How To Calculate Customer Acquisition Cost (CAC) And Slash It In Half
Dreaming of creating a product used by millions worldwide is free. However, turning that dream into reality by attracting new customers can be an expensive endeavor.
Without new customers, it’s impossible to grow. That's why it's important to understand your average customer acquisition costs (CAC) and learn how to lower them.
Get ready! I’m about to help you understand what CAC is, and how to crack the code to growing your business cost-efficiently—your investors will be happy you read this!
What is Customer Acquisition Cost?
I wish I could sugar coat this, but acquiring new customers costs money.
To put it simply, CAC is the sum of all expenses related to sales and marketing activities aimed at attracting and converting potential customers into paying ones. These activities turn consumers into Marketing Qualified Leads (MQL) and Sales Qualified Leads (SQL).
To get a clear idea of the costs involved, it's essential to visualize the customer journey. This involves understanding the buying process and mindset of potential new users in combination with the marketing funnel. By mastering this process, you can grow your business cost-efficiently.
Visualizing CAC provides an understanding of the costs involved, such as:
- Customer research and analysis to identify potential new customers
- Events and sponsorships (e.g. conferences, community events)
- Public relations and outreach (e.g. press releases, media interviews)
- Cost of producing promotional materials (e.g. brochures, business cards)
- Advertising costs (e.g. print, online, outdoor)
- Content marketing (e.g. blog posts, white papers, webinars)
- Paid search and social media marketing (e.g. Google Ads, Facebook Ads)
- Product Demo and Shopping carts
- Discounts and promotions to incentivize new customers to buy
- Employee salaries and overhead costs associated with sales and marketing teams (eg. Sales commissions and bonuses for acquiring customers)
And what do all of these tactics have in common? They come with a big ol’ price tag.
Why is understanding CAC important?
The time of rapid, uncontrolled growth is long gone.
Welcome to 2024—cost-efficient growth is the name of the game.
Investors expect you to take the lead, disclosing reliable and consistent financial information about your progress in growing your customer base and average customer value as part of your earnings.
Even if you don’t rely on an investor (e.g. bootstrapping), you still have to be profitable. That is unless you want to be part of the illustrious 70% of new businesses that fail in the first 5 years of existence.
The next challenge to overcome? Climbing CACs. A study by Profitwell showed that CAC increased by >60% over a 5-year period.
If you don’t know your CAC, you can’t expect to know how to cut it significantly. It impacts profitability to the extent that a high CAC is an existential threat.
How to Calculate CAC: The Magic Formula
If you cannot measure it,
-LORD KELVIN
you cannot improve it.
So how do you calculate your CAC? Here is the CAC calculation formula—you might want to write this down somewhere.
Customer Acquisition Cost = Total Acquisition Costs, divided by the number of New Customers Acquired. Or, simplified:
CAC = TAC / NCA
The Total Acquisition Costs (TAC) include all expenses incurred to acquire new customers.
The Number of New Customers Acquired (NCA) is the total number of new customers acquired during the period for which you’re measuring CAC.
Plug these two pieces of information into the formula to get your CAC.
For example, if your total acquisition costs for the first year were $50,000, and you acquired 250 new customers during that period.
Your CAC is: $50,000 / 250 = $200
Try Our Customer Acquisition Cost Calculator
Curious what your CAC is right now—or what it could be if you made some changes? You can play around the numbers with this handy interactive calculator.
Use these key supporting metrics to master your CAC
CAC is one of the key product success metrics to determine the effectiveness of your sales cycle and total marketing efforts. It’s also a helpful figure for making informed decisions about how to allocate resources internally.
But there are other metrics that support CAC to help you make better choices.
Here’s a (non-exhaustive) list of other metrics to keep close at hand:
- Sales and Marketing Costs (SMC): The total cost of all sales and marketing efforts, including advertising, promotions, and sales commissions.
- Marketing Percentage of Customer Acquisition Cost (M%CAC): The proportion of marketing costs relative to total acquisition costs.
- Cost Per Lead (CPL): The cost of generating a lead, calculated by dividing the total cost of lead generation efforts by the number of leads generated.
- Time to Payback CAC (TPC): The period of time it takes for a business to recover the cost of acquiring a new customer through revenue generated by that customer.
- Customer Lifetime Value (LTV): The total value that a customer brings to a business throughout their relationship with the business.
