What is Customer Acquisition Costs (CAC) and How to Calculate It
When starting a company, entrepreneurs strive to get as many customers as they can, regardless of the cost incurred in this venture.
However, if you plan to run a successful company in the long haul, you need to pay attention to the total costs of sales and marketing strategies or efforts needed to acquire a customer.
Getting customers will no doubt help the growth of your company but you also have to factor in the cost, time, and energy expended on securing them. You need to balance customer acquisition costs with customer lifetime value.
If you are too cautious about your Customer Acquisition Cost (CAC), you will miss out on attracting lots of customers which is good for your profit margins. However, if you are too carefree about your Customer Acquisition Cost (CAC), you will get a lot of customers but struggle to make a profit.
In this article, you will learn the meaning of Customer Acquisition Cost (CAC), why businesses need to track CAC, understanding CAC breakdowns, how to calculate CACs with examples, how you can reduce customer acquisition costs, and how to balance Customer Lifetime Value (CLV) with Customer Acquisition Cost (CAC).
Let’s get started.
What is Customer Acquisition Cost (CAC)?
Customer acquisition cost (CAC) refers to the total marketing and sales cost a company spends to earn new customers over a period.
The total marketing and sales costs include salaries, bonuses, commissions, programs, and marketing spend such as adverts, and overhead costs associated with attracting leads and turning them into customers.
CAC is a metric that has been gaining increased prominence in the business world with the emergence of web-based advertising campaigns and internet businesses.
Traditionally, companies struggled to accurately track customers' inflow. Today, companies can run highly targeted campaigns and track customers accurately as they move from interested leads to repeat consumers,
The Customer Acquisition Cost (CAC) is a metric used by both businesses and investors. It measures the cost of attracting and convincing a potential customer to purchase a product or service. Businesses use this metric to determine the profitability of their marketing campaigns and overall business.
CAC compares the amount of money a company spends attracting customers against the number and volume of sales it actually gained.
Reducing your Customer Acquisition Cost (CAC) means that your business is spending money efficiently and on course to see a high return on investments.
Why Businesses Need to Track CAC
CAC is a key performance indicator (KPI) that many business managers and investors use to determine the profitability of a business. Businesses need to track CAC to improve their return on investment, improve their profitability and profit margins, and measure the success of marketing and sales campaigns.
1. To Improve Return on Investment
Understanding and tracking the cost of acquiring new customers is essential for analyzing the return on investment from the company’s sales and marketing efforts.
Today, customers use multiple channels to acquire customers. By tracking their CAC for each channel, a company can determine which channel is the most cost-effective way to acquire new customers.
The company can then decide to use the most cost-effective channel for acquiring customers more and devote more resources to it which can help boost the company’s return on investment.
Also, channels that are not getting any return on investment or leading to losses can either be scrapped or have their marketing strategy reviewed for better results.
2. To Improve Profitability and Profit Margin
Customer Acquisitions Cost (CAC) helps businesses to fully analyze the value per customer and use this information to improve their profit margins. A business needs to understand its customer lifetime value (CLV) to determine how much it can spend on customer acquisition costs.
Understanding and tracking CAC can help you identify what the CAC is for each marketing and sales channel you use, and prioritize those channels where the CAC is lower than the value per customer.
CAC helps improve profitability and profit margin for businesses by revealing the cost of customer acquisitions. Businesses can use the information to improve the profitability of their sales funnels by prioritizing channels with higher profit margins.
SaaS businesses must track their cost of acquiring customers regularly because of their unique circumstances. Since they have a low cost of goods sold (COGS), they set a low entry fee with the expectation of earning a profit over a period as customers keep paying subscription fees.
The cost of developing the software for SaaS businesses is more expensive than what it charges customers initially. For SaaS businesses to make a profit, it has to attract new and repeat customers, while ensuring it does not have a high CAC.
3. To Measure the Success of Marketing and Sales Campaigns
Both businesses and investors use Customer Acquisition Costs (CAC) to measure the success of marketing and sales campaigns. Both customer acquisition costs (CAC) and customer lifetime value (CLV) go hand in hand. A company should try to get its CLV to be 2 to 5 times its CAC.
