What is customer acquisition cost (CAC) and How to calculate it
Every customer you attract costs money, and getting the balance right between how much you pay to attract a customer, and how much that customer is worth to your business is one of the most important ones to get right. In this guide, we look at CAC (Customer Acquisition Cost) and how you can calculate and optimize yours.
Everything has a cost.
To run your business, you’re paying for:
- Capital equipment
And you need to make sure you generate enough revenue from your customers to cover these costs.
But attracting new customers comes with its own set of costs:
And plenty more besides!
This is called customer acquisition cost (CAC), and your goal should be to keep it as low as possible to earn the maximum amount of revenue for the lowest expense.
In this article, we’ll show you why CAC is so important for every business to understand, how to calculate it, and strategies to improve it.
But first, let’s give a detailed definition of CAC.
What is customer acquisition cost (CAC)?
Customer acquisition cost (CAC) is the total number of expenses it costs to gain a new customer. It can also be used to calculate the cost of generating new leads and subscribers.
The lower the cost, the cheaper it is to acquire new customers, and the higher the opportunity for more revenue and profit for your business.
You have to engage in many activities to acquire new customers:
- Content marketing
- Targeted advertising
- SEO on your website
- Social media marketing
- Customer success strategies
- Running promotions and giveaways
- Tracking the buyer’s journey
- Hosting events
- Testing landing pages
And the list goes on and on and on.
The CAC metric is crucial for companies to understand in order to optimize their investments in everything listed above. Tracking CAC can also reveal how effective your tactics or strategies are.
If you’re spending a lot of money on Google PPC ads but you’re not converting new customers, then perhaps you should spend more time on your social media and content marketing strategy, or put more effort into SEO.
Reducing the cost to acquire customers helps your company grow and increase its profit margins.
But CAC doesn’t exist in a vacuum on its own…
It’s directly related to the lifetime value of your customers.
How CAC is tied to another important metric: Customer lifetime value (CLV)
Customer lifetime value is a calculation of how much total revenue you can reasonably expect to gain from a single customer. It’s a combination of a customer’s revenue value and their anticipated lifespan as an active customer.
One of the benefits of calculating CLV is being able to identify the most significant customer segments in your audience who are the most valuable to your company. In terms of the Pareto Principle, it helps you see the 20% of high-value customers responsible for 80% of revenue.
The longer a customer continues to purchase your products and services, the greater their lifetime value becomes.
CLV really only makes sense when you factor in CAC.
For example, if the CLV of your average customer is only $500 and it costs close to $1,000 to acquire them (advertising, marketing, special offers, labor), then could severely be losing money if you’re not able to pare back your acquisition costs and/or increase CLV through other products and services.
Another factor to keep in mind is the cost to serve.
The cost to serve represents all the expenses needed to get the product or service delivered to the customer. It’s what we mentioned in the introduction to this article:
- Paying employees
- Buying and maintaining capital equipment
- Stocking inventory
These and so many other expenses are the costs of operating your business.
Understanding CAC, CLV, and the cost to serve together gives you a full picture of what’s driving customer spend how much it delivers to your business’s bottom line.
But for the scope of this post, let’s continue diving deeper into CAC.
Why is CAC so important for your business?
Customer acquisition cost can reflect the future success of your business in terms of your return on every investment and will matter more and more as your business grows and becomes profitable.
Here are 3 reasons why CAC is so important to calculate (and reduce):
Optimizes your CLV
As we pointed out in the last section, your CAC informs your CLV and vice versa.
The more you reduce your CAC, the higher your potential CLV becomes.
And the higher you increase your CLV, the more it offsets your CAC.
When you first start tracking CAC as a business metric, create a benchmark of where you’re at currently. Then, on a quarterly basis, reevaluate your CAC and find ways to improve it. By doing so, you’ll automatically be improving your CLV.
Optimizes your payback period
Payback period in capital budgeting refers to the time required to recoup the funds expended in an investment or to reach the break-even point.
In the case of CAC and your business, this is the period of time it takes to make back the money spent on acquiring a customer. Recouping lost funds should be your top priority when gaining a new customer.
Knowing exactly what your CAC is will tell you precisely how much revenue you need to generate from each customer to break even and move towards profitability.
CAC can give you a shortcut to making sound decisions in your business.
Let’s assume you operate a SaaS business and are testing 3 different ads this quarter. Each ad receives 100 clicks and generates 10 new customers.
If that’s the only metric you measure with your ads, then you might as well keep running all of them next quarter.
But let’s dig a little deeper…
And look at the cost per clicks (CPC) for each ad.
Ad 1 has a CPC of $5.
Ad 2 has a CPC of $8.
And Ad 3 has a CPC of $10.
If Ad 1 was able to generate the same number of customers as Ad 2 and 3 at a substantially reduced cost, then it would be financially prudent to discontinue Ad 2 and 3 and focus on improving the results you get from Ad 1.
How do you calculate CAC?
The most basic calculation for CAC is dividing all the costs spent on acquiring new customers by the number of customers acquired in the same period as the money was spent.
For example, if you spend $1,000 on marketing and sales (and any other necessary expenses) in 1 year and acquired 100 new customers, then your CAC is $10.
Accurately calculating CAC requires you to know the specific financials of your expenditures on all activities and tools to acquire customers.
Some businesses tally up all their expenses and divide them by the number of new customers acquired. While others calculate CAC for each specific expense for an even more detailed view. We recommend trying to do both for a well-rounded picture.
Here’s a list of expenses to consider using in your CAC formula:
Ad spend is the amount of money spent on all forms of paid advertising. Google PPC ads, Facebook ads, Native ads, and any others.
Employee salaries and labor
In-house marketers and salespeople are oftentimes the ones driving new customer acquisition. Their salaries, bonuses, commissions, and other labor costs have to be factored into the total costs of acquiring customers through their efforts.
Content marketing involves a number of costs. Paying for employees to create the content, tools for distributing the content, tools for monitoring content performance, plus so much more. Gather these costs together to understand all your content marketing expenses in order to get an accurate calculation.
Technology is used to produce content, track customer progress (CRMs), build and maintain websites and landing pages, improve your SEO, handle customer support, and perform many jobs within your organization. When this technology is used to acquire customers, the support costs should be factored into your CAC.
If you’re a SaaS business, you have to pay software engineers to update and maintain your product, apply patches, locate bugs, and improve the user experience. Rolling out a quality product has a direct effect on how well you’re able to acquire new customers.
How to reduce CAC by improving customer experience
Now that you know what CAC is and how to calculate it, the question you’re probably asking yourself is, “How do I keep CAC as low as possible?”
The answer is to deliver a better customer experience.
That starts with how you market your product, the touchpoints on the customer journey to buying your product, and the interactions customers have with your content and team.
But you can’t haphazardly track this stuff.
If you’re serious about reducing costs and maximizing the number of customers you can acquire, then you need a platform that lets you see the big picture of all your expenses and efforts while allowing you to drill into the details for data-driven decision-making.
This is what Qualtrics gives you.
They help you monitor and improve every key moment along the customer journey - uncovering areas of opportunity, automating actions, and driving critical organizational outcomes.
They also provide real-time, actionable, customer intelligence accessible at every level of the organization – from executives to frontline.
By monitoring all the most important data about your customers, you can reduce your CAC while increasing your CLV.
Learn more about customer experience management