- The ratio of Customer Lifetime Value to CAC (LTV:CAC): The relationship between the value a customer brings to a business over their lifetime and the cost of acquiring that customer.
- Gross Margin Customer Acquisition Cost (GM-CAC): The amount of gross margin generated by a new customer over their lifetime, divided by the cost of acquiring that customer.
So, what is a good customer acquisition cost?
Knowing the CAC, how do you know if it is above or below average? How can you be certain the CAC isn’t too high?
You can look at two things:
The average CAC by industry
The first one is to look at the CAC benchmark in your industry.
Limp Bizkit would say that “results may vary” and that definitely applies to your CAC. The average costs vary per industry.
A study done by firstpagesage researched the CAC in 20 industries, including SaaS and eCommerce. Here's what they found:
Organic CAC refers to product-led growth strategies that enable attracting new customers through recommendations and organic growth.
Paid CAC refers to the various paid methods used to acquire customers, such as advertising, events, and sponsorships.
The LTV to CAC ratio
We covered this one briefly in the previous metrics section.
LTV is to CAC what Beyonce is to Jay-Z, what Ryan Reynolds is to Blake Lively, and what Offset is to Cardi B—we can’t talk about one without thinking about the other.
This is a common benchmark, and the ratio investors prefer to see is 3:1.
A higher rating might indicate a growth opportunity, so in those cases, consider increasing marketing spend.
And if your LTV to CAC ratio is equal, or your CAC is higher than your LTV? Look at controlling your costs because you, my friend, are losing money.
The top factors that drive up customer acquisition costs, explained
You might be asking yourself how to avoid running into a doomed LTV to CAC ratio. How can you prevent CAC from spiraling out of control, and what kinds of issues could send it into a tailspin?
Let’s look at the 5 key factors that drive up CAC.
A poor understanding of your customer’s value journey.
Now imagine you just go out swinging and randomly spit out marketing campaigns at potential customers. How do you know you are targeting them with the right message at the right time? What evidence do you have to show that each marketing tactic is succeeding at every step leading up to a customer’s decision to purchase?
The answer? You don’t. The approach might prove to be successful, but you will not know why. You will not know if you could have been more profitable or cost-efficient.
Poor targeting and an unclear view of what potential customers are seeing, from first touchpoint to the actual purchase phase, results in wasted marketing ad spend and increased CAC.
Limited brand awareness and reputation
I'm sure that any startup founder can attest: a lack of brand awareness and reputation makes it challenging to attract paying customers.
Some fun facts:
- A study done by Edelman found that a whopping 81% of customers need to trust a brand first before making a purchase.
- The Sprout social index report shows that 77% of purchases are from a brand with a good following on social media.
Brand awareness and reputation are key. For an unestablished brand, it requires additional marketing sales expenses and efforts to persuade a customer to purchase.
Lack of differentiation from competitors
The keys to success are to clearly differentiate, continuously innovate, and constantly improve your products and services.
So, what happens with your CAC if you don’t? In my experience, it’s twofold.
Not having a key product differentiator reduces brand loyalty. Brand loyalty impacts retention. In The Loyalty Effect: The Hidden Force Behind Growth, Profits, and Lasting Value, Fred Reichheld mentions that increasing customer retention rates by just 5% can reduce customer acquisition costs by as much as 30%.
Not having a clear product differentiator limits your growth potential. Attracting new customers becomes difficult and expensive.
Ask yourself this question: When presented with two solutions to a problem, would you go for the one with clear proof of the solution, or would you go for the less clear option?
Non-existent sales and marketing processes
If your sales and marketing process is inefficient, consider it non-existent. This is the mindset you need to adopt to challenge yourself to become better each and every day.
An efficient process is one that is streamlined and regularly reviewed to eliminate redundant tasks.
A good example of what it isn't is a process predominantly consisting of lots of manual steps. It’s also not a commission and incentive process with unclear targets and unrealistic expectations for the sales team.
While marketing and advertising through the right marketing channels are necessary to attract new customers, excessive spending due to unclear processes quickly eats into profit margins.
Inefficient processes and lack of automation lead to wasted time and resources. They impact your marketing and sales team’s productivity, morale, and—at the bottom line—your profitability.
High customer churn rates
Churn due to poor customer service, generic experiences, and subpar quality, is the best way to watch your money go up in smoke.