Understanding CAC Breakdowns
CAC Per Marketing Channel
Most marketers, investors, business owners, and managers want to know the customer acquisition costs for every marketing channel you use to acquire customers.
Knowing the marketing channels where your business has its lowest CAC helps you know where to increase your marketing spend for more profit. Also, knowing the marketing channels where your business has its highest CAC helps you know what channels are ineffective and require adjustments or outright scrapping.
Businesses should allocate more of their marketing budget to lower CAC channels. The advantage for businesses is that they can obtain more customers for a fixed budget amount.
CAC per marketing channel means calculating how much money you spend on your various marketing channels to attain customers. Some common marketing channels employed by businesses include blogging, Google Adwords. Facebook Ads, Instagram Ads, YouTube Ads, and more.
Calculating your CAC per marketing channel is simple. First, you have to identify the marketing channels and then gather all your marketing receipts in that channel to find out the sum you spent on a particular marketing channel.
Now that you know what you spend on each channel, you can assume each channel worked to draw the same amount of customers and use a simple averaging method to calculate your CAC per marketing channel. However, it is difficult for the non-internet business to figure out which channel is responsible for which customers if the business uses multiple channels at once.
Online stores can easily know what marketing efforts lead to direct sales because of the conversion tracking feature that tracks results from each marketing channel.
eCommerce platforms like Shopify, BigCommerce, and other Shopify alternatives offer tracking tools like customer analytics that trace paying customers to their attribution source. For example, if a customer comes from an organic search result from Google, you know SEO is responsible for that acquisition.
When it comes to CAC per marketing channel, you need to note that each marketing channel supports the next channel. For example, your blog reinforces your Pay-Per-Click ads to bring in customers. This interconnectedness of marketing channels is more common in outdoor advertisements. For example, billboard ads reinforce TV campaigns which in return reinforce radio spots.
CAC by Industry
CAC varies from one industry to another. Cost Acquisition Cost (CAC) by industry measures the amount it costs to acquire a customer across different industries. According to Propeller, here are the estimated CAC costs per industry.
- Banking/Insurance: $303
- Consumer Goods: $22
- Financial: $175
- Manufacturing: $83
- Marketing Agency: $141
- Real Estate: $213
- Retail: $10
- Transportation: $98
- Travel: $7
- Technology (Hardware): $182
If your business belongs to another of these industries and your CAC is close to the estimated figures, it is an indication that your business is doing well.
CAC by Marketing Campaign
CAC by marketing campaign refers to the cost of acquiring customers for every marketing campaign your business embarks on. Knowing the marketing campaigns where your business has its lowest CAC helps you know where to increase your marketing spend for more profit.
CAC by Product or Product Category
CAC by product or product category refers to the classification of the cost of customer acquisitions for every product or product category in your business catalog. Some products or product categories require low CAC to attract customers while other products or product categories have a high CAC.
Knowing the CAC by product or product category helps you identify the product or product category where your CAC is profitable and where it is not so profitable.
CAC by Region
Companies spread across states, cities, or countries calculate their customer acquisition cost by region to know what places they are effectively utilizing their CAC and where they are not generating any results. In regions where the customer acquisition costs are low compared to the profit derived from the customer, the company can decide to increase its marketing spend on such regions.
CAC by Season
For seasonal products or services that attract more patronage in one season than the others, CAC by season is an important metric for such businesses. For example, a children’s toy company will usually see its customer acquisition costs at their lowest during the festive season compared to any other time of the year.
Beach wears and bikini clothing lines will also experience a lower CAC during the summer seasons than during any other season.
How to Calculate Customer Acquisition Cost (with Examples)
The formula for calculating customer acquisition cost is the total cost of sales and marketing divided by the total number of new customers acquired.
Customer Acquisition Cost = Total Cost of Sales and Marketing / Total Number of New Customers Acquired
The cost of sales and marketing includes ad spend, employee salaries, creative costs (money you spend on creating content), technical costs (technology that your marketing and sales team use), publishing costs, production costs, and inventory management.
To calculate customer acquisition costs, there are three steps involved.
- Determine and add the total marketing sales expenses for the period you are evaluating. It can be monthly, quarterly, or yearly. The importance of this step is to narrow down the scope of your data.
