What is Customer Acquisition Cost, and Why is it Important?

Customer acquisition cost (also known as CAC) is, as the name implies, the cost a business incurs in its attempts to acquire new customers. The CAC number is a critical metric for any company interested in monitoring its marketing return on investment (ROI).

More and more companies are measuring their CAC than ever before. For one reason, it’s a more accessible metric to measure with digital marketing. Secondly, CAC has become an integral metric for companies that are making marketing decisions based on data.

Because digital marketing can target specific groups of customers, measuring CAC is much easier. Traditional marketing channels are difficult to target specific groups of customers, making this metric much less impactful.

When analyzing your customer acquisition cost, it is also essential to include your customer’s lifetime value (LTV). Customer Lifetime Value is the value that a customer represents to a business for the length of time that your customer will do business with you.

How much would you pay to get a customer?

Depending on your business, the LTV of your customers will vary. As an example, a grocery store will see its typical customer once a week. Consumer relationships with grocery stores go on for years. It takes a sizable event to get a consumer to move away from their grocery store of choice.

Let’s say that a typical consumer will shop at their favorite grocery store once a week. Let’s further assume that an average shopping trip for these consumers results in $ 100 revenue. If these averages stay the same over a year, the lifetime value of that customer is $ 5,200.

If you pay too much to get this customer, then you’re going to lose money on this customer. If you don’t pay enough, you’ll never get them to become a customer. According to the Food Industry Assoc. the net profit for a grocery store after taxes is 3.0%. With this in mind, a customer that generates annual revenue of $ 5,200 represents a profit to the store of $ 156.

Let’s take a look at a different scenario.

This time your company is Apple. It is reported that Apple makes 35%+ on their iPhone so let’s look at this and see what the LTV is for an Apple iPhone customer.

Apple releases a new iPhone every year. Let’s say that a typical iPhone customer replaces their iPhone every other year. This year’s iPhone 13 Pro sells for a minimum of about $ 1,000. With a 35% profit, Apple will make about $ 350 on every phone it sells.

If we assume that an average Apple iPhone customer will continue buying Apple iPhones for the next six years (every other year), that’s a LTV of $ 2,100.
The amount of marketing dollars you can spend to gain one Apple iPhone customer is dramatically more than you can spend to get one new grocery customer.

It’s not about the amount; it’s about knowing.

Regardless of whether your company is a grocery store or a technology brand, this is not about the amount of money you have to spend but instead the importance of knowing what you should spend. As stated earlier, spend too little, and you won’t attract new customers, spend too much, and you’ll be out of business.

What’s Included In Customer Acquisition Cost

There are a couple of ways to measure CAC. One way is to say that every customer is worth a dollar spent in your CAC formula. Spend $ 1,000 and get 1,000 customers, and your CAC is $ 1.00.

We don’t subscribe to this calculation because of the lifetime value element to a customer’s value. We feel that you have to look at the entirety of a customer relationship.

To arrive at the second method of measuring CAC, keeping the customer’s entire value in mind, you need to add up all of the costs associated with getting a new customer, generally sales and marketing costs over a year. Then divide that amount by the lifetime value (LTV) of customers you acquired in the same period.

Customer acquisition cost formula

Sales/Marketing Costs $ 10,000
Customers Acquired 10
Customer Lifetime Value $ 156.00
Customer Acquisition Cost $ 6.41

How To Reduce CAC

If you find that your customer acquisition cost is too high, there are a couple of strategies that you can use other than cutting your sales force or slashing your marketing budget.

Increase Sales Instances: The first strategy you can employ is to entice your customers to shop with you more frequently. It’s no accident that Apple produces a new iPhone every year.
Increase Retention: Keep your customers shopping with you for a longer period of time. Why do people continue to go to the same grocery store week after week? What is the life expectancy of your customers? What can you do to get them to stay with you longer? The longer they stay with you, the higher their LTV. It may help to improve your online customer service.
Add On Sales: When was the last time you purchased a phone and didn’t get a new case? What about a service plan? Increasing the overall amount of a transaction, especially with high-profit items, the lower your CAC will be.
Marketing Automation: Utilizing marketing automation tools will improve the quality of leads that come into your system, lowering your marketing costs.
Marketing automation will also reduce wasted sales calls to potential customers that aren’t ready to buy. This keeps your sales force focused on prospects that can convert.
Target Marketing: Stop running marketing campaigns based on impressions! Start running marketing campaigns based on specific targets. People that make up the most likely to become a customer make so much more sense and dramatically reduce your marketing costs from the old traditional method of casting a wide net.

Conclusion

By not knowing what your customer acquisition cost is, there’s a real possibility that your current marketing dollars are underperforming or you’re spend marketing dollars in areas that aren’t getting you maximum results.

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