We’ve spoken at length about the importance of attracting new customers on this blog. But it’s not just about attracting quality leads, is it, it is also about doing so at a profitable rate that allows you to build a sustainable business.
After all, if it costs more to convert a visitor into a paying customer than what you're making off them, what’s the point?
Understanding your customer acquisition cost (CAC) is at the heart of growing your business in a scalable and profitable way” - Uku CEO, Nathan van Zyl
That’s where customer acquisition cost comes into play.
What is Customer Acquisition Cost?
Customer acquisition cost, or CAC, simply put is how much it costs a business to attract and convert a new customer.
A valuable business metric, CAC is oftentimes looked at in conjunction with a company’s customer lifetime value (LTV) - another metric which measures the value generated by a customer over their entire lifespan with a business.
For more about CAC and LTV, listen to this Growth Machine podcast where Wilson Hung, the Director of Growth for Kettle & Fire, talks about the relationship between the cost to acquire new customers and their lifetime value.
How do You Calculate Your Customer Acquisition Cost?
CAC is calculated by dividing the total cost of marketing and sales (which include advertising and marketing spend, salaries, commissions and bonuses and all overhead costs related to sales and marketing efforts, including tools and software, as well as inventory upkeep, production and publishing costs) by the number of customers acquired over a specific period.
The calculation looks like this:
An example of this calculation for a software company, for instance, will look like this:
Let’s assume a CRM software company spends $30 000 on a marketing campaign. After the campaign, the company discovers that 1 200 new customers started a subscription to their service.
Every year, the company is expected to spend an extra $50 000 on technical and production costs for these new customers.
The CAC for this software company would be:
CAC = ($50 000 + $30 000) ÷ 1 200 = $80 000 ÷ 2 000 = $40
This means the software company spent $40 to acquire each new customer.
At Uku, we use these 5 steps to calculate your total customer acquisition cost. You can also download this free customer acquisition cost calculator to determine your CAC.
Oh, and if you were wondering why it was important to calculate your CAC, here’s why:
“Understanding CAC is critical for businesses of all sizes. However, it’s particularly relevant to startups that are in the early stages of scaling up or trying to woo potential investors. Once you know your CAC, you can evaluate the cost of growing the business and the value each new customer brings. Aside from demonstrating that your business model is sound, CAC can be used to analyse your marketing ROI and optimise your campaigns”
What’s a Good Customer Acquisition Cost?
CACs differ across industries as things such as the length of your sales cycle, purchase frequency, purchase value and customer lifespan can all influence your overall costs.
Below are some average CAC across industry - you can use these as a benchmark to see how your CAC compares. Are you spending more or less than your competition?
In addition, the average CAC for other industries are:
- Retail: $10
- Consumer Goods: $22
- Transportation: $98
- Telecom: $315
- SaaS Companies: $205
- Education Industry: $862
- Business Consulting: $410
A healthy CAC will be in line (or below) industry averages and ideally stand at a 3:1, or higher, ratio against your LTV.
To calculate the ratio, you simply need to divide your LTV by your CAC. You should end up with one of the following equations:
- 1:1 Customer acquisition costs are the same as the income it brings
- Less than 1:1 Customer acquisition costs are higher than the income it brings.
- 3:1 Customer brings more income than the company spends on attracting them.
Of course, the ideal for any company is to have their CAC as low as possible (an industry rule of thumb is 3:1 or 4:1) and their LTV as high as possible to maximise profit and build a sustainable, scalable business.
To do so, let’s look at some smart ways to reduce your customer acquisition cost.
3 Ways to Reduce Customer Acquisition Cost
As a company’s CAC is most directly influenced by marketing costs and conversions, focusing on these factors is your best bet for reducing customer acquisition costs.
1. Launch a Referral Programme
One of the easiest and most cost-effective ways to reduce customer acquisition costs is by starting a referral program to increase conversion rates.
Countless big firms, including Tesla, Dropbox, Uber and Google have launched such programmes with great success.
And what can we say, if it’s good enough for Google, well then it's good enough for us.
How did they do it?
They offered points (a free item) to existing clients who referred new customers. These points could then be used to unlock premium software features. This not only solved for the user by providing more tools and functionalities but also for the company as it essentially functioned as a marketing channel too.
Not only will new referrals drive down CAC but it can lead to your existing clients becoming more invested in your company and products too, especially if they can benefit from the referrals they make, which is why dual-sided rewards work such a charm.
Learn more: How to Build a Customer Referral Program
2. Optimise Your Website and Simplify Your Purchasing Process
While it may sound very obvious the easiest way to ensure you close a sale is by streamlining your purchasing process and making sure it’s as fast, effective and helpful as possible.
That includes optimising page load speed and allowing customers to check out as guests.
A Google survey found that a staggering 53% of mobile website visitors will leave if a page doesn’t load in less than 3 seconds while another study found that a 2-second delay in load time resulted in abandonment rates of up to 87%.
Optimising your pages for mobile and reducing “visitor load”, the amount of visual load, motor load, and cognitive load. Essentially, the amount of work required to use an interface. “The higher the load, the less likely it is that a user will work with your interface” notes e-commerce optimisation specialists Site Tuners.
A simple example of how to make shopping easier for your customers is the ARPU app. The app, which is used by Shopify and other high-growth brands, allows “customers to add items to their next order without going through a checkout process” explains co-founder Wilson Hung.
It increases sales as merchants can send out email notifications to customers before their order is shipped to ask them if they want to add anything else to their cart. It’s simple yet highly effective as it ups the convenience factor for customers.
Overall, ARPU clients have reported $5.9 million in upsells.
3. Shift the Focus from Acquisition to Retention
Another highly effective way to reduce customer acquisition costs is by focusing on customer retention.
Today, it’s a staggering 5 to 25 times more expensive to attract a new customer than it is to retain one. In addition, a nominal 5% increase in retention can mean a 95% increase in profitability, making retention a key factor in reducing CAC.
“What’s interesting about that to me is this idea of being able to understand the full lifetime value of a customer very quickly points most sophisticated advertisers towards activities and strategies that they can do to further the conversation with a customer after the acquisition. So rather than going off and getting a new customer as often as we were before, now the balance seems to be shifting towards speaking to the people that you already have – cross-sell upsell, and improve the relationship” - Rory Capern, advisor to Canadian SaaS companies
Listen to Rory expand on this idea, along with the latest trends in customer acquisition cost reduction, in the podcast below.
Reducing operational expenditure, including CAC, is front of mind for all businesses in this highly competitive landscape we call the 21st century. And while the old adage “you have to spend money, to make money” still holds true today, by knowing where and how you are spending your money and what the returns on that expenditure are, you can ensure that you are receiving the best possible dividends for every Rand spent. By knowing your CAC and LTV, you can better plan marketing and sales efforts to maximise ROI and build a sustainable company.