With the advent of the internet, more and more companies have started pouring money into high-target ad campaigns to better attract and convert prospects into paying customers. Young companies in particular can fall into the trap of trying to gain new customers—at any cost. But the vast majority of people and companies don’t have an unlimited budget to pull from (otherwise I’d be writing this article from Bora Bora).

Instead companies meticulously track their revenue and budget. One way companies track how they’re allocating revenue is via customer acquisition cost (CAC). This tracks whether they’re making more than they’re spending on trying to acquire new customers. So what is CAC and why does it actually matter for your business? We’ll tell you more below.

What is Customer Acquisition Cost

Customer acquisition cost measures the cost of converting a prospect into a customer. CAC is a catchall that accounts for conversion from prospect to paying customer regardless of whether the lead came from the website, blog, paid ad, or sales outreach. The measured cost also includes all revenue spent to attract new customers, such as sales and marketing team wages, ad spend, technical costs, and general overhead. The metric helps demonstrates a company’s profitability as it compares revenue spent attracting new customers to the actual number of customer acquired over a specific period of time.

Why CAC is Important

There’s the saying that gets thrown around the SaaS community all the time that “it costs more to acquire new customers than to keep them”. It gets said because it’s true. CAC has a massive impact on your business.

Keeping CACs low is especially important for new startups that are building their customer base and don’t have the financial backing of three years of established customer revenue to fall back on. Early-stage investors will also use CAC to consider the profitability of a company prior to investing. If the majority of your revenue is spent on gaining new customers, who don’t pay enough to offset the acquisition costs, you’re very quickly going to run out of money to afford keeping the business open.

Understanding how CAC works can allow you to better optimize your sales and marketing strategies. If you can identify which aspects of your outreach are underperforming and which ones are excelling at attracting new customers you can make those processes more effective. As you lower CAC and make your acquisition funnels more efficient, your company’s profit margin improves and the company has a larger revenue to utilize.

How to Calculate CAC

The basic formula for CAC is as follows:
CAC = cost spent on sales and marketing / total number of new customers
Note: cost spent and number of new customers apply to a specific time frame.

Sales and marketing is a broad term to cover acquisition efforts so let’s break down some examples of what could be included in that value. The most obvious value to include is the salaries of everyone on the sales and marketing team. Now the sales and marketing teams both likely use software as part of their daily outreach activities like Salesforce and Hubspot, so add those subscriptions costs in as well. If the marketing team runs a paid ad for six months, that might need to be included too, depending on the timeframe you’re measuring. If the sales team attends a training workshop, you can include that. If the blog is on a specific hosting subscription that get’s added.

Let’s do a quick example though of how you might go about calculating your basic CAC. Say your company spends $50,000 on sales and marketing costs in one quarter and your company acquires 500 new customers in that same quarter. Your cost of acquiring each new customer that quarter would be $50,000 / 500 new users = $100 CAC.

Now here’s where CAC starts getting a bit more complicated: not all expenditures are expected to have an immediate affect on acquisition rates. Timing really is everything.

Many paid marketing campaigns, for example, are intended to increase company exposure in the market with the goal of increasing web traffic over a period of time—it may take a week or month or even a quarter before there’s a return. Similarly, companies have a sales cycle where the sales team puts all their efforts into courting a new customer with the explicit understanding that they have an average lag (maybe a month) on those efforts resulting in a closed deal.

Blogs are another great example of a lagging ROI. You may pay your team or outsource a freelancer to write a blog post for $100 in January. That blog post is intended to live on the internet and help drive web traffic and potential sales for the next two years. So, if you calculate your CAC and there’s not a massive difference between January and the December before, you wouldn’t say the blog was a waste of money. It just hasn’t had the necessary time to gain exposure and traction. Understanding and accounting for the timeline of specific actions to have a ROI helps ensure your team doesn’t scrap a profitable, but long-term campaign.

What’s a Good CAC

Great question—there’s not a clear cut answer.

Different industries have a wide range of average CACs.

  • Travel: $7
  • Retail: $10
  • Consumer Goods: $22
  • Marketing Agency: $141
  • Financial: $175
  • Technology (Hardware): $182
  • Real Estate: $213
  • Banking/Insurance: $303
  • Telecom: $315
  • Technology (Software): $395

There’s also a number of factors that play into the variation between industries: length of sales cycle, value and frequency of purchase, customer lifespan, and maturity of the company.

With all the potential for variation between verticals, there’s a general ratio companies use to understand their own CAC on their overall business: CLV to CAC.

How does LTV Relate to CAC

Customer lifetime value (CLV) is the predicted revenue one customer generates over the course of their relationship with your company. Comparing CLV to CAC measures how long it takes a company to recoup its initial investment required for obtaining a new customer. In order to get the most out of your investments, the accepted ratio of CLV:CAC is 3:1. Your customers should be worth about 3x more than they cost to acquire in the first place.

Source: https://www.forentrepreneurs.com/startup-killer/

If your ratio is 1:1, then your company isn’t actually making a profit because you’re spending just as much acquiring new customers as you are receiving from them. If the ratio is higher than 3:1, then you may be missing out on a key demographic and it may be time to look into spending more to attract new prospects.

Source: https://www.forentrepreneurs.com/startup-killer/

How to Improve CAC

Now that you have an idea about what CAC is, why it’s important, and how to calculate it, let’s talk about making improvements. Where’s the fun adding up all those costs if you don’t know how to go about lowering them after?

Here a few things you can do to get the most out of your CAC.

Add Value

There’s about a million different things you can do to add value throughout the customer journey and that’s the whole point. You can find areas of product friction and work to decrease them, write high quality blog posts and optimize SEO, include fun videos on your website, or even start a podcast. Collect customer feedback to understand their perception of your product’s value and use those reviews and case studies for marketing. The sky is the limit so get creative and have fun. The more exciting and interesting your product appears, the more likely someone is to convert into a paying customer.

Track Sales and Marketing Cycles

Take stock of how long your current sales process is, what stages the average customer goes through, what blockers typically pop up, and then work to decrease the time and friction involved. The faster your sales cycle becomes, the more revenue and the higher number of customers you can close.

Also pay attention to marketing cycles and which campaigns are actually making a return on investment. If you notice a paid ad campaigns isn’t making the expected returns after a few months, it may be time to cut your losses and reallocate that money into an active, more profitable campaign.

Improve Conversions

The more you can engage customers off the bat, whether on your blog, the website, or calls, the more likely they are to convert into a prospect and, ideally, a customer. Use analytics tools to track how people are engaging with your website to see if there are avenues that can be better exploited for growth. You may notice that certain prospect segments are more likely to convert on certain platforms. Use that information to take action and better direct your sales and marketing teams towards good-fit leads. A higher conversion rate means you’re getting more bang for you buck on CACs.

Conclusion

Growth at any cost will only drive your company into the ground. But then again if there’s no growth you’ll end up in the same place too. CAC helps you determine just how effective your efforts spent on sales and marketing campaigns actually are for acquiring new customers. Couple CAC with CLV and you can make a solid determination of the profitability of your company. Although the metric can’t answer every financial question or give you the answer to life’s many problems, it’s a great place to start—especially to keep your company afloat.