What is Customer Acquisition Cost (CAC)?
This post offers some useful insights into another vital website metric, the customer acquisition cost (CAC), and how it can impact your bottom line. Here you will learn how to measure CAC, its benefits, and two other related metrics – LTV and Churn Rate – that you must track along with CAC.
Without further ado, let’s start exploring this metric.
This is one of the most crucial metrics to track for companies doing business online! According to KissMetrics, customer acquisition cost is “The One Metric That Can Determine Your Company’s Fate”.
The Cost Acquisition Cost (CAC) metric measures the amount of resources and money that a company spends in obtaining new customers. Tracking this metric has become all the more crucial, especially when the companies started doing business on the internet on a large scale and began marketing their products and services online extensively.
This metric is measured by combining all the costs incurred for sales and marketing efforts for a certain period divided by the number of new customers acquired during that period. CAC includes all the efforts taken by a company to familiarize its products or services to their target audience or prospects. And driving them to the sales funnel to make them active customers.
This YouTube video by York Group covers some useful tips about this metric,
How to measure CAC?
Let’s say, your company has spent $50,000 on sales and marketing in the last 12 months. And 500 new customers were acquired during that period. Then CAC (single customer) is calculated by dividing $50,000 by 500, which is equal to 100. So the cost of acquiring one customer is $100.
CAC = $50,000/500 = $100
There’s also an alternative method to calculate CAC. This is done by factoring in the three variables that make up CAC, which are CPL (Cost per Lead, e.g. costs of marketing campaigns), Touch Cost (salaries for sales team), and conversion rates at every step of the sales process. Although this approach offers a more comprehensive view of this metric and helps you gain a wider understanding of the customer acquisition cost and conversions, it can be a bit complex to get accurate results.
CAC calculation with this alternate method is as follows,
- Touch Cost
- Conversion rate at every step of the sales funnel
Then CAC = (CPL per client + Touch Costs per client) * Conversion Rate
But while measuring the CAC metric, you must consider the following scenarios. For example, if a company has invested in marketing campaigns for promoting something new or in search engine optimization efforts that are in nascent stages, it will require some time to yield results. These scenarios must be factored in while calculating Customer Acquisition Cost else it may give out incorrect figures for this metric.
The sales and marketing cost mainly include the salaries of sales and marketing personnel, paid advertisement, licenses for marketing automation software and CRM, aids, events, content creation, blog and website maintenance, social media promotion and more.
Earlier, a big majority of the companies employed the shotgun advertising approach to reach out to a larger swath of an area and its prospects. But this approach had very fewer means to track consumers. Now most of the firms doing business online have switched to the rifle approach or targeted marketing.
In the rifle approach, the web-based companies run highly targeted advertising campaigns and employ intuitive tools like our FoxMetrics suite of analytics tools to keep track of their prospects and their behaviors. With FoxMetrics, companies can keep track of their customers as soon as they become leads and advance to permanent loyal customers. This approach has made the calculation of CAC much easier for the firms as well as their stakeholders.
What are the major benefits of tracking CAC?
The CAC is a highly crucial metric for both web-based firms and their stakeholders. The companies can leverage this metric to study their growth prospects. And the investors can use this metric to find the profitability of the firms they have invested in. The profitability can be obtained by finding the difference between the money generated from the sales and the cost of acquiring those sales.
This metric is also tremendously useful to the marketing team of a company. Analyzing the CAC metric can help them make the most of their advertising revenue and campaigns. Put differently, the lesser the cost of acquiring customers, the higher will be the profitability of the firm. The profit can then be passed on to the customers to improve their stature in the market.
Why should you know LTV (or Customer Lifetime Value) along with CAC?
If you are unaware of the LTV component, then knowing the cost of acquiring a customer is practically worthless to you. The LTV tells you how well you can monetize a purchaser. The LTV will vary across industries and companies, but usually, if you have an expensive product, the cost of acquiring a customer will be higher. This metric reveals the amount of revenue that you can generate on a recurring basis from a new customer throughout their association with your company.
A customer’s value and the resulting profit of acquiring that customer can only be calculated with the help of CAC. Once the value of a customer is assessed, it becomes easier for a company to determine the amount of resources that can be lucratively invested on that specific customer. Generally, it allows the company to determine a customer’s worth.
According to Mike Volpe, former CMO, HubSpot, “[A] good b2b SaaS [ Software as a Service] companies in a growth stage should have a ratio in the 3-5 range.” It is crucial for a company to offset these two metrics cost-effectively. The goal should be to maintain a profitable ratio between these two instead of aiming for some numbers. As a business owner, you must always strive to decrease your customer acquisition cost while increasing the LTV. Most industry experts recommend a CAC to LTV ratio of 3:1. If it is not, then it’s time to optimize your marketing campaigns, sales and pricing structure.
