Balancing the cost of attracting new customers and the value those clients bring to your business can be a challenge. Marketing, sales, and other expenses can increase quickly when acquiring new customers, potentially negating the additional sales revenue they yield.
Fortunately, increasing your entity’s profitability while attracting new customers becomes much simpler when you know and understand your customer acquisition cost (CAC).
Our comprehensive guide will help you get a handle on CAC, including what it is and how knowing what yours is can benefit your business. We’ll also provide practical examples and explore how CAC can be used with other important metrics to help you identify how you can optimize your operations.
What Is Customer Acquisition Cost (CAC)?
You may be able to guess what CAC is just from the name. For complete clarity: CAC the amount of money that a company spends to acquire a new customer.
This metric accounts for all of the expenses – think salespeople’s salaries, marketing and advertising costs, and even utility bills – that your business incurs to convert a prospect into a paying customer.
Why Is Customer Acquisition Cost Important?
Acquiring new customers is costly – especially when compared to retaining existing clients. Knowing your CAC will help you to identify exactly how much you’re spending to bring in new business. Plus, you’ll be able to work out your return on investment (ROI) per customer as well as how efficient your sales, marketing, and other acquisition strategies are.
Working out your CAC (we’ll take a closer look at how to do that a little later) requires you to have in-depth insights into your business’s operating expenses.
Understanding exactly where you’re investing funds as well as the ROI that expenditure drives is extremely useful for identifying ways to streamline or expand your business if the opportunity arises.
How to Calculate Customer Acquisition Cost
Finding the spending sweet spot for acquiring new clients can be challenging. Fortunately, though, calculating CAC is simple. All you need is the CAC formula:
CAC = MCC ÷ CA
Here, MCC represents the total business costs related to acquiring a customer and CA represents the number of customers acquired. Keep in mind that MCC includes all monies spent on bringing in new business.
Of course, you need to identify a specific time period in order for this calculation to provide any meaningful data. It’s usually best to look at a specific month, quarter, or year. Better still, choose three consecutive periods to allow yourself to identify trends and changes.
Types of Costs to Include in a CAC Formula
The CAC formula covers all business expenses that relate to converting a prospective client into a paying customer. To make it easier to understand what should be included in the calculation, you can expand the CAC formula to look like this:
CAC = MCC ÷ CA
CAC = (S + TC + PC + PS + O) ÷ CA
This expanded formula includes all of the relevant expenses – salaries (S), technical costs (TC), promotional costs (PC), creative costs (CC), and overheads (O) – that you need to include in your assessment. Let’s take a closer look at each of these.
Likely the largest portion of your business expenses, salaries include the compensation you pay to marketing and sales employees as well as others who are essential for ensuring operations run smoothly and create a great ecommerce experience for your customers.
Of course, great employees are well worth the investment, but if you feel this figure is too large you may want to consider how you can improve your team’s productivity.
2. Technical Costs
Monies spent on sales and marketing software fall into the technical costs category. A workflow management tool that streamlines processes would be a technical cost. As would payment infrastructure that allows you to accept payments online.
With Pay.com, you can minimize the amount of money you spend on technical costs. Our flat-rate, per-transaction pricing model ensures that you can easily track your fees on your Pay Dashboard – so you needn’t worry about any nasty surprises when calculating your CAC.
3. Promotional Costs
Your expenditure on advertising and marketing campaigns makes up promotional costs. This can include everything from paid advertising spots to product giveaways that are aimed at acquiring new customers.
For example, a $750 spend on Google Ads falls into promotional costs. If you gave away a free product or trial of your service to anyone who signs up for your mailing list, the cost of that product or service would also fall under promotional costs.
4. Creative Costs
Everything you spend in order to create content – think hiring freelancers to write or optimize blogs, buying a camera to take product shots, or even taking your team out for a lunch meeting – falls under creative costs.
This category of expenses can quickly balloon, especially when you’re using the services of consultants, so it’s a good idea to pay close attention to it.
Overheads are the ongoing expenses you incur to run your business. These costs aren’t directly related to your marketing and sales efforts, but you need to cover them to ensure that you keep your company’s doors open.
These expenses include rent, wages or salaries for administrative and other staff; utility, office equipment, and inventory upkeep costs; professional service fees; and others. In most cases, these expenses will be attributed to various areas of your business, so you would need to work out the pro rata amount required to acquire customers.
Customer Acquisition Cost (CAC) vs. Lifetime Value (LTV)
Customer acquisition cost and lifetime value (LTV) are used together to determine whether you’re investing too much – or too little – to acquire new customers.
Also referred to as customer lifetime value, LTV is the amount of revenue that a single customer generates throughout their relationship with a company. To calculate LTV, you need to have the following information on hand:
- Average purchase value (APV): Total revenue over a period divided by the number of purchases in the same period.
