Ask any marketer – they’ll tell you that growth is good. But at what cost and for what gain? What defines these costs and how are they interpreted? Can acquiring customers at a loss be profitable? These are the types of questions we can gain insight into by understanding our Customer Acquisition Cost (CAC). In this blog, we’ll look at the basics of CAC, how to calculate it, understand its role in business strategy, and why CAC is just the beginning of the broader customer picture.
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What is Customer Acquisition Cost (CAC)?
Customer Acquisition Cost (CAC) determines the resources (e.g., sales and marketing expenses) required to attract new customers over a period of time.
The general formula for Customer Acquisition Cost is:
CAC = Sales and Marketing Expense / Number of New Customers
This is over a period of defined time (e.g., 2020 in its entirety).
“Sales and Marketing Expense” include things such as:
• Commissions and bonuses
• Overhead costs
• Advertising costs (e.g., commercials, video ads, banners, billboards, physical paper ads, posters)
• Social media costs
• Events costs
• Creative costs
• Technical costs
How to calculate CAC
LTV to CAC comparison is a key metric. LTV or Lifetime Value (also known as CTV or Customer Lifetime Value) refers to the total amount of money your business earns from a customer throughout their relationship with your business.
The calculation is:
CLV = (Average Order Value) x (Sales Frequency) x (Average Retention Time)
For more information see our other blog about LTV here: https://dev.indellient.com/blog/how-to-improve-customer-lifetime-value-in-e-commerce/
• LTV: CAC ratio shows how much customers are worth compared to how much it costs to obtain them.
• A 3:1 ratio is ideal, lower than this means you are only breaking even
• A 5:1 ratio is considered very good and what top companies average, although this can also be considered too high as you may not be spending enough on sales and marketing and may be missing opportunities.
In other words, LTV is the revenue stream and CAC is the Expense.
The goal for a typical company should be to earn back your CAC on a customer within one year. While this is a standard, it’s not the only path to success. This depends on the industry, your revenue model, and the maturity of your company. For instance, your company may be new and may require you to be aggressive when gathering a user base, and sacrificing payback periods if you can land an enterprise-level user or gain market dominance in your sector.
These are basic guidelines and may not fit with the position of your company. For instance, depending on your company’s maturity level, it’s okay to run a higher CAC than LTV depending on your north star metric. (e.g., a higher user base is worth more than the Average Revenue Per Customer).
Balancing and adjusting CAC is vital to managing your business. Your CAC is a variable you can adjust to speed or slow your growth and scale as a company.
CAC doesn’t just have to be used as a sum of all expenses versus new customers. You can complete a more targeted analysis by focusing on specific advertising. For example, a video on YouTube leading to a specific number of leads versus a blog post leading to a specific number of leads. In fact, this is how you should be using the metric to adjust where you’re using your marketing dollars.
CAC can also be refined for a more accurate outlook. Costs such as the cost of goods and the cost of services provided can be added to the sales and marketing expenses. Everything is measurable! There are limitless tools to help you experiment with CAC and different messaging.
CAC within the business strategy
While on its own, CAC can be a defining metric for measuring marketing performance vs spend, it does not tell the entire story. As is the case for most metrics and KPIs: supporting data and understanding the business objectives are paramount.
Businesses pursuing aggressive growth strategies are likely to rapidly acquire customers to establish market dominance. The goal of these hyper-growth companies is to acquire as many customers as possible, thus grabbing as much percentage of the Total Addressable Market (TAM) as possible. Therefore, this strategy favours valuation and market share more than revenue and is typically appealing to well-funded start-ups and iterative micro-transaction companies.
For these businesses, the ratio of LTV to CAC will be something they are willing to accept lower ratios or ignore altogether in favour of campaign effectiveness (number of acquisitions). These businesses with a loss leader strategy might favour metrics such as:
• Adoption rate
• Market penetration rate
• Revenue churn
• CLV to CAC ratio
Businesses in a more mature TAM are more likely to focus on metrics that optimize costs, inspire loyalty, and improve the value and longevity of a customer. These metrics include:
• Customer retention
• Improving CLV
• Achieving a higher average revenue per customer (ARPC)
Data pipelines and the need for a complete customer picture
CAC is simply one piece of the puzzle. It’s a single data point that indicates the customer has begun a journey. While acquiring new customers is always a cause for celebration, most marketing leaders tell you retention and loyalty are the real wins.
That’s why you need an entire customer picture, and for that picture to exist, every touchpoint with a customer needs to be collected and benchmarked against expected outcomes.
To get a complete picture of the customer, let’s look at all the systems a typical organization needs to touch:
• Customer Interest: Ads, Website, Marketing Automation, Email
• Customer Acquisition: Product, Billing, CRM
• Customer Onboarding: Product, Billing
• Customer Retention: Product, Billing, Feedback
• Customer Loyalty: Email, Marketing CRM, Website, Product, Billing
As you can see in the example above, data points from eight different systems are necessary to get a complete picture of the customer journey.
Most organizations can collect data from these systems in silos, but many struggle to connect the dots to see the bigger picture. ZDNet reports that 62% of organizations still use manual processes and spreadsheets like Excel and Google Sheets to stitch together elements from data files and visualize data.
How can an organization retain customers and improve ARPC when it cannot confidently navigate a positive customer experience or measure customer happiness?
That’s where a data infrastructure with pipelines can make a lasting difference. Don’t be intimidated! Data infrastructure and pipelines don’t have to be complex or expensive. Most organizations can get started relatively quickly using their existing excel spreadsheets and a database.
To learn more about getting started with data infrastructure and pipelines, check out our webinar: Breaking Silos: Using Data Integration to Improve Campaign Visibility and Decision Making
Identify and gather the information from the various sources needed to come up with these calculations. Then, present them in an easily understandable and clear way so you can see where your dollars are going. The metrics you use aren’t always apparent and might be unique to the structure of your company. This is where Indellient can help. We possess a wealth of knowledge and experience in data management and data analytics. No matter the maturity level or structure of your organization, we’ll work with you to identify your metrics and strategize a way to work them into your CAC.
Indellient is a Software Development Company that specializes in Data Analytics, Cloud Services, and DevOps Services. Indellient provides custom and embedded analytics solutions to companies of all sizes. To learn more about how your organization can identify and strategize metrics to work them into your CAC, get in touch with us.