, which is challenging to compute, making it impossible to quantify your CAC for television ads.

2. Email marketing

Email marketing is one marketing channel that outclasses traditional marketing channels, such as television, radio, and magazines, as it’s less expensive. With email marketing, you don’t require television slots or publishing space in magazines. 

With 72% of customers preferring email communication, this medium allows potential customers to interact with your content without it disrupting their daily routine.

According to research, a mid-size business expects to spend between $10 to $1500 per month if they self-manage their email marketing campaign or pay $300-$500 per month if they use an email marketing agency.

Calculating CAC

You can track the people who convert by tracking the number of clicks on your email advertisements, then divide the total email marketing spending by this number to calculate the CAC.

3. Content marketing

Depending upon the business size, goals, and volume of content produced, businesses spend between $2,500 to $75,000 per month on content marketing.

When you focus on using evergreen content, you even yield results years after publishing. What’s more interesting is that you don’t spend a cent on acquiring customers from evergreen content.

Unlike television and other traditional methods, content marketing has no continuing cost, meaning your acquisition cost per customer keeps decreasing as you acquire more customers. Apart from decreasing CAC, content marketing fuels your marketing strategy by educating customers about products they might want to purchase. 

For instance, if you’re a SaaS business offering project management tools, sharing infographics about how the tool benefits your company helps you educate customers, and they learn more about your brand. 

Calculating CAC

By using various analytical tools, you can understand how customers arrive at your website, helping calculate your CAC. For instance, someone might visit your blog and click on the CTA to complete a transaction.

4. PPC advertising

Pay-per-click or PPC advertising is another low-cost marketing channel that helps you decide which keywords or phrases to use in your digital advertisements. If lady luck is by your side and yours is the highest bid, your ads will appear at the top of the search engine result pages (SERPs) for a particular keyword. 

Medium-sized businesses are likely to spend $10,000 to $500,000 per month on PPC advertising, depending upon their marketing requirements. 

PPC increases revenue because it shows your ads to customers who are searching for products similar to yours. 

Here’s the average cost per click (CPC) of Google Ads by network and industry. Knowing the CPC helps you know how much each click on your Google ads costs. 

Calculating CAC

Using analytics tools, estimate the number of people converted via your PPC ad. Next, divide the amount you spend on PPC advertisements and divide it by this number to calculate the CAC from the PPC advertisement.

‍

Marketing channel

Set up cost

Calculating CAC

Television

$100,000 to $8 million

$104,735 for a 30-second video

No

Email marketing

$10 to $1500 per month for self-managing

$300-$500 per month for using an email marketing agency.

Yes

Content marketing

$2,500 to $75,000 per month

Yes

PPC advertising

$10,000 to $500,000 per month

Yes

SEO

$1500 to $5000 per month

Yes

‍

5. Search engine optimization (SEO)

SEO helps your website rank higher on the SERPs for particular keywords and phrases related to your industry.

With SEO, you bring a steady stream of organic traffic to your website, meaning potential customers still visit your website once you stop paying for PPC advertisements. Investing in SEO is like investing in a strategy that continues to improve over time. 

Businesses spend $1500 to $5000 per month on SEO, but the cost could shoot up if you hire SEO services per project. 

Calculating CAC

To calculate CAC, estimate the monthly SEO cost, including total employee hours and other monetary investments you made for SEO, then divide this value by the number of SEO conversions to get your CAC.

Customer acquisition cost by industry (Benchmarks)

After getting a gist of the CAC per marketing channel, you will have two things clear in your mind:

• Marketing channels you should invest in.
• The strengths and weaknesses of your marketing department. 

Companies compare their CAC with the industry average to know their strengths and weaknesses. If your CAC value is higher than the industry average, consider reducing your CAC by minimizing marketing spending. If you have a lower CAC, you have an advantage in the market because you’re acquiring customers by spending less than your competitors - giving you more freedom on your marketing spending.

The average CAC for various industries is:

Higher education and college have the highest organic and inorganic CAC, irrespective of their customer acquisition strategies. In comparison, e-commerce has the lowest organic and inorganic CAC.

It’s perfectly normal to make comparisons because you have a marketing budget to sign off on before using those funds for marketing and sales activities.

Creating customer lifetime value

A better way to understand your CAC is by pairing it with a lifetime value of customers (LTV) because focusing only on your CAC might cripple your business. And here is why: Not all costs are bad for your business. 

In any growing business, costs are viewed as investments. While some costs are essential for winning customers, some might not make sense. So, how do you decide which cost is a smart investment? That’s where LTV comes in. 

LTV calculates the revenue one customer brings in over their lifetime by continuing to purchase your products or availing of your services.

Interestingly, LTV is challenging for young start-ups or digital businesses because they lack historical data. Still, it’s an essential metric for understanding the cost to a business of various activities. 

What sets this metric apart from others is that LTV helps you understand how well your products resonate with customers, what areas you excel at, and which areas require improvement. It even helps you calculate the return on acquisition costs and understand the long-term outlook of business models.

LTV to CAC comparison

To understand if CAC is worth the investment, compare it with your LTV. 

In short,

• CAC measures the cost of acquiring new customers
• LTV measures the ability to monetize those customers

Striking the right balance between CAC and LTV creates a business model which is scalable and profitable.

When

CAC > LTV =  Poor business model

LVT > CAC = Perfect business model

In order to calculate LTV, you require a few variables:

• Average purchase value: The first step is dividing the total revenue by the number of purchases during a particular time period.

• Average purchase frequency: Divide the total purchases customers made by the unique customers who purchased during that same period to calculate this metric.

• Customer value: Multiply the average purchase value made by customers with the average purchase frequency to get this metric.

• Average customer lifespan: Average the number of customers who purchase from your brand over a fixed number of years to get this metric.