Churn translates into a need to replace churning customers with new ones, and that means—you guessed it—spending more money. At the same time, you lose the chance to increase MRR. The amount of money spent by repeat customers is 67% more than that of new ones.
Additionally, churned customers will never become advocates. A community of champions is worth its weight in gold in referrals. They provide free advertisement and sway potential customers, reducing CAC.
Needless to say, churn rates impact your CAC the way concrete shoes impact your ability to float.
Best Practices for Reducing CAC (with Successful Case Studies)
Now that we know what drives up CAC, let’s roll up our sleeves and dive into three best practices for controlling it.
Understand your customer’s value journey
You want to understand how people actually shop versus how you sell. Start with figuring out your customer’s value journey.
- Understand the source of your leads, so you can focus on the most profitable ones and terminate irrelevant ones
- Track how your deals progress and determine the conversion rate of leads into paying customers.
- Understand where a potential customer is in their journey, so you can act appropriately.
Then, like Jerry Butler, make it easy on yourself and leverage product analytic tools to understand your target audience’s time to revenue. This is the average time it takes them to go from first touch to purchase.
Knowing your customer’s journey, their feelings throughout the process, and the average time from first touch to closing, identify improvement opportunities.
Case Study: How Slack’s understanding of the customer value journey reduced their CAC
In its early days, Slack was looking for a way to make its mark in the world of corporate communications. Mapping and deeply understanding their customer’s value journey, they learned there was a lot of hesitation to purchase.
Understanding this, they introduced a Freemium model that wasn’t a half-baked one. Quite the opposite, even—it was so darn useful, it quickly became an indispensable part of people’s work lives. People raved about it to their colleagues, and on social media.
Utilizing product analytics insights they decided not to impose arbitrary time limits on free users. Instead, they made it so that once you hit a threshold, Slack was already so vital to your workflow that you couldn’t imagine going back.
The result? Churn and CAC decreased, and customer lifetime value went up.
Customer Value Journey for the win!
Streamline sales and marketing
If you want to maximize customer experience and increase the chance of winning customers, streamline your marketing and sales processes.
According to MarketingProfs, the return on investment of aligning sales is up to 36% higher retention rates and 38% higher sales win rates.
End the war between Sales and Marketing. Align their goals and strategies, by creating an efficient and effective lead-generation process. This includes defining lead qualification criteria and developing a lead handoff process that ensures sales are only spending time on high-quality leads.
Case Study: How Superoffice aligned marketing and sales to crush CAC
In 2016, Superoffice, a cloud-based Customer Relationship Management (CRM) solution, experienced dissatisfaction among salespeople with the quality of sales-ready leads and among Marketing of the lack of follow-up on leads.
So what did they do?
Instead of pitting sales against marketing, they positioned them as allies, giving rise to “Marketing as a shared responsibility”. Initially, the focus was on brand awareness and social selling. They then developed a plan to become more aligned, holding frequent meetings to discuss content, campaigns, digital activities, and goals, letting the world see who they are as people and as a brand, and sharing their culture of CRM and a smile.
The efforts resulted in a 168% increase in business leads, and a 61% increase in social media visits their websites.
Improve customer retention
As I mentioned, customer churn impacts CAC. You want to keep your existing customers happy, so you can one day turn them into your advocates.
To increase customer lifetime value, focus on building long-term relationships with your customers. Provide exceptional customer service, personalized experiences, customer loyalty programs, and high-quality products and services.
Case Study: How Groove achieved a 71% reduction in churn rate
Back in 2013, Groove’s 4.5% churn rate meant their growth was at risk. Unfortunately, they didn’t have insights into why customers were churning. They decided to do something about it by researching user behavior and uncovering the key metrics that influenced users to abandon and stay. They found that in the first 30 days of joining, the length of the first session, and frequency of logins were the key metric.
To improve the important metrics, Groove cooked up several data-driven experiments, for instance by emailing users whose first sessions were short, with the offer to help them through the onboarding.
Groove’s ability to recognize the behaviors that indicated when customers were about to churn allowed them to take action and prevent some of those at-risk users from leaving, reducing churn by 71%.
Aspire to acquire!
Understanding and managing CAC is crucial for any business that wants to grow and scale successfully.
Determining a good CAC is essential and to win it you need to understand and be able to create effective sales and marketing strategies and manage those factors that drive up these costs.
By regularly monitoring and optimization of your Acquisition strategy, you can achieve growth and sweet, sweet success.
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