As the CEO of a company that provides digital services, people often ask me about the most important analytics for their businesses. I always tell them that one number they should always track is customer acquisition cost (CAC). This is crucial for creating an effective marketing plan and measuring your success. Without this data, I have no real idea of how successful my marketing efforts are. I’ve always hated spending my clients hard earned money without giving them a true appreciation of their return on investment (ROI). Many businesses aren’t clear about why CAC is so essential and how they can track it accurately.
Customer Acquisition Cost vs. Customer Lifetime Value
There’s a close relationship between the cost of acquiring customers and the lifetime value (LTV) of customers. When I create long-term goals for a business, I’m looking to do more than simply sell a single product or service. I’m looking to build long-term relationships my with customers. That’s the purpose of creating an email list or newsletter, staying in touch with customers via social media, and traditional outreach such as direct mail or phone calls. The more value I can extract from a customer, the more I can afford to spend to acquire him or her. The same principles apply to my clients business’, the more I understand about your business, the better I can do for you.
One way to measure the health of a business is to look at the ratio of LTV to CAC. It should be roughly 3:1, meaning that the lifetime value of a customer is about 3x what I spend to get him or her. If this ratio is out of whack, it indicates that I’m paying more to acquire customers than they’re worth.
If this ratio is out of whack, it indicates that I’m paying more to acquire customers than they’re worth.
Another crucial metric I always pay attention to is the average lifetime value (ALV) of a customer. This is particularly important for businesses providing SaaS or any type of subscription service. However, it also applies to any business that seeks loyal and returning customers, whether a restaurant, auto dealership or medical practice. I calculate the average amount customers spend and multiply this by the number of months I keep my customers. If your business is newer, you have to work with whatever data you have or use estimates.
Understanding or at least estimating CLV is essential in order to calculate CAC. Once I’ve acquired a customer, it’s much easier and cheaper to sell him or her additional services. This is true even if they haven’t signed up for a subscription. If I contact customers via email, I’m only paying the costs of any services I might use (e.g. MailChimp, Constant Contact). Keep this in mind!
Customer Acquisition Cost vs. Conversion Rates and Cost-per-Action
Conversion rates are closely connected to CAC. I use tools such as Google Analytics to calculate conversion rates for website or ad campaigns. Social media advertising platforms on sites such as Facebook and Twitter also provide tools that let you measure conversion rates for your ads. Cost Per Action (CPA), a term widely used in e-commerce, refers to the cost of converting a customer for a specific campaign. CPA is important for calculating conversion rate when running ad campaigns.
While conversions and CPA are crucial for measuring campaigns when calculating CAC, I also consider costs and expenses beyond advertising, which may include shipping costs, paying employees (or, if you outsource, agencies or freelancers), overhead, equipment, utilities, and any other costs associated with running your business. Other factors I consider are refunds and cancellations. If I ignore any of these expenses, I’ll underestimate CAC.
Guidelines to Better Understand Customer Acquisition Cost
Many businesses calculate CAC by dividing the amount of money they spend on marketing and advertising by the number of customers they acquire through these methods. This is a good beginning but it’s overly simplistic. Here are some factors I consider when calculating CAC.
- There’s no “ideal” CAC. Suppose my business had a marketing budget of $10,000 last year and I acquired 500 new customers that year. This makes my CAC $20. Is this good or bad? There’s no way to tell without considering a whole host of factors such as my production costs, how much I charge for products, and whether my business model is based on recurring fees (e.g. Netflix, SaaS) or mostly on one-off purchases.
- If I’m marketing on a variety of channels, a single CAC number will be of limited value. For example, if I use PPC ads, Facebook ads, SEO, and offline tactics such as direct mail, I really need to calculate my CAC for each channel. Otherwise, I won’t be aware if one channel is providing greater CAC than another.
- Be aware of attribution. This is the matter of identifying where customers come from, which is often more complex than it appears. For example, if I make a sale from an ad, the customer may have already seen other ads, gotten a recommendation from a friend, or read some of my organic content before actually deciding to buy. There are various attribution models that help you address this issue. one of the simplest is last interaction model, which simply focuses on the last touchpoint the customer used before buying something from you. Google Analytics provides some helpful information on attribution models. The point is to realize that acquiring customers isn’t as simple as it first appears.
- While my overall goal is to lower CAC, I also pay attention to other goals such as building brand awareness and human behaviour. Newer businesses, in particular, often need to invest in marketing and brand building strategies that aren’t immediately profitable. In this case, trying to lower CAC may be counterproductive.
“Make your product easier to buy than your competition, or you will find your customers buying from them, not you”. – Mark Cuban
Why Measuring Customer Acquisition Cost is So Important
Theoretically, if I had enough money to invest, I could get as many customers as I wanted. For example, if I was selling a weight loss supplement, I could log in to Google AdWords and outbid all of my competitors for keywords such as “lose weight,” “best weight loss product” and so forth. In practice, however, I’d probably end up losing lots of money on such a campaign. Why? Because these are extremely competitive -i.e. expensive- keywords. Having my ads appear at the top of the search results might bring me lots of customers but the cost of acquiring these customers would be prohibitively high. So I’d search for less competitive keywords and track the profitability of my campaigns.
“Of course, tracking ads is only one aspect of CAC”
Of course, tracking ads is only one aspect of CAC. Most businesses don’t just sell products. They set up entire sales funnels or lead generation machines. To use an example in a different industry, consider a college or university trying to get students to sign up for a graduate program. Hardly anyone is going to read a single ad and fork over hundreds or thousands of dollars to sign up. There’s a drawn-out process that usually involves phone calls, online information sessions, and numerous emails. The institution needs to know exactly how much it costs to acquire each new student and plan its marketing accordingly. The same is true for every business.
Understanding CAC, for reasons I’ve covered, is not a simple or precise formula. However, it’s still a crucial aspect of running a successful business so it’s important to identify it as accurately as possible.
If you need help better understanding how your digital spend ties into CAC, LTV, give me a shout or contact us.