Understanding Customer Acquisition Cost (CAC)
Often overlooked and misunderstood
Everyone wants as many new customers as possible. If you aren’t bringing in new customers, your business isn’t growing. But at what cost do you gain those new customers? Do you know what your cost is to gain a new customer? Have you figured this out? Do you know how to figure this out?
Customer acquisition cost (CAC) is the amount of money a company spends to acquire a new customer. A company’s CAC is the total sales and marketing expenses that it spends to obtain a new customer over a certain period of time. It’s how you’re able to measure your return on investment (ROI) on your sales and marketing efforts of obtaining customers.
If the CAC is too high it indicates that adjustments need to be made in the sales and marketing strategy to reduce costs to acquire customers more efficiently. On the flip side, if CAC is low, that means the company is effectively acquiring customers and the current strategy is working. Allowing for more investment into something that’s already showing success.
There is a formula to calculate your CAC. Start with adding up your total sales team expenses. The salary of sales people, commissions, incentives, bonuses, travel expense etc. Then you add up the marketing expenses. Any advertising and marketing costs you’re spending to acquire new customers.
Then you divide that by the number of new customers acquired over the certain period of time you’re measuring (monthly, quarterly, yearly). This gives you your CAC.
This is an important metric to understand because it’s a reason many businesses fail. Burning through a lot of money or high percentage of revenue to grow isn’t sustainable. Low or negative gross margins isn’t a receipt for long term success.
As the cost to acquire customers increases, it’s becoming even more vital to monitor this metric. The growth at all costs mindset is very hard to maintain and in this current environment, those days may be waining. Inefficient growth eventually reaches the end of the road. You want to drive profitable growth, which drives higher profit margins.
Monitoring Sales Expenses
Another sunk cost within your CAC is employee turnover. Upfront costs and the cost to train are front loaded. Employees payback is returned over time. If people aren’t around long enough to see payback you’re losing money. If you’re constantly hiring and firing you need to review your sales model. Why is this happening? Do you like spending all your time finding, hiring and firing? I sure don’t. Find great teammates, reward them and prosper together.
If your sales team is constantly prospecting and has a healthy pipeline it may be tempting to add more sales people. Instead of adding more to the headcount which increases the sales expense, look to double down on your current producing sales people. The existing reps may have enough capacity to close more sales. Adding more to the headcount could takeaway from your best performing sales people who you want to reward.
This may be a part where you focus on quality over quantity. Revenue and profit over volume and units. Can you improve your margins? Lower CAC, higher revenue per customer brings higher net revenue. Plus more revenue for your best people.
Monitoring Marketing Expenses
CAC allows you to analyze and then it shows the most cost effective ways to acquire customers through your marketing. You should know the CAC of each of your marketing channels and advertisements that you run. The ability to measure marketing more now than ever has brought more focus onto CAC.
All marketing should be measurable in some form. If you’re spending on what you consider unmeasurable marketing, you may have to pause or stop that program to measure if it’s really working. You can always start back up. But you should be able to tell if each form of marketing is profitable and worth it to continue.
Eliminate what isn't working and profitable. This allows you to put more money into what is working. Identify the kinks in your sales funnel and get them out.
Work on improving your tracking of new customers. Where are they coming from? When someone contacts your company and you see they’re not a customer, do you ask, what made you contact us? If in person, try asking what made you choose us? Track where your new customers are coming from.
You’re going to get the I was referred by x. I got your mailing about x. I saw your ad here. I noticed your billboard. This will show you what advertising and marketing methods are your best ROI.
It costs less to keep current customers than it does to find new ones. Reducing the cost to attract new customers helps your company grow and increase its profit margins. Play the long game and remember it’s a marathon, not a sprint.
Do you know your CAC payback? How much cash are you burning to get x amount of revenue? How many months or years does it take to get paid back for your CAC expenses?
This can vary from industry to industry as some have higher CAC costs than others. Also your customer lifetime value (CLV) or lifetime value of a customer (LTV) along with your churn or retention of customers comes into play. I’ll be discussing this in a separate post.
The Coffee Table ☕
Over spring break we took our kids to watch The Super Mario Bros movie. The kids really liked it and my wife and I also enjoyed it. It brought back my childhood memories of playing Super Mario on Nintendo as a kid. The blowout box office success tells that it’s a hit with many and is a great boost for movie theaters.
- who writes wrote a great piece called Scary economists and bad news. She discusses the media scaring everyone about a recession and how you need to keep all aspects of the economy in perspective. Just hand picking bad news for doom and gloom clicks doesn't help.
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