- Average purchase frequency (APF): The number of purchases over a period by the unique number of customers who made purchases during that period.
- Customer value (CV): The product of the APV and APF
- Average customer lifespan (ACL): The average period for which a customer makes purchases from your business.
The ease with which you’re able to access this information will depend on your sales and inventory systems. Using Pay.com as your payment service provider, you can track exactly what your customers purchase, how much they spend, and how often they transact via your Pay Dashboard.
When you have the all the figures you need, you can calculate your LTV using the following formula:
LTV = CV × ACL
This will give you an estimate of how much revenue you can expect each of your customers to generate for your company during the course of your relationship. Plus, you can use the LTV to find the ratio between your customer’s value and how much it costs to bring in that revenue.
Customer Acquisition Cost to Lifetime Value Ratio
Let’s consider an example to better understand the CAC:LTV. Adventure Apparel, a bricks-and-clicks outdoor goods store has a CAC of $1,200. Using the LTV formula, it finds that its average customer spends $5,000 over the course of their relationship with the business. This means that:
CAC:LTV = 1,200:5,000
CAC:LTV = 4.17
The general rule of thumb is that your CAC to LTV ratio should be 3:1. Adventure Apparel’s CAC:LTV of 4.12 indicates that it may want to increase its spending on sales and marketing.
Customer Calculation Cost Examples
The various categories of expenses that go into calculating CAC mean that different types of businesses need to pay attention to different variables when working out this cost. Let’s look at a few examples.
Example 1: Focused Fabrications
Focused Fabrications (FF) is a manufacturing company that produces metal sheeting used for roofs. Customers in its sector value person-to-person interactions, so FF employs 20 salespeople at $60,000 per month.
It also spends $10,000 per month on producing adverts and placing them in relevant industry publications as well as $500 on its sales software and $5,000 to rent offices from which its salespeople operate.
From this expenditure, FF acquires 500 new customers for a CAC of $151:
CAC = ($60,000 + $10,000 + $500 + $5,000) ÷ 200
CAC = $75,500 ÷ 500
CAC = $151
Example 2: Happy Homes
Real estate business Happy Homes (HH) sells residential property in California. Its six employees work remotely and are only paid commission on their sales. However, HH provides each employee with a company issued laptop valued at $1,000.
The business spends $5,000 to photograph the homes in its portfolio. It then hires a developer to set up a website and upload the images, which sets it back $10,000. To ensure the properties are seen by potential buyers, HH spends $9,000 on advertising.
All of these efforts result in 60 new customers doing business with HH and a $500 CAC:
CAC = (($1,000 × 6) + $5,000 + $10,000 + $9,000) ÷ 60
CAC = $30,000 ÷ 60
CAC = $500
Example 3: Renegade Remittance
Renegade Remittance (RR) is a payment infrastructure provider. In one period, it spends $50,000 to maintain and improve its product, $30,000 on marketing campaigns, and $20,000 on equipment.
At the end of the period, RR finds that 5,000 new customers have signed up for its services. This results in the following CAC:
CAC = ($50,000 + $30,000 + $20,000) ÷ 5,000
CAC = $100,000 ÷ 5,000
CAC = $20
The Benefits of Working with Pay.com as Your Payment Service Provider
As a business looking to increase its customer base, it’s important that you balance your acquisition expenditure with the revenue that new customers will bring. Doing this will help to ensure that you can grow your client base while remaining profitable.
Pay.com’s full-service payment infrastructure comes equipped with powerful reporting and analytics features. Using your Pay Dashboard, you can track every transaction and cent earned so that you can easily work out your CAC:LTV ratio and make better business decisions.
In addition to in-depth customer insights, Pay.com offers:
- Low fees: Our flat-rate, per-transaction pricing model means that you only pay for what you use, to ensure you keep your costs in check.
- Multiple ways to pay: You can offer your customers a variety of payment methods on your checkout page. This reduces friction and encourages customers to keep returning to your store to extend their LTV.
- Seamless experience: Our developer-friendly API can easily be integrated with your existing website to ensure a seamless experience that builds trust with your customers.
- Secure transactions: Pay.com uses 3D Secure 2.0 to authenticate transactions, so you can be sure your business is protected from fraud and the costs associated with it.
The Bottom Line
Knowing how much it costs to acquire new customers will ensure you’re able to make sound business decisions that increase profits. The CAC is the fundamental tool for assessing the amount of money that your entity spends on bringing in new business.
Using this metric along with others, like LTV, can help you to better understand where you can optimize your operations to drive profitability.
With Pay.com, you can easily track your customer’s lifecycle, including LTV, using the Pay Dashboard. Plus, with the ability to offer your customers multiple payment methods, secure transactions, and a seamless checkout experience to build trust in your brand, they’ll be certain to extend their customer lifespan.