Landing new clients is the name of the game in sales, but that doesn’t mean you can sit back and relax as long as there’s money coming in. It’s also important to look at how much is actually being spent to turn leads into paying customers. That is, you need to calculate your customer acquisition cost.
What is Customer Acquisition Cost?
Put simply, customer acquisition cost (CAC) is – you guessed it – the cost of acquiring a new customer.
CAC is a metric no company can afford to ignore, so we’ll spend this article discussing:
- Why CAC matters to your business
- How to easily calculate CAC
- What to change if your CAC is too high
- The average CAC across major industries
- LTV: CAC ratio
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What is the Value of Knowing your Customer Acquisition Cost?
Understanding CAC is critical for businesses of all sizes. However, it’s particularly relevant to startups that are in the early stages of scaling up or trying to woo potential investors. Once you know your CAC, you can evaluate the cost of growing the business and the value each new customer brings.
Aside from demonstrating that your business model is sound, CAC can be used to analyze your marketing ROI and optimize your campaigns. If you can figure out how to minimize the cost of signing a new customer, you’re one step closer to bumping up your profit margins.
How to Calculate Customer Acquisition Cost
The simplest formula for calculating CAC is:
(Money + Time Spent) / Number of Customers Acquired
A more sophisticated version of this formula involves breaking down the cost variables into specific sales and advertising expenses. For instance, money put towards running a PPC campaign, banner ads, and retargeting could all be included in calculating CAC.
Additionally, you should include the cost of the hours that go into landing a new customer. This would include the time your team spends contacting leads, tweaking landing page content, and meeting to plan a new campaign.
Here’s a visual breakdown that shows how to get the average CAC by looking at your sales and marketing costs relative to how many new customers are acquired during a certain time period:
The specifics of how CAC is calculated are somewhat dependent on the industry. For instance, a SaaS startup might calculate this metric slightly differently than an e-commerce business.
A SaaS company might look at the following variable to determine how much they can afford to budget for their CAC:
Customer Lifetime Value
The amount each customer spends during their life cycle (also known as LTV). This can be a complicated metric and we’ll discuss it a bit more later on, but here’s the basic formula:
(Monthly revenue per paying user * gross margin) / Customer churn rate
Signup-to-Paying Conversion Rate
What percentage of people who register become paying customers? This is especially important to consider for companies that offer free trial periods or freemium models that only convert some users into premium account holders.
Number of users signed up / Number of users who started paying
Signup Conversion Rate
What percentage of visitors to your website become registered users?
Number of landing page visitors / Number of visitors who registered
The steps for calculating CAC for an e-commerce site would be similar. But since there’s no free trial, you can simply combine steps two and three to calculate how many website visitors become new customers:
Number of landing page visitors / Number of visitors who completed a purchase
Strategies for Reducing Customer Acquisition Cost
If your CAC is higher than you’d like (or can afford), something’s gotta change. Here are a few strategies you can use to reduce CAC and improve your bottom line.
1. Conversion Rate Optimization
Optimizing your website can increase your revenue and lower your CAC by making it easier for visitors to convert. This is particularly important for e-commerce sites that might be losing out on sales even if their traffic is high.
Check that your site loads quickly, displays properly on mobile devices, and that your checkout process is simple and bug-free. You should also perform A/B testing on your landing page copy to find out what works best for your target market.
2. Shorten Your Sales Cycle
The faster a new customer is signed, the less time and resources your company has spent acquiring them. Take a closer look at your sales funnel to see where most abandonments take place.
For instance, if your sales communications aren’t closing the deal quickly enough, revamp your messaging or adjust your vetting process for efficiency. Qualify leads early to ensure your team is only spending time pursuing those that are likely to become customers in the near future.
3. Reward Referrals
If you can get consistent referrals from existing customers, your average CAC will drop significantly. Say, for instance, a customer who cost you $15 to acquire refers two new customers. This brings your CAC down from $15 to $5 because you landed three new customers for the cost of one.
Implement an attractive referral program that gets more customers to spread the word about your business – not just because they enjoy your product or service, but also because you’re offering a referral bonus to sweeten the deal. This could be something as simple as an discount code for their next purchase or a temporary upgrade to your premium service for referring new users.
4. Create Added Value
Even if your product is great, savvy consumers sometimes require an extra incentive to part with their hard-earned cash. This might involve offering new upgrades that set your service apart from competitors or perhaps bundling certain products together. By bumping up the perceived value of your services, you’ll help customers feel more confident in their decision to buy and thereby reduce CAC.
How CAC Differs Across Industries
Not all business can expect to achieve an identical CAC. Different types of companies have different costs associated with landing new customers. Also, more expensive products and services tend to have higher CAC.
To give you an idea of how drastically CAC can vary, here’s a quick look at the average CAC in a variety of industries:
- Travel: $7
- Retail: $10
- Consumer Goods: $22
- Manufacturing: $83
- Transportation: $98
- Marketing Agency: $141
- Financial: $175
- Technology (Hardware): $182
- Real Estate: $213
- Banking/Insurance: $303
- Telecom: $315
- Technology (Software): $395
Sources: Entrepreneur and Kurt Kummerer
LTV: CAC Ratio
Remember, CAC isn’t the only acronym you need to consider. To get the most value out of knowing CAC, you also need to calculate LTV – the lifetime value of a customer (also known as CLV).
One of the most important metrics for any business, LTV is the amount of revenue generated by a customer over the course of their lifetime. Understanding LTV requires estimating the customer lifespan, retention rate, churn rate, referral rate (virality), and profit margins per customer.
While you certainly want to aim for a low CAC, it’s also important to maximize LTV so you can maintain a healthy LTV: CAC ratio. Generally speaking, this ratio should always be at least 3:1. Anything lower and your customer acquisition cost is too high.
Keep an eye out in the coming weeks for a more detailed discussion on LTV and how to calculate it. In the meantime, let us know your tips for reducing customer acquisition cost!
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