Customer lifetime value (LTV) = Customer value x Average customer lifespan

Put this image into a picture

LTV to CAC ratio

Businesses use LTV to CAC ratio to understand sales, marketing, and customer service spending habits.

LTV to CAC provides a brief overview of how much customers are worth with respect to how much money businesses are spending to acquire them. As mentioned above, striking the right balance between LTV to CAC ensures you get the most from your financial investments.

LTV: CAC

Meaning

Is it a viable business model

3:1

The lifetime value of each customer should be at least 3 times the cost of acquiring them. 

Yes

1:1

Companies earn as much money as they spend money on acquiring new customers. 

No

5:1

Companies don't do enough on their sales and marketing and miss out on potential opportunities to attract leads.

No

Anything below 3:1 indicates spending way more money on acquiring customers than you earn back over the customer's lifetime. It even shows your inability to retain existing customers - another concerning sign for your business. 

Such a low value indicates you need to review the CAC of your prominent marketing channels and consider your growth marketing funnel to understand areas of concern in the fault line.

On the other hand, a higher value means you can spend more aggressively to acquire new customers.

How to improve your CAC

To improve your CAC, you must deliver more value to customers, optimize your PPC campaigns and implement feedback from existing customers, so you’re better equipped to attract high-quality leads to your business. Here are a few strategies to improve your CAC:

1. Deliver more value to customers

Customer value is the perception of what a service or product is worth to a customer versus available alternatives. These perceived benefits or values go beyond the product’s functionality and cost. 

When the benefits you offer are more valuable to customers, they are more likely to purchase your products and services. Typically, perceived benefits include factors like enjoyment and social status. So, ensure your company focuses on increasing the perceived benefits of your products while reducing the perceived cost.

You can provide extra value for money, such as:

• Free repair and fixes during downtime
• New product features
• Discounts on the new version of products and services
• Free shipping
• Hassle-free checkout process

Other ways to deliver more value to customers include:

• Provide customers with more sales autonomy. 70-80% of customers prefer digital self-service and remote human interactions. When businesses focus on remote human interactions, it helps them convert consumers from leads into long-term paying customers.

• Try cross-selling products and services online. When selling online products, focus on cross-selling alongside processes such as sales process mapping. This mapping process visually represents your sales lifecycle stage, giving you a macro view of the entire sales process. This provides a clear and actionable path to move prospects forward in the sales process.

For instance, Sephora uses a separate segment called New Arrivals for cross-selling their products.

Source

2. Analyze critical data to maximize advertisement spending

Monitoring the success of each marketing channel to determine which marketing expense and platform offers the highest ROI.

• Track CAC per marketing channel: Rather than calculating the overall CAC, isolate the cost you spend on individual marketing channels, such as SEO or email. Divide this cost by the number of customers you earn within a particular period

• Calculate LTV to CAC ratio: In an ideal world, the perfect LTV: CAC ratio is 3:1. If it’s either low or high, you need to optimize your marketing spending on channels where they matter the most. You can achieve an ideal LTV: CAC ratio by building new engagement opportunities for customers and providing loyalty bonuses to existing customers.

3. Implement a customer referral program

When customers refer warm leads from their personal and professional networks, their particular CAC is zero if they convert. These so-called “free” customers lower your CAC and build a strong customer referral program in which your customers might be interested. 

Here is an example of T-mobile using referral programs.

Provide some incentives to customers who refer new leads. Incentives give customers a motivation level to refer candidates. 

4. Focus on A/B testing

For 60% of businesses, A/B testing is the best conversion rate optimizer. Typically, a higher conversion rate translates to fewer resources, resulting in a lower CAC.

Focus on A/B testing different parts of your email, landing pages, advertising, call-to-actions (CTAs), website, and product listing. 

When A/B testing, ensure you don’t test everything simultaneously, as it could lead to chaos. Focus on testing one change at a time while keeping other variables constant.

For instance, Groove's landing page saw a conversion of only 2.3%, so the company focused on A/B testing and came up with another version with a conversion rate of 4.7%.

Source

5. Implement customer relationship management (CRM)

Nearly all successful and reputable companies with repeat customers use some form of CRM tool. This tool empowers you to build a stronger relationship with customers and meet their demands. Use CRM to lower your CAC in the following ways:

Analyze repeat customers: Powerful CRM tools uncover key details about your customers, such as when they make a purchase and which products they prefer purchasing.  Customers can be attracted based on their preferences and requirements.

Send surveys: Surveys are an excellent way to collect customer feedback, and CRM automatically sends such surveys using email. Through these surveys, you gather relevant data, helping you learn more about what your audience needs and prefers, improving your CAC.

6. Improve your funnel

A bad sales and marketing funnel eats your investments resulting in higher CAC. When two businesses sell similar products, one with a better sales and marketing funnel will acquire customers for less money. 

For instance, look at the following example, where business A and business B sell similar products:

From the table, it’s clear that business A loses 30% of its customers after the live demo stage and another 57.14% in the final stage. So, they end up paying $600 per 30 customers - a CAC of $20.

In addition, business B loses 15% of its customers after the first stage and another 29.4% in the second stage. So, they end up paying $600 for 60 customers - a CAC of $10.

As business B retains more customers through every funnel, they have a lower CAC.

Getting a grip on your customer acquisition cost

For start-ups and small businesses, every penny counts. Having an in-depth understanding of CAC and LTV means you will invest the right amount of money into your sales and marketing. 

Rather than flushing your hard-earned money down the drain and recklessly spending fundraising money, it’s better to calculate your customer acquisition cost.

When running a business, remember that growth at any cost is the perfect recipe for disaster. Preventing this disaster today is what is going to separate you from competitors.