CAC – an introduction
Each customer you acquire costs money to do so. Making sure that a customer spends more than it cost to acquire them is the basis of profit or contribution.
Understanding how much it costs to win a customer is vital for making your business economics more efficient – and more profitable.
Investors will expect management teams to have a really good handle on their CAC and want it to form part of their regular management information.
What is CAC?
Whether you’re selling sports equipment or enterprise software, each customer that buys from you will have cost you money, either through marketing, sales or both. CAC tells you the cost of acquiring each customer. Understanding your CAC (by channel or cohort) can help you improve your marketing return on investment, profitability, LTV:CAC ratio and overall growth.
Why is CAC important?
Understanding how much each customer costs to acquire is critical to understanding how to maximise overall contribution from each customer. Once you better understand your CAC you can answer much more strategic questions. 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?
Without measuring and regular monitoring it's hard to understand CAC, and hard to make informed decisions.
The dynamics of CAC
While measuring and monitoring CAC is an important first step, a higher CAC isn't always a bad thing. There's a natural relationship between CAC and average order value (AOV) or subscription price and so a higher CAC may actually could be driven or drive higher revenue.
In fact, when assessing customer acquisition cost, it's very relevant to take into account how much revenue you make from that customer across the entire customer lifetime. Comparing the two is known as LTV:CAC ratio.
Monitoring this ratio and relationship can help smooth out what would otherwise be time or geographical cohort fluctuations in CAC that could lead to incorrect decision making.
How do you calculate CAC?
The formula to calculate CAC is:
Customer acquisition cost = Total sales and marketing costs focused on new customers / Number of new customers acquired
CAC worked example
Consider the below sales channels with sales and marketing spend per channel.
It's relatively clear that the most effective marketing channel for this company is web marketing with a CAC of £140.
CAC and attribution
In the above example it's assumed customers have been acquired either offline or online. However, in reality, attributing customer to a specific channel is much harder 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 is shown here.
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 various marketing and sales touch points in order to move them down the sales cycle.
In the absence of simplicity or complete clarity in acquisition channels or sales cycle length, a sensible assumption, applied consistently, should give reasonable CAC that can be tracked over time.
CAC and longer sales cycles
Another important aspect to note in calculating CAC and attributing the acquisition costs to the customer (or cohort of customers) it relates to, is the actual matching of the sales and marketing costs to when the customer has been onboarded and started generated revenue for you. This may very well be different to the accounting.
In a more transactional business, such as an e-commerce business, the result of marketing spend and new customers is typically a relatively short period. However, in some businesses the sales cycle (and cost of acquiring a customer) could be over a number of months.
Where longer sales cycles are involved, there needs to be a mechanism to capture all the related customer acquisition costs to use in the CAC calculation.
Understanding how much it costs to acquire each customer by channel, cohort and/or geography is fundamental for any fast-growth business. It allows management teams to quantify the effectiveness of their sales and marketing channels and activities, inform sales and marketing strategies and gives credibility and confidence to growth assumptions.
Potential investors will scrutinise CAC carefully and without a track record of managing and understanding CAC, they’ll feel future sales predictions are much harder to rely on.
Developing data driven sales and marketing strategies that help you track and understand how your CAC is performing are key to success.