In order to expand your customer base while still turning a profit, you should focus on customer acquisition cost (CAC). The objective of this post is to give you a quick and comprehensive rundown of how to calculate CAC and which industry benchmarks to use to compare your CAC to.
What does CAC stand for?
The CAC stands for the cost of acquiring a customer. A company's CAC is the total sales and marketing cost required to earn a new customer over a specific time period.
Sales and marketing costs include all program and marketing expenditures, salaries, commissions, bonuses, and overhead associated with attracting and converting leads.
It is important for successful companies to constantly reduce the cost of customer acquisition - not just to recoup revenue, but also to measure the effectiveness of their sales, marketing, and customer service teams.
What is Customer Acquisition Cost (CAC)?
CAC, or customer acquisition cost, is a business metric that determines how much it'll cost your organization to attract new customers.
The CAC is a measure of how much a company spends on sales and marketing to earn a new customer. An important metric to consider when determining profitability is the amount of money spent on attracting customers versus the number of customers gained. CAC can be compared to LTV (lifetime value) in order to determine how profitable you will be in the future once the customers have been around for more time.
Customer Acquisition Cost Use Case Scenarios
Identifying every budget line item that contributes to CAC can be difficult, so we've outlined some scenarios that can help you identify where you incur costs to acquire customers throughout your business.
Customer Acquisition Cost in Marketing
Your blog content will bring in high-quality organic leads 24 hours a day if your inbound marketing program is operating successfully. You won't have to spend as much on paid advertising to generate high and low-quality leads.
Customer Acquisition Cost in Sales
Let's say your sales team is constantly prospecting and nurturing a healthy pipeline. Despite the temptation to increase headcount, you don't need to hire additional reps every quarter to hit your quota. As a result, the existing sales representatives have enough capacity to handle the number of leads in the pipeline and close them.
Customer Acquisition Cost in Customer Success
The customer success team at your company should cultivate relationships with happy customers. Thus, they will help the business generate new customers by writing testimonials and reviews, serving as case studies, and telling their friends and family. Furthermore, if these leads turn into customers, you will have earned them for free, further reducing your customer acquisition cost.
Having a lower CAC means that your business is spending money more efficiently, which will result in higher profits. Calculate your current CAC so you can reduce it.
How to Calculate Customer Acquisition Cost
Step 1: Choose the time period for calculating
In order to calculate your customer acquisition cost, you must first determine the period you're evaluating (month, quarter, year). You will be able to narrow down your data scope this way.
Step 2: Calculate your CAC
Divide your total marketing and sales expenses by the number of new customers you acquired during the period. You should use the result value to estimate the cost of acquiring a new customer for your company.
The formula below can be used to calculate CAC for your business.
CAC Formula
The formula for calculating customer acquisition costs is: Cost of Sales and Marketing divided by Number of New Customers Acquired.
Below is a graphic showing how this formula works.
Suppose your company spends $500K on sales and $300K on marketing. During the last fiscal quarter, your company acquired 800 new customers. In other words, if we were to calculate the CAC for your business, the cost to acquire a new customer for that quarter would be $1K ((500K + 300K)/800 = $1K).
Step 3: Compare your CAC to key business metrics
You can compare CAC with other key business metrics once you have calculated it for your company. You will discover meaningful insights about your marketing, sales, and customer service campaigns this way.
Types of Costs to Include in a CAC Formula
Consider the following expenses if you're not sure what your "cost of sales and marketing" is.
Ad Spend
Ad spend refers to the money you spend on advertisements. New customers can be attracted by advertising for some businesses. Your ads must resonate with your target audience in order to be effective. By dividing the revenue produced by an advertisement by the amount you spent on that advertisement, you can determine whether you're getting a good return on the marketing campaign.
Employee Salaries
Investing in great employees is always a good idea. If you feel this cost is too high, pay close attention to how you approach it. Layoffs and pay cuts are not the only options for reducing salaries. Chatbots and marketing automation, for instance, can enhance your team's workflow and improve your company's productivity.
Creative Costs
Content creation costs are what you spend on creating it. This could be money spent on hiring talent to promote your company or on lunch for your team meeting. Content production involves all of these costs.
Technical Costs
The technical costs relate to the technology that your marketing and sales teams use. You would incur technical costs if you purchased a reporting tool to track the progress of your open deals.
Publishing Costs
Publication costs are what you spend on releasing your marketing campaign. It could be TV airtime, paid social media ads, or a newspaper or magazine ad.
Production Costs
In terms of production costs, these are the costs associated with creating content physically. Video production, for instance, involves buying a camera, creating a set, editing the video, etc. Content production costs add up, especially if you hire a third party.