It is calculated by multiplying the average sale, number of recurring sales and average lifetime of the customer’s partnership.
LTV = Avg. Sale * Number of Recurring Sales * Avg. Partnership Lifespan Of The Customer
An example will make this calculation much clearer. Let’s imagine that you are in the business of selling software services and your average monthly service contract is priced at $5,000. If your average partnership lifespan with a client is around 3 years,
The LTV of a customer = $5000 * 12 months * 3 years = $180,000
Once you have calculated the LTV, then you can use it to assess whether your Customer Acquisition Cost will be feasible against your LTV. Put differently, the LTV will help you analyze if acquiring a customer by spending a particular amount will be profitable enough for your business or not. If it’s not, then you must reassess the customer’s suitability to your business and the pricing structure.
Why is it vital to calculate the ‘Churn Rate’ along with Customer Acquisition Cost (CAC)?
To measure the full impact of CAC, it is important to calculate the churn rate. But what exactly is this churn rate? The Churn Rate can be classified into two: customer churn rate and revenue churn rate.
Customer Churn Rate
The customer churn rate tells you how good (or bad) you are at retaining your customers. In other words, it is the number of customers who severed ties with your company in a specific period. The customer churn rate is computed by doing a simple division.
Customer Churn Rate = Number of lost customers during a period, (e.g. in a month) / Actual number of customers during that period.
So, if you had 60 customers at the beginning of a month and you lost 6 customers by the end of it, your customer churn rate is 10%.
Revenue Churn Rate
The revenue churn rate tells you the amount of recurring revenue lost during a specific period. This is an important metric to measure that decides the stability of your business. It is crucial to measure your ability to retain customers. But in order to accomplish that you must find out your revenue churn rate. The calculation is quite similar to that of the customer churn rate.
Revenue churn rate = Amount of lost recurring revenue during a period/Actual amount of revenue at the start of that period.
For instance, if the total revenue of your company at the beginning of a period (say, a month) was $250,000, and the loss of recurring revenue was $25,000 by the end of that period, your revenue churn rate is 10%.
What are the challenges of measuring CAC?
Calculating and improving your company’s CAC can be demanding on various levels, particularly if you are trying to assign the cost of customer acquisition to particular clients or group of customers. It is more crucial to know how much money you have spent in terms of advertising and marketing for acquiring a particular sale.
In many scenarios, merely totaling up the sales and marketing expenses over a specific period may not give you the accurate cost of customer acquisition (CAC). Most of the time, a company’s sales and marketing budget are not exclusively targeted at acquiring new customers.
CAC Best Practices
To increase the profitability of your business, here are some best practices that you can adopt to calculate, track, and optimize CAC.
- Create different CAC targets for different customer groups. That’s because every customer group is acquired differently and the money spent on every customer group is also different. This will allow you to spend more to acquire more lucrative customers.
- Keep your spending to a bare minimum if your business has just started out. That’s because money only cannot help you create a business model that is repeatable and scalable.
- Take your tactical goals into account while deciding on a target CAC. Are you planning to seize a sizeable market share? Do you want to gain a competitive edge by unveiling a revolutionary product? Or are you intending to weaken your arch rival?
- Determine your funds. How quickly are you exhausting your initial capital? What is the length of your runway? If you have sufficient funds you can spend more on acquiring new customers even as you are starting out.
- The CAC targets and metrics must be kept strictly as an internal matter of your business. Never let this metric risk your reputation even if you have to spend more time and funds on a particular customer.
Wrapping it up
Tracking your customer acquisition cost along with customer lifetime value and churn rate can reveal some vital attributes about your business. It can offer valuable insights into the effectiveness of your pricing model and performance of your sales team. It can help you closely monitor your finances and determine your budget in advance for forthcoming expenses.
Accomplishing these business tasks is extremely hard if you are not using the right analytics tool. But thanks to the FoxMetrics suite of tools now website analytics is easy, efficient and intuitive. With years of hardcore web analytics experience under our belt, there’s no metric tracking scenario that FoxMetrics cannot tackle.
Our widespread analytics experience has enabled us to redesign and refine our tools to perfection and track any business situation that you may have. It is programmed not just to track a metric in multiple angles, but also offers tips to maximize its impact for increasing your bottom line.
You can learn more about FoxMetrics tools here.