- Find out the total number of new customers you acquired.
- Divide the total marketing and sales expenses by the number of new customers acquired in that period. The result you get is your company’s estimated customer acquisition costs.
Let’s assume a fertilizer company spends $500,000 on sales and $300,000 on marketing in the first quarter of 2021. During that period, the company generated 8,000 new customers. What is its customer acquisition cost (CAC)?
Customer Acquisition Cost = Total Cost of Sales and Marketing / Total Number of New Customers Acquired
First, we have to find out the total cost of sales and marketing which is $500,000 plus $300,000, giving us $800,000.
Customer Acquisition Cost = $800,000 / $8,000
Customer Acquisition Cost = $100
After finding the customer acquisition cost for your company, you can compare it with other key business metrics to uncover more detailed insights about your sales, marketing, and customer service campaigns.
An e-commerce company that sells sunglasses spent $100,000 on advertising last month and got 20,000 orders from 10,000 new customers. What are its customer acquisition costs (CAC)?
Customer Acquisition Cost = Total Cost of Sales and Marketing / Total Number of New Customers Acquired
Customer Acquisition Cost = $100,000 / 10,000
Customer Acquisition Cost = $10
The e-commerce company has a CAC of $10.
An eCommerce business sells kitchen appliances and wants to calculate its customer acquisition costs for the last quarter of 2020. Since it is a B2C (business-to-customer) brand, it uses online sales and marketing channels to acquire customers, spending its sales and marketing budgets on email marketing, Google Ads,
Here is a breakdown of its marketing and sales costs.
- Website hosting and maintenance – $1,000
- Email marketing – $3,000
- Google Ads – $1,000
- Facebook and Instagram Ads – $10,000
- Paid influencers in the food and cooking niche – $5,000
- salary for employees handling marketing campaigns – $15,000
- Marketing employee’s expenses for home office – $1,000
- Guest posts – $1,000
- Photographer, videographer, and studio rental fee for high-quality images and videos for web and advertising purposes – $5,000
The total marketing and sales cost is $42,000. Over the quarter, the eCommerce business acquired 1,000 customers. What is the customer acquisition cost for an eCommerce business?
Customer Acquisition Cost = $42,000 / 1,000
Customer Acquisition Cost = $42
Whether the cost of customer acquisition is high or low depends on how much revenue each customer brings to the company. It is the reason why CAC is also discussed together with the customer lifetime value (CLV).
How Can I Reduce Customer Acquisition Costs
Reducing customer acquisition costs to as low as possible should be a priority of every business. Marketing and sales campaigns can be more effective, customer acquisition costs can always be reduced and improved, and businesses can get more value from customers.
There are several ways businesses can reduce their customer acquisition costs, they include improving on-site conversion metrics, reducing the number of touches required to complete a sale, and implementing customer relationship management (CRM).
1. Improve On-site Conversion Metrics
Businesses can improve their conversion rates with A/B split testing. You can use A/B split testing to test any aspect of your website such as new checkout systems to reduce shopping cart abandonment rates. It allows you to test and improve your landing pages, mobile optimization, site speed, and other factors that boost the performance of your website.
When you invest in conversion rate optimization (CRO), you make it easy for visitors to convert into leads, and then from leads into customers.
Conducting A/B testing helps you to know which landing pages lead to the best conversion rates so you do not waste money on ineffective landing pages and increase your customer acquisition costs.
2. Reduce the Level of Touch Required to Complete a Sale
Having too many steps through which customers need to pass to complete a sale will increase your customer acquisition costs.
Too many touches are potential blocks that can give customers excuses not to complete the sale. It is ideal to reduce it to the barest minimum so that it can convert more prospects easily into paying customers.
Although not all products are equal (some can easily be understood while others may need more level of touch to be understood), there are also ways to minimize costs for both you and the customers.
Here are some ways you can use to reduce the level of touch required to complete a sale.
- Create a demo video that answers all their likely sales questions convincingly.
- Tackle all the common sales objections in your copy or on your website.
- Use customer references to avoid the need for a trial.
If your customers are likely to compare your product or service to your competitors, do this for them by creating a comparison matrix section on your site.
