Customer Acquisition Cost (CAC) Guide: How and why to use it
Customer Acquisition Cost (CAC) Guide: How and why to use it

Defining Customer Acquisition Cost

Customer Acquisition Cost is the measure of the cost to acquire new customers. CAC is essential to understanding the effectiveness of ad campaigns and marketing strategies. The lower the CAC of a business, the more effectively and cost-efficiently it brings in new customers. Therefore, understanding your Customer Acquisition Cost is essential to effective marketing.

This article will discuss both how to determine and how to interpret Customer Acquisition Cost. It will provide formulas for calculating CAC as well as advice on which formulas to use. In addition, the article will explore other metrics that are important to contextualizing CAC, as well as how to calculate these metrics.

Calculating Customer Acquisition Cost

CAC is calculated as a measure of marketing costs and customers attracted via said marketing. Multiple potential formulas for calculating CAC depend on the information you want to gather.

For a more straightforward approach, one that takes into account only one specific ad campaign in a vacuum, Customer Acquisition Cost can be calculated like so: 

CAC = Marketing Cost / Customers Acquired
CAC = Marketing Cost / Customers Acquired

Where marketing cost is the cost