Marketing is now a numbers game. As a performance marketer, you’re probably already comfortable calculating common metrics like CTR, CPA, and ROI. If you want to take your performance marketing to the next level, however, and show that you know how to win the game, you’ll need to start calculating another metric called CAC — short for customer acquisition cost.
The most important metric you can use is CAC. If you aren’t calculating it properly, your company will be in some serious trouble. Just imagine what would happen if you spent $10 to acquire one paying customer who only bought $7 worth of items from your business.
It’s a financial disaster in the making and you’ll have a lot of explaining to do! Avoiding such a precarious situation isn’t hard once you understand the formula for calculating customer acquisition costs.
What does customer acquisition cost mean?
CAC is the amount of money it costs your company to acquire a paying customer. This is often confused with CPA (cost per acquisition), where the acquisition could be a newsletter signup, a lead or a registration for a free account. In these examples, there is no purchase. That is the key difference between CAC and CPA.
Why is CAC important?
You can gain valuable insights from understanding your customer acquisition costs, and you should evaluate your CAC periodically to understand how well your acquisition strategy is working.
If you see that your CAC is increasing over time, most likely you’re spending more on acquisition but not gaining a proportional number of new, paying customers.
Alternatively, your spend might be steady, but your new customers aren’t purchasing products or services at the same rate or price point that they once were. Both instances need investigating further so that you can tweak your strategy and get back on track.
How do You Measure Your Customer Acquisition Costs?
The basic and notoriously bad formula for calculating customer acquisition cost is to add up the amount you spent on your marketing campaign and divide that by the number of customers you acquire.
Marketing spend / Number of new customers = CAC
For example, you spend $3,000 on marketing efforts that bring traffic to your site. If you acquire 1,000 new paying customers from this campaign, your CAC would be $3.
Calculating your true CAC is not this simple, but it’s not that much more complicated either. All you need to do is think a little bigger and factor in all the other costs that are part of doing business.
The real formula is: CAC = Total acquisition spend / Number of new customers
What goes into your total acquisition spend will depend on some different factors related to your particular business such as:
- Total marketing spend – campaign budget, plus the cost of content and graphics, marketing tools, etc.
- Total sales costs – sales or affiliate commissions, strategic partnerships, etc.
- Total support costs – customer service, tech support, etc.
- Total overhead expenses – office or warehouse space, equipment, online servers, etc.
There are also instances when you might want to present your boss with a ‘Loaded CAC’, which includes salaries for anyone else who might be involved during the customer acquisition phase.
Then there are two more factors to consider: the length of your sales cycle and whether your customers are one-time or repeat buyers.
Most B2C companies have cycles that last a few days and may or may not have returning customers. B2B brands could have a cycle of several months with customers paying for services for years.
Examples of how to calculate your customer acquisition costs.
Let’s take a look at how all this would play out for two different types of companies and how each would calculate their customer acquisition costs.
You work for an e-commerce company that sells products to customers for $100 each.
Each product costs you $50, so you add a 100% markup, enabling you to earn a profit of $50 per item.
In one month, you spend $3,000 to bring traffic to your site, and this effort earns you 300 new paying customers.
If your total acquisition cost (remember, this is your campaign spend, plus all the other things you pay for such as warehouse space, website maintenance, etc.) is $5,000, then your true CAC would be $16.66.
The formula looks like this: ($3,000 + $2,000) / 300 = $16.66
You work for a SaaS company like Buffer that offers free and paid subscriptions.
With a freemium business model like this, non-paying clients should only be part of your CPA data.
After a few weeks or months, however, some customers on the free plan will upgrade to a paid plan, so even if they signed up during a specific month’s campaign, you must attribute them to a different month’s marketing costs.
To put your CAC into perspective, you’ll need to understand one more metric called CLV or customer lifetime value.
What is CLV and how do you calculate it?
Determining your CLV will tell you how much a customer is worth to your business over their lifetime. It will help you to understand if your acquisition costs are on the right track. If you find that your CAC is higher than your CLV, you are spending more money than you are earning and it’s a huge red flag.
Here are the metrics you’ll need to calculate your CLV and the formulas:
- Average Order Value (AOV) = Total Revenue / Number of Orders
- Purchase Frequency (F) = Number of Orders / Unique Customers
- Customer Value (CV) = AOV x F
- Customer’s Average Lifespan = 1 / Churn Rate Percentage
Take all those values and put them into the CLV formula:
CLV= CV x Customer’s Average Lifespan
To put this into perspective, let’s say your SaaS company from Scenario 2 offers a yearly service subscription for $1,000 and, on average, your customers use your product for three years.
Your company earns $100,000 from its 100 customers, making your AOV $1,000 ($100,000 / 100). In this case, your customer value (CV) would be $1,000 ($1,000 X 1). Your CLV would be $3,000.
The formula looks like this: $1,000 x 3 = $3,000
Get calculating but be aware.
Although all these formulas use math which is often only right or wrong, calculating customer acquisition costs and lifetime value is imperfect.
There will always be additional costs that you didn’t factor in, like discounts or charge-backs. Don’t be discouraged. Get your numbers as accurate as possible and continue to improve as you gain more insights.