Inventory Upkeep
Even SaaS businesses must spend money on maintaining and optimizing their products. Utility bills and storage fees at a facility would be included in this cost for businesses that sell physical products. If you sell software, you would spend this money on updates and patches to improve the user experience.
Customer Acquisition Cost Examples
Let’s look at a few examples that illustrate how to calculate CAC.
Example 1: A Software Company
Suppose a CRM software company spends $30,000 on marketing. As a result of the campaign, 2,000 new subscribers signed up for the company's service.
These new customers are expected to add $50,000 to the company's technical and production costs each year.
The CAC for this software company would be:
CAC = ($50,000 + $30,000) ÷ 2,000 = $80,000 ÷ 2,000 = $40
Each new customer costs $40 for the software company.
Example 2: A Consumer Goods Company
To attract 1000 new customers, a consumer goods company spends $5,000 on sales and $1,000 on marketing. As a result, the CAC of the company is calculated as follows:
CAC = ($5,000 + $1,000) ÷ 1,000 = $6,000 ÷ 1,000 = $6
Example 3: A Manufacturing Company
Suppose a manufacturing company selling building materials spends $10,000 on marketing and $5,000 on sales but acquires 200 new customers.
CAC = ($10,000 + $5,000) ÷ 200 = $15,000 ÷ 200 = $75
Example 4: A Real Estate Company
A real estate company that sells duplexes spends $25,000 on marketing and $10,000 on sales. The company acquired 70 new customers after running their ads.
In this case, the CAC would be as follows:
CAC = ($25,000 + $10,000) ÷ 70 = $35,000 ÷ 70 = $500
LTV to CAC Comparison
Customer lifetime value (LTV) is one metric to analyze in relation to customer acquisition cost. Customer lifetime value is the revenue a customer is predicted to generate over the course of their relationship with a company.
There are a few variables you will need to plug into the formula to calculate LTV:
Calculate this number by dividing your company's total revenue over a time period (usually a year) by the number of purchases made during the same time period.
Calculate the average purchase frequency by dividing the number of purchases over a time period by the number of unique customers who made purchases.
Multiply the average purchase value by the average purchase frequency to calculate the customer value. This number can be calculated by averaging out the number of years a customer continues to purchase from your company.
Lastly, multiply the value of the customer by the average lifespan of the customer to determine the LTV. Over the course of a customer's relationship with your company, you can expect an average customer to generate a certain amount of revenue.
As a result, your company's LTV to CAC ratio is a quick indicator of how valuable a customer is compared to how much it costs to gain them.
LTV to CAC Ratio
The LTV to CAC ratio (LTV: CAC) guides businesses' marketing, sales, and customer service spending. This chart illustrates how much a customer is worth compared to how much the business is spending on acquiring them.
It is important for companies to find the right balance for this ratio to ensure they are getting the most out of their financial investments. You should be able to recoup your customer acquisition costs in about one year, and your LTV should be three times your CAC.
When it's close to 1:1, that means you spend just as much money acquiring customers as they spend on your products. You may be missing out on leads if it's higher than 3:1, such as 5:1, which indicates you're not spending enough on sales and marketing.
You may be wondering what a good CAC looks like at this point?Depending on your industry, that may vary.For your team's benefit, the following section of this article breaks down the average customer acquisition costs by industry.
Customer Costs by Industry
Different industries have different customer acquisition costs. These factors include, but are not limited to:
- Length of sales cycle
- Purchase value
- Purchase frequency
- Customer lifespan
- Company maturity
In order to put CAC into perspective, here is a breakdown of average customer acquisition costs by industry, according to First Page Sage:
How to Improve Customer Acquisition Cost
It is possible to improve the LTV:CAC ratio closer to 3:1 by reducing customer acquisition costs. The following are a few strategies to consider:
- - Invest in conversion rate optimization (CRO): Converting visitors into leads or leads into customers and making purchases on your site should be simple and straightforward. Optimize your website for mobile forms and shopping, make sure your website copy is clear, and create a touchless sales process so your visitors can buy from you at any time.
- - Add value: Give customers what they value. Do your best to provide customers with what they're asking for, whether it's a product fix, a new feature, or a complementary offering.
- - Implement a customer referral program: In the event that your customers refer you to an interested warm lead in their network, their CAC will be $0 if they convert. Develop a customer referral program your customers will want to participate in in order to reduce your CAC over time.
- - Streamline your sales cycle: Reduce the length of a typical sales cycle to increase the number of sales you can influence in a year. Connect with more qualified leads more effectively by using a CRM and prospecting tools.
Wrapping Up
Only when you know how much it costs to bring in new customers can you make informed business decisions and predict how profitable your company will be.
Take a moment to find out what your company's customer acquisition costs are, so you can allocate your resources more efficiently.