Today’s challenge is to answer two questions every business owner asks themselves which are:
- How much does it cost to acquire a customer? and
- How long does it take to recover the cost of acquiring a new customer?
Pay too little and the customer will go elsewhere; too much and you’re wasting money. So how much is enough and what costs should you include?
Each customer that buys from you will have cost you money through marketing, sales and onboarding.
Understanding how much each customer costs to acquire is critical to understanding how to maximise overall the contribution from each customer. Once you better understand your CAC you can answer much more strategic questions such as:
- Are there ways you can reduce CAC?
- Are there more efficient marketing tactics or channels you could be using?
- Are you effectively reaching your target market or is there inefficiency in the way you attract customers?
- Should you be investing in more targeted paid advertising? Or doing more direct selling?
And when assessing customer acquisition cost, it’s important to take into account how much revenue you make from that customer (or the average of all your customers) across the entire customer lifetime. Comparing the two is known as CLV:CAC ratio.
The formula to calculate CAC for your business as a whole is: Total marketing and sales costs / Number of new customers acquired.
This calculation gives an overall estimate of CAC, but in reality, attributing customers to a specific channel, although harder, is far more useful for decision making purposes e.g. an offline customer may have seen your web marketing, signed up to your newsletter and had a number of other touch points before signing up at an event. In this instance, the CAC for this customer would actually be higher than the average.
The same attribution dilemma applies to various online channels too.
For CAC to be sufficiently accurate, there needs to be a way in which to measure where customers are coming from and the various marketing and sales touch points needed in order to move them through your sales system .
In the absence of simplicity or complete clarity in acquisition channels or sales process length, a sensible assumption, applied consistently to each channel, should give a reasonable CAC for each channel that can be tracked over time.
The next stage is to calculate the CAC payback period to measure how quickly your customers contribute to profit after the initial cost of converting a lead into a customer. This calculation is based on the gross profit generated by the sale.
The longer the payback period, the more pressure is being put on your borrowing requirements. Therefore, shortening your payback period will free up capital sooner.
This is what the CAC payback period looks like for a CAC of £140 which generates the that amount of gross profit over six months:
So, your nine ladies dancing challenge is to calculate your overall CAC and, if you have the data, your CAC for your primary marketing channel.
Now compare that with the revenue you generate from the average of all your customers across the entire customer lifetime (CLV) to calculate your CLV:CAC ratio.