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Everything You Need to Know About Customer Acquisition Costs

Customer acquisition costs (CAC) are critical metrics to any business. It refers to how much of your resources were allocated and spent growing your customer base.

These resources can include paid advertising, web hosting, salaries of your sales and marketing employees, events, sponsorships, blog postings and even social media maintenance.

It’s crystal clear that customers are the lifeline of any business. Without them purchasing your product or service, there is no reason to continue operations.

That’s why when your cost of customer acquisition is low, the better it is for your bottom line. Spending more on acquiring customers than making money from them is one of the easiest ways to exit the scene.

Knowing what your customer acquisition costs are can empower you as you optimize your business model. In this article, we will discuss the different ways how customer acquisition cost can be computed.

We will also discuss how to calculate CAC per marketing channel or campaign, the benefits of using the CPA formula for your paid advertising and what your CAC means to you and your investors.

As a bonus, we will also cover the different ways you can lower your expenses when acquiring new customers.

Computing your cost of acquisition

The easiest way to know your cost of customer acquisition (CAC) is to divide the total marketing costs of acquiring new customers (MCC) by the total number customers you were able to acquire within the same period (CA).

how to compute cost of acquisition

For example, you spent 600 dollars on marketing and you were able to acquire 60 new customers.

cost of acquisition formula

Following the formula, your cost of acquisition per customer (CAC) is 100 dollars.

However, there are caveats to this kind of approach.

For instance, paying a consultant to do early stage SEO can help usher in a brand new set of customers for you for the month of July.

While that is great for for your growth, it is hard to expect the same results come August or September. Although it is possible that the benefits of SEO to your online marketing can be sustained, it can still cloud the relationship when accounting for your cost of acquisition.

Another contention is how customer acquisition costs apply to different industries.

For instance, a 10-dollar cost of customer acquisition for an online retailer that spent 1000 dollars for 100 new orders pales in comparison to an electronics company that also has a CAC of 10 dollars.

Because in the case of the online retailer with a hypothetical average order value of 25 dollars and with a 100% markup on all products, it means it only makes 12.50 dollars per order and generates 2.50 dollars from each customer to pay for marketing and sales expenses.

This view of the customer acquisition costs is also incomplete as it fails to consider the possibility of customers making more than one order in the course of their lifetime.

This is the reason why calculating customer lifetime value is just as important as calculating your CAC. It gives you a clearer understanding of what your CAC means to your business.

Think about it.

A CAC of 10 dollars can be very small if a customer makes a 25-dollar purchase in the course of 10 years. The struggle to keep customers loyal and encouraged to make more than one purchase is a scenario common among online retailers and businesses.

Another way to compute for customer acquisition costs is to expand your MCC by including your other expenses. The formula will look like this:

cost of acquisition expanded formula

You can include wages (W; especially if you have a sales and marketing team working for you).

You can also include marketing and sales software (S; this can include POS systems, A/B testing software, analytics tools, and ecommerce platform service).

Professional services you sought (PS; copywriters, designers and business consultants you work with), plus overheads (O) that are related to sales and marketing can also be included as part of your expenses.

Taking the above example again where MCC is 600 dollars and there were 60 new customers acquired (CA), if we include other expenses as listed below:

W = 5,000 dollars
S = 2,500 dollars
PS = 850 dollars
O = 275 dollars

Following the formula where…

cost of acquisition formula example

Our new CAC is 153.75 dollars.

The newly computed CAC of 153.75 dollars is more accurate than the previous CAC of 100 dollars. It is more representative of the actual costs spent.

Take note that expenses and acquired new customers should always be within the same time period.

Calculating CAC per marketing channel or campaign

As a business owner, it is essential for you to know how profitable your marketing channels are.

cost of acquisition per marketing channel

In the illustration above, it shows that efforts towards organic search are more profitable than other channels.

Enumerate the different marketing channels you use and rank them based on CACs. Once you know which of your channels are driving the lowest CACs, double your marketing spend on those areas.

Why?

Because pumping more money into lower CAC channels will help you generate more customers at a fixed rate.

Start calculating your CAC per marketing channel or campaign by creating a CAC spreadsheet and list down all the marketing channels you had for a particular time period, the amount spent for each channel and compute for the respective CACs. The illustration below is a sample that you can use.

Customer acquisition calculation spreadsheet format

Make sure to use this approach with a bit of caution. What if one of your marketing channels is a PPC ad that you tested for one day and you spent only 5 dollars for it?

Looking at it on your spreadsheet, it will naturally appear that it is the best marketing channel for you because of its low CAC. Doubling your budget on PPC is not recommended as you have not fully used its potential for that time period.

If you are using PPC ads for your ecommerce products, you can easily track conversions by referencing your analytics data. You can easily note the actual value your PPC ads are bringing to your business relative to your other marketing channels.

A wise thing to remember when it comes to your marketing channels is that it should be in support of one another. For instance, your PPC ads should reinforce your blog posts, your blog posts should speak highly about your business and the products you are selling, and so on.

Using the CPA formula for PPC ads

We have been mentioning so much about PPC ads that we’d also like to discuss what cost per action or the CPA formula is.

CPA is another business metric that you can use to examine the relationship between your total AdWords spend divided by the total conversions you were able to acquire.

Simply put…

cost per action formula

In essence, your CPA will always be higher than your cost per click because not everyone who clicks on your ad will complete your desired conversion goal whether that is making a purchase, filling out your contact form or downloading your mobile app.

By using the CPA formula, you are accounting for the number of clicks you need before someone actually converts.

