The Cost Of Acquiring A New Customer

December 6, 2017

 

 

 

 

Customer acquisition cost (CAC) is a metric that has been growing in use, along with the emergence of Internet companies and web-based advertising campaigns that can be tracked.

Traditionally, a company had to engage in shotgun style advertising and find methods to track consumers through the decision-making process.

Today, many web-based companies can engage in highly targeted campaigns and track consumers as they progress from interested leads to long-lasting loyal customers. In this environment, the CAC metric is used by both companies and investors.

CAC, as you probably know, is the cost of convincing a potential customer to buy a product or service. In this article, we will explain the CAC metric in more detail, how you can measure it, and what steps you can take to improve it.

What the CAC Metric Means to You

As mentioned above, the CAC metric is important to two parties: companies and investors. The first party includes outside, early stage investors who use it to analyze the scalability of new companies. They can determine a company’s profitability by looking at the difference between how much money can be extracted from customers and the costs of extracting it.

For example, in terms of the upstream oil market, if an oil supply is in an area requiring heavy infrastructure investments, the amount applied to extract the oil may be greater than its market price per barrel.

Investors view companies through the same lens. They are concerned with the current relationship, not on future promises of improving the metric, unless they can be justified.

The other party interested in the metric is an internal operations or marketing specialist. They use it to optimize the return on their advertising investments. In other words, if the costs to extract money from customers can be reduced, the company’s profit margin improves and it makes a larger profit.

Then, investors are more interested in providing the company with the resources it needs, partners are more committed to growth, and the company can use the improved profit margins to pass the value to its customers for a greater market position.

How You Can Measure CAC

Basically, the CAC can be calculated by simply dividing all the costs spent on acquiring more customers (marketing expenses) by the number of customers acquired in the period the money was spent. For example, if a company spent $100 on marketing in a year and acquired 100 customers in the same year, their CAC is $1.00.

There are caveats about using this metric that you should be aware of when applying it. For instance, a company may have made investments on marketing in a new region or early stage SEO that it does not expect to see results from until a later period. While these instances are rare, it may cloud the relationship when calculating the CAC.

It is suggested that you perform multiple variations to account for these situations. However, we will provide some examples of calculating the CAC metric in its most pragmatic and simple form with two examples. The first company (Example 1) has a poor metric. The second (Example 2) has a great one.

Example 1: An ecommerce company

In this example, we take a fictitious ecommerce company that sells organic food products. The company spent $100,000 on advertising last month, and its marketing team says 10,000 new orders were placed. This suggests a CAC of $10, a figure that has no meaning in itself.

If a Mercedes-Benz dealer has a CAC of $10, the management team will be delighted when looking at the year’s financial statements.

However, in the case of this company, the average order placed by customers is $25.00, and it has a markup of 100% on all products. This means that on average, the company makes $12.50 per sale and generates $2.50 from each customer to pay for salaries, webhosting, office space, and other general expenses.

While this is the quick and dirty calculation, what happens if customers make more than one purchase over their lifetime? What if they completely stop shopping at brick and mortar grocery stores and buy from only this company?

The purpose of customer lifetime value (CLV) is specifically designed to resolve this. You can find a CLV calculator by simply searching in your favorite search engine. In general, this metric helps you form a more accurate understanding of what the customer acquisition cost means to your company.

A $10.00 customer acquisition cost may be quite low if customers make a $25.00 purchase every week for 20 years! However, in this ecommerce company, they are struggling to keep customers and most of the customers make only one purchase.

Example 2: An online CRM (SaaS) software company

The company in this example provides an online system for managing sales contacts for customer relationship management. The cost of distributing the software is low since it is cloud-based, and customers need little support. Moreover, it is able to easily retain customers because of the pain customers would experience uploading all the contacts, tasks, and events they are tracking onto a new CRM software.

The company has worked its way up the search engines and has an expert sales support team working for minimum wage, based out of their call centers in a rural Midwestern town. The company also has many strategic partnerships which provide a steady supply of customers. In fact, they spend only $2.00 acquiring a new customer with a lifetime value of $2,000. Here is the calculation:

  1. Total cost of new customer sales support call centers: $1,000,000/year

  2. Total cost paid to strategic alliance partners per customer: $1.00

  3. Total monthly spending on search engine optimization: $20,000/year

Total new customers generated in the year: 1,020,000

Customer acquisition cost: ($1,020,000 / 1,020,000 customers) + $1.00 per customer = $2.00

As in our previous example, the amount is worth only the money extracted from customers. This company has used a customer retention calculation to determine that its customer lifetime value (CLV) is $2,000. That means this particular company is able to turn a $2.00 investment into $2,000 of revenue! This is both attractive to investors and a signal to the marketing team that an effective system is in place. For more tips on scaling your business sign-up for our ezine

 

 

 

 

 

 

 

 

 

 

 

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