Customer acquisition cost: what it is, why you need to know it, how to calculate it?

In modern business, the concept of customer acquisition cost, or CAC for short, is widely used to calculate the necessary amount of expenses to attract one client. A higher metric means the company can use a larger number of advertising channels for this purpose.

In turn, the effectiveness of such a campaign increases significantly — the money spent on one client will ultimately bring two, three, and more potential consumers. This is a very necessary and important tool that expands the target audience of consumers.

What is customer acquisition cost?

By definition, CAC is the final amount spent to attract one client. When launching a business project, you should pay particularly close attention to this expense item, because for a successful start it is highly desirable to know how much time, energy, and finances your undertaking will require.

The main task when launching a new business is to find a certain balance between the costs of attracting clients and the amount of revenue received from them. The correct ratio is the cornerstone of success in any business, determining the profitability of the business at current customer costs.

Why evaluate CAC (customer acquisition cost)?

CAC evaluation is used to understand how profitable the costs of attracting new clients are. This metric indicates the level of efficiency in using the marketing budget. It helps to see how productive and effective the company is, whether there is a reason for concern, and where intervention is required.

CAC solves the following tasks:

• bringing the LTD/CAC ratio to the optimal level (lower threshold 3:1);

• optimization and determination of the project payback periods.

How to calculate CAC?

Two components take part in the CAC calculation:

• expenses for maintaining the marketing and sales department, namely: salaries of all employees, cost of equipment and tools, software, and marketing activity;

• number of clients for the reporting period.

To calculate CAC, you need to divide the first component by the second. For example: the total expenses of the marketing department for a certain period amounted to 36,000 USD, and 1,000 clients arrived. Then

CAC = 36000 / 1000 = 36 USD spent to attract 1 client.

Why calculate CAC?

Companies require CAC calculation to improve their investment attractiveness, because investors are always interested in its level and use this metric to analyze scalability  and determine the potential profitability of the company.

CAC shows how much money you can get from clients bringing in their own clients, given the costs allocated per notional consumer. Investors very often put forward their requirements, which include the CAC metric.

What customer cost is considered optimal?

To get an accurate CAC calculation, you should calculate it for each advertising channel separately to understand which of them is underperforming and promptly direct funding there for marketing measures.

To determine the optimal level of cost for one client, you need to determine the ratio of LTV and CAC.

LTV — the profit an acquired client brings during the whole time they stay with the company. CAC — the cost of acquiring that client.

LTV is calculated using the following formula: average order value X number of orders during the month X average margin X average time of cooperation with the client.

If this ratio is below 1:1 — your business is facing failure and urgent measures are required to improve the situation.

• 2:1 — indicates a weak project payback.

• 3:1 — points to the productive work of the business model, which is considered the optimal metric.

• 4:1 — the business is highly productive and clients have a low cost, bringing high profit.

To ensure the recommended 3:1 level, you need to find new channels and attract more people to your brand. Change your attitude towards attracting new consumers and make the necessary edits to your marketing strategy — this is the key to success.

Which business areas should do such a calculation? 

CAC calculation is most needed for those companies that are still at the stage of starting their economic activity, because at first it is always very difficult to designate the optimal cost boundaries.  At the same time, the risk of overspending on attracting clients is extremely high, and so is the risk of allocating too little.

In the case of excessive costs, a loss of profitability is possible, and with a lack of funds, you will have to use the cheapest, low-efficiency methods, which will hinder the company's success.

How to reduce customer acquisition cost:

Costs for business promotion can be reduced by lowering expenses. To save money, the following effective methods exist: 

1.     Look for new promotion channels to expand your reach within the target audience

These can be banners on partner websites, contextual advertising, social networks — find the tools that help you cut costs. Use e-mail marketing services and the offered templates — this will significantly reduce the CAC value.

You can save on software if you work on a free plan and limit your business activity to 2500 client addresses and 15000 emails per month.

2.     Analyze purchasing behavior to understand their needs and take this into account when selecting suitable promotion channels. 

Apply behavioral marketing to build a chain along which the buyer moves from information about the product to its purchase.

Analyze the reasons for a potential buyer leaving without a purchase and draw the right conclusions to correctly forecast how the client will behave in certain conditions. 

What else is worth remembering:

Always distinguish CAC from CPL (cost per lead), because a lead is a user performing a required action and its price consists of the amount of money spent on guiding them to a specific action. The lead cost is designated as CPL and directly affects the CAC metric.

By establishing the cost of leads on different channels, we find out the customer acquisition cost in each channel, which will allow rational distribution of the allocated budget among them — directing it to profitable channels and adjusting the price of the final product. 

What is included in marketing costs within CAC?

An important component of CAC is marketing costs, which consist of:

• the total salary of all employees engaged in marketing and sales;

• non-production costs that go towards maintaining the marketing department;

• expenses on marketing tools.

Marketing costs include:

• running an advertising campaign;

• salaries of marketers and salespeople;

• website software with various services;

• services of freelancers participating in customer acquisition;

• other marketing expenses.

Customer acquisition cost can be reduced without losing efficiency. What is needed for this?

You can save on customer acquisition operations even if you have a profitable business and have ample funds. It is entirely possible to decrease CAC while maintaining efficiency by performing the following actions:

• search for new promotion channels, as well as use them rationally and comprehensively;

• carefully analyze purchasing behavior and rebuild the sales funnel according to it.

Conduct the analysis using free services to save money on marketer services, and optimize business processes to develop your business.

CAC calculation on a real business example

You can see the operation of the CAC calculation formula in the following real example.

Initial data:

• contextual advertising traffic — 10000 clicks;

• individual click price — 3 UAH;

• PPC specialist salary — 10000 UAH;

• traffic from non-organic search results — 30000 clicks;

• operator salary — 5000 UAH;

• visitor-client conversion - 5%;

• new clients:

orders from context — 5000*0.05=250

from organic search results — 30000*0.05 = 1500

• repeat orders of regular buyers — 3000 pcs.;

•  total number of orders — 4500 pcs.

We calculate the prices separately for each channel, counting the operator's salary proportionally to the accepted orders.

Contextual advertising:

• expense (3 UAH*10000)+10000 UAH = 40000 UAH;

• operator salary (5000 UAH /4500)*250 = 278 UAH;

• total expenses for the channel 40278 UAH;

• number of orders 40278/250 = 161 UAH.

Organic search results - add the salary of the telephone operator working across all channels:

• SEO specialist salary 10000 UAH;

• operator salary (5000/4500)*1500 = 1667 UAH.

• total expenses for the channel 11667 UAH;

• number of orders 11667/1500 = 7.78 UAH.

Each new buyer will cost the business owner 161 UAH through the contextual advertising channel and 7.78 UAH through the organic search results channel.

How much time is needed to return the customer acquisition costs?

To determine the payback period, you need to divide the monthly income from one client by the cost of their acquisition. This figure depends on several factors, therefore it is determined separately for each specific case.

You can use averaged data for preliminary calculation.

Conclusions

The importance of a balanced LTV and CAC ratio is beyond doubt and the optimal CAC metric is 3:1. Such an optimal ratio should be achieved to ensure coordinated work and effective results in attracting new clients.

If you do not have enough experience and capabilities to independently achieve the required proportions and ratios, invite a specialist from the company Marketing MIX — we will help you correctly calculate CAC and achieve the desired indicators for the cost of leads and customer acquisition costs.