Reducing your customer acquisition costs is greatly helped by minimizing the touch required to close the sale.
3. Implement Customer Relationship Management (CRM)
In today’s world, nearly all successful companies implement some form of customer relationship management (CRM). All businesses should have a CRM tool or software that helps them track the influx of leads at a specific period.
You can reduce your customer acquisition costs by using the best CRM tool that gives you accurate and real-time insights into your customers. The best CRM tool should give you all the effective user insights you need such as email lists, limited-time offers and deals, loyalty programs, blogs, and other techniques that capture loyalty.
The data you get from your CRM software should be used to improve your conversion rates. Anything you do to improve your conversion rate will help reduce your customer acquisition costs.
On Balancing CLV with CAC
Customer acquisition cost (CAC) is used in conjunction with the customer's lifetime value (CLV) to measure the true cost of customers to businesses.
CLV refers to the predicted revenue that a customer will generate for a company over the entire period that the customer remains loyal to the company.
To calculate CLV, you will need to know a few variables that fit into the formula.
- Average Purchase Value: You can calculate this value by dividing the company’s total revenue generated over a period (usually a year) by the total number of purchases recorded over the same period.
- Average Purchase Frequency: You can calculate this number by dividing the total number of purchases recorded over a period by the total number of unique customers who made purchases during the same period.
- Customer Value: You can calculate this number by multiplying the average purchase value by the average purchase frequency.
- Average Customer Lifespan: You can calculate this number by averaging out the number of years a customer makes purchases from a company.
The formula for calculating the customer lifetime value (CLV) is:
Customer Lifetime Value (CLV) = Customer Value x Average Customer Lifespan
Balancing your company’s CLV with its CAC refers to finding out a customer's value relative to the cost of acquisition. Businesses use the CLV to CAC ratio to guide their budget spend for sales, marketing, and customer service.
CLV to CAC ratio shows a brief overview of how much customers are worth to the company compared to the cost that the company is spending to acquire such customers.
Companies should ensure that they find the right balance for this CLV to CAC ratio to ensure that they are always getting the maximum potential from their financial investments. Ideally, companies should recoup the cost of customer acquisition in roughly a year window from acquiring the customer.
The best CLV to CAC ratio is 3:1, in other words, the lifetime value of your customers should be thrice the cost of acquisition.
A CLV to CAC ratio close to 1:1 or at 1:1 means you are recouping your customer acquisition costs (CAC) but not making any profit. In other ways, you are spending as much money on acquiring customers as they are spending on your products.
If your CLV to CAC ratio is higher than 3:1, it means you are underfunding your sales and marketing efforts. Even though you are getting more value or money from customers than you are spending on them, you are missing out on lots of opportunities to attract new leads, earn more, and grow your company.
Customer Acquisition Costs FAQ
All expenses used to acquire new customers from advertising, wages associated with marketing and sales, inventory management, and other sales and marketing tactics are parts of customer acquisition costs.
CAC is calculated by simply dividing all the costs spent on acquiring more customers by the number of customers acquired in the period the money was spent.
The formula for calculating CAC is:
CAC = MCC ÷ CA
Here, MCC is the total marketing campaign costs related to the acquisition and CA is the total customers acquired.
LTV, short for “lifetime value” measures the long-term revenue per customer. The LTV/CAC ratio compares the value of a customer over their lifetime, compared to the cost of acquiring them. A ratio of 1:1 or one with a higher CAC value means you are losing money on customer acquisition.
A good benchmark for LTV to CAC ratio is 3:1. Generally, 4:1 indicates a great business model while a ratio of 5:1 or higher means you are likely under-investing in marketing, and your business could become even more profitable by acquiring more customers.
CAC’s payback period is the amount of time it takes to earn back the money used in acquiring customers. Think of each customer you pay to acquire as an initial investment, and like all investments, there should be a break-even point.
The break-even point is often referred to as Time to Recover CAC or Months to Recover CAC. Your payback period determines the efficiency of your acquisition model.
To calculate the CAC payback period, divide a customer’s CAC by the total revenue they contribute in one year. The result is then converted to annual figures i.e 1.5 = 18 months or a year and a half. For small businesses, it is important to have a payback period of less than one year.