The Cost Of Customer Acquisition
So, you’ve done it. People are actually putting their hard-earned dollars in your hands to get the thing you’re offering. Amazing. Now you’re thinking that your initial launch phase is almost over. You want to go deeper, spin silver into gold.
There’s no shortage of advice out there on how to do it. Maybe you want to create the most incredible promotional campaigns that people will talk about for decades. Perhaps build amazing infographics that go viral and do all the work of getting customers for you. Or it could be that you just want to double down on making your offerings the best you can possibly make them.
Whatever path you choose, you might have a problem that needs to be dealt with sooner than later. Before you do any of that—before you can successfully and strategically begin growing your brand—you’ll need to answer a question:
How much does it cost to acquire a customer?
Not Knowing Your Numbers Is Like Driving 120 MPH With Your Eyes Closed
And instead of gas, you’re burning money.
Having clarity on your numbers is critical to everything you do, because it plays into the core concept of business—get more dollars coming in than you spend. If you don’t know the exact number you spend, then you simply won’t be able to calculate to what extent you’re profitable and to what extent you can grow.
That not only means you won’t be able to create accurate financial projections, it brings with it a whole host of other problems. You won’t know whether to adjust your pricing because you don’t know the cost of promotion you can sustain. Riskier tactics that might have potentially higher return are off the table. Being ambitious with experimenting when you don’t know the hard numbers on each sale would irresponsible.
Let’s face it, you absolutely want to try things that are a little off the beaten path, because if you simply did what all your competitors did, you wouldn’t be able to establish your brand as something different.
The Marketing Power of Knowing Acquisition Costs
If you’re a man who came into adulthood in the United States, you’ve likely used a Gillette razor at some time in your life. For many, that’d be the result of one of the most brilliant marketing campaigns in modern history—the company mails over 2 million men free razors on their 18th birthdays, every year. Sometimes they miss. Consider, however, the costs of doing such a thing, the scale of it.
How can they take such a risk? Mainly because they’ve not only thoroughly tested the tactic on a smaller scale, but because they understand exactly how much money that promotion, and everything that supports it, costs. They know they’ll make their money back on the blade replacements men will buy (which have, sadly, gone notably up in price since the 1950s).
Consider as well the many free trials for enterprise-grade services available to you. Ones you can sign up for today, that would otherwise cost hundreds or thousands of dollars. Or those meal delivery services that give tons of credit on the front end. Or the banks that provide a gazillion miles just for signing up for a credit card.
You cannot know what you can give away to get customers until you know how much it usually costs you to do so. If you find your cost per customer hovers at $100 when you take into account all your marketing, then maybe it’s worth it to simply give people $100 to join.
So, you need to understand your customer acquisition costs (CAC). Now, I don’t want to mislead you—you’re not suddenly going to be able to do everything you dream of doing once you calculate your numbers. But doing so is certainly one of the main prerequisites for innovative growth tactics. While knowing your CACs is not the end-all of your analytics, it will sure as heck make your job a lot easier.
What Is CAC?
Very simply, CAC is the cost you pay to acquire a customer. That’s it.
Now, some of you might be rolling your eyes right now. Why, thank you for writing an entire article on how to do simple division, you think. Except it’s not nearly as easy to calculate CAC as most immediately imagine. And of all the calculations you might be willing to screw up, this ain’t one of them.
For instance, do you factor in the cost of employment as part of your marketing? What about that one-time promotion you did ages ago, the one you’re not quite sure had any impact on your numbers? What about future experimentation and optimization on your marketing funnels, how do you factor those in? That’s a lot of different puzzle pieces to fit together.
The truth is, there’s no “one-size-fits-all” answer to those questions because every company has their own way of measuring CAC. Sometimes, multiple ways. We’re going to go over two of them in this article, one that’ll be your go-to simple number, the other a more overarching figure you can use in your broader strategy.
The Simple Way To Calculate CAC
When you just need a straight cause-and-effect number, this is how you want to do it. Imagine you sell “Service A” online. The equation becomes:
Direct Marketing Costs For Service A / Customers For Service A = “Simple” CAC
This answers one question: What is the cost of actually getting a customer, right now? Everything about the calculation is meant to get you something you can actually use to gauge your current situation.
Here, direct marketing means all the advertising or marketing initiatives you do, specifically meant to promote Service A. So any online ads, press releases, mailings, social media contests, anything you think is meant to directly lead to a sale. And yes, that includes the unsuccessful ones too, because you’ll likely have duds in the future as well.
You’re not factoring in labor unless it is actively required to market your service. So the one-time designer you hired for your main website isn’t included, but the content writer who is constantly producing SEO fuel for search engines is.
In terms of time frame, you don’t want to include everything you’ve ever done in this calculation. The fact that you’re reading this means you’re likely involved in a faster-paced business, and things change. The circumstances you were in last year are probably very different from those you are in now.
Therefore, including that data can skew your results drastically. Again, we want the cost of getting a customer today. Several months of information is usually a good bet, any shorter and your number can run afoul of seasonal variables.
An Example of Simple CAC
Floatstar sells cloud storage to businesses (they don’t actually exist, but we’re going to pretend they do). They offer a $500 yearly plan for unlimited cloud storage with enterprise-grade security.
They have three main methods of getting new clients:
- They advertise online through Google Ads and LinkedIn Ads.
- They have salespeople go door-to-door to businesses in their city to pitch their service.
- They have a generous referral program that brings about one additional client for every two that join.