As your improve your conversion rate, your CPA will naturally go lower. And together with your cost per click, your CPA will determine for you the total cost of your PPC campaigns.

Of course, do not forget that when it comes to Google AdWords, your quality score also affects your CPA.

In this article, we wrote about how the AdWords auction works and how important it is in determining your cost per conversion. In short, the higher your quality score, the lower your CPA becomes.

What is the average CPA you should strive for?

This depends now on your business model and the industry you are in. However, the illustration below is a rundown of average CPAs per industry that you can use as a reference.

cost per action per industry

What CAC means to you and your investors

Now that we know how the cost of customer acquisition can be computed, the essence of making separate computations per marketing channel you have and what the CPA formula has in store for us when it comes to PPC ads, the question that needs to be asked now is – what does the CAC mean to you and your investors?

For early stage investors foreign to the dynamics of a future investment, a viable way for them to measure a company’s potential and scalability is to base it on the CAC.

This metric alone can provide insight on the company’s profitability and how much money can be made from customers given the average cost of marketing and advertising.

This view of the CAC applies not only to traditional markets, but also to ecommerce businesses and SaaS startups. Investors are keen on the current customer acquisition strategy companies use to engage with customers and very little on what can be done to improve CACs in the future unless these can be justified.

Aside from early stage investors, your CAC means everything to you as well as you continuously optimize your marketing expenditures and stay within budget.

For every advertising campaign, it is essential to maximize your ROI. If you can slowly reduce your CAC and even manage to achieve free acquisition or growth based purely on virality, your profit margins will definitely improve.

Remember that the growth of your business is also dependent to other metrics. But at the heart of it all, if you cannot acquire customers at a low cost and do not get as many returns from them, it will be challenging to sustain operations.

6 ways to keep customer acquisition costs down

Successful businesses know that when it comes to acquiring new customers, there needs to be a balance between the actual cost of acquiring them and the ability to monetize from them.

A balanced business model is key to longevity and is aptly represented by the illustration below.

how to balance customer acquisition costs

Of course, this can be difficult to achieve especially for startups still feeling their way in the industry. Aside from regulating trends over time, a good rule to remember by is to include these measures in your customer acquisition strategy.

Distribute your marketing channels. The different channels your new customers are joining from all have unique costs attached to it. More than the cost, your marketing channels behave differently as well.

For instance, your social media channels may be bringing in more customers than your email marketing efforts.

Study your marketing channels closely. Identify those that are giving you great numbers and those that are lagging behind. You have two options for your least performing marketing channel – you can optimize it or reduce your budget for it altogether.

Keep in mind that your customer acquisition strategy should be as good as the marketing channels you have. Pay close attention to each and make the most out of your budgets.

Have your ideal customer profile in mind. The danger of not establishing your ideal customer persona is you might be acquiring traffic that will probably never convert. Before you do any form of acquisition, know who you are targeting.

The more specific your characteristics are, the easier for you to build your customer base. The more money you can also make from them.

Here are some questions you can ask as you identify your ideal customer profile:

  • What is the age group of your ideal customers?
  • What are their perceived roles in life?
  • What are their needs and challenges?
  • What are their interests and hobbies?

Be creative with your customer profiles so you can connect more with the people you want to sell your products to.

Encompass their main characteristics. The more you get to understand them, the better your customer acquisition strategy will be.

Retarget your customers. Customer acquisition costs are more expensive when you are targeting new customers. Hence, the importance of doing retargeting.

Get back to your old customers, get in touch with them and make sure to get their contact details on your first interaction so you know how to reconnect with them in the event that they do not convert.

When retargeting display ads are done right, you can convert as much as 70% of your website visitors. Click To Tweet

Use the power of referrals. Aside from retargeting old customers back, take advantage of what a referral program can do for you. If a customer you acquired for 10 dollars can bring in five customers, it means you acquired six customers for only 10 dollars. Your CAC is only 1.67 dollars.

Although proven effective in reducing the cost of customer acquisition, make sure your referral program is unique and feasible.

Optimize your website. Especially for ecommerce sites, it is a possible that the reason why your acquired traffic is not converting is due to issues in your website funnel.

Your ‘Add to Cart’ process might be buggy, your checkout forms are way too long or there are questions your customers are encountering that could have been answered by having an FAQ page.

When conversion rate optimization is a priority, you have stronger chances of converting your visitors into actual paying customers.

Time your sales communications well. You need to be quick in converting your leads into customers. If it takes you half a year to convert a lead, your customer acquisition costs will be larger than if you took action immediately.

Reducing the length of your sales cycle is a technique you can use to reduce your CAC. Make your communications often and send these quickly to your hot leads. Qualify them early and identify how close they are to the end of your sales funnel.

Conclusion

To keep your business growing at a steady and sustainable pace, never ignore the cost of customer acquisition. Pay close attention to this metric from the very start and always use it as a reference for your profitability.

Aside from doing proper computations and implementing ways on how you can reduce your CAC, it is just as wise to ask yourself if your budget for marketing expenditures is realistic or not.

Once you have a viable business model and know the different techniques of a low cost sales model, you can successfully raise capital and improve your business as a whole.

Do not forget also that along with your CAC, your customer lifetime value is just as essential a metric for your business.

Your ability to make money from your customers is different from one company to another. Your ROI from acquiring customers should be greater than your CAC. Similarly, as you minimize your CAC, you should maximize your customer lifetime value for better returns.

As they say, it is a pure balancing act – regularly track down your numbers, optimize the marketing channels that are bringing you the most customers and reduce your acquisition costs as much as possible.

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