To calculate CAC, we’ll use the detailed analytics these guys possess via their CRM systems, advertising dashboards, and Google Analytics. This is essential to coming up with the right number (and you, of course, definitely already have this set up). Here’s how we’ll take that all into account.
We’re going to go with a three-month period, and add all the direct advertising costs over those three months.
Direct Marketing Costs (3 Month Period):
Google Ads: $20,000
LinkedIn Ads: $10,000
Salespeople Salaries: $30,000
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$60,000
Now, we simply divide that number by the number of new clients obtained during that period. In this case, 500 businesses signed up. You might wonder about the referrals, but those are already factored into this number. Ultimately, we end up with this:
$60,000 Direct Marketing Costs / 500 New Clients = $120 Simple CAC
Floatstar can be reasonably certain that in the next few months, it will cost them $120 to acquire each new client. That means they are free to explore riskier marketing initiatives, like offering a $100 reward to affiliates who manage to sign up a new business. After all, it’d be cheaper than their existing efforts.
But Sometimes, ‘Simple’ CAC Isn’t Good Enough
That calculation is essentially saying, “Given your current marketing tactics and circumstances, this is your cost per new customer for the next few weeks or months.”
Now, this will depend greatly on what kind of business you run, but in nearly every case that number is not going to be accurate forever. Things change. Seasonal factors and holidays can mess up your numbers. Maybe the method of advertising that’s worked so well suddenly stops working. Or perhaps you yourself try new things that greatly increase (or hopefully decrease) your marketing expenses. You simply can’t predict what the path ahead will look like with any great certainty. But you can guard yourself against the worst.
The simple calculation doesn’t take all those variables into account. Therefore, for long-term planning, you want a more robust, conservative number. This is the number you want to use when you’re thinking up your marketing plan, a critical piece of the growth equation.
How to Calculate a More Comprehensive Metric—‘Strategic’ CAC
We’ll call this “strategic” CAC. The main difference being that it takes into account a far longer time period and more variables. This calculation becomes:
All Marketing Costs For Service A / Customers For Service A = “Strategic” CAC
In most cases, this number will be far higher than your Simple CAC. After all, you’ve hopefully optimized your marketing over the years or months. You’ve likely tried things that haven’t worked before you found your groove. And that’s OK, both numbers have their place.
Instead of adding up only the marketing you’ve done that directly leads to a sale of your service, you want to add up, well, everything. That one-time sweepstakes you did. The cost of building your website. The expense of all the labor required to enable you to do your marketing. Everything even remotely related to getting your service in front of prospects.
The biggest difference in this calculation is the time frame. You want to use data from the longest window you can reasonably use. Years would be ideal. The caveat here is that you do not want to use data that no longer applies. For instance, say you used to sell t-shirts and now you sell do-it-yourself gardening kits. Totally different markets, and pretty much all of that data from before you made that shift is not worthwhile, because those circumstances are unlikely to affect your future operations.
Essentially, what you’re doing with this number is accounting for all the inevitable screw ups, strokes of bad luck, and seasonal variations that might occur.
An Example of Strategic CAC
Let’s go back to our wonderfully hypothetical cloud storage service, Floatstar. They’ve made their plans for the next fiscal quarter, but they want to ensure their goals for the next five years are feasible. What should they budget for marketing, for instance?
So they widen their time frame from three months to two years. They take both costs and customers acquired during that period, and so their numbers might look like this:
Marketing Costs (2 Year Period):
Website & SEO: $20,000
PR: $30,000
Training & Professional Retreats: $15,000
Instagram Ads: $10,000
Facebook Ads: $20,000
Google Ads: $120,000
LinkedIn Ads: $50,000
Salespeople Salaries: $260,000
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$525,000
Again, we divide that number by all clients obtained during that two-year period and get this:
$525,000 Marketing Costs / 3,000 New Clients = $175 Strategic CAC
Floatstar now knows that their cost per new client is unlikely to exceed $175 as a whole, and can use that figure to model future costs and project what they need to grow. By performing both these calculations, they have a figure for current projects and for long-term strategic planning.
But there tends to be a few things you’ll need to watch out for when figuring out your own CAC.
The Common Pitfalls (and How to Step Around Them)
The core issue with calculating CAC is that there is no one-size-fits-all solution, nothing that works for every company. Every team needs to use their own judgement on figuring out what to include in their numbers and what to leave out.
One issue can be people using a simplified formula for CAC when they should really be using the strategic version. It is human nature to believe (and wish) that things that are happening now will continue to happen that way. Especially if those things are good.
But you know that the one thing that is completely unsurprising about life is that it will always find a way to surprise you. Failing to account for the ebbs and flows of fortune and circumstance can lead to you overstretching your marketing budget or coming up with inaccurate projections.
To do all of the above well, accurate tracking and strong data sets are non-negotiable. When you work with bad data, you get bad results…period. The tools you’ll need to ensure accuracy will vary depending on what you sell. Look towards your ad platforms, CRM systems, and balance sheets.
Most importantly, many don’t realize that…
CAC Is Just 1 Piece of the Puzzle
A big one, but just a piece nonetheless. This information ensures you’re not losing money and not doing anything that’ll truly get you in trouble. It tells you what you’re really spending to gain a customer. But what about the other half of the equation?
Knowing what your customer is really spending for your product is just as important. When you understand the lifetime value of your customers, you can start doing really creative tactics that can put you in the red on the front end and make a heck of a lot more on the back end.
The Cost Of Customer Acquisition was originally published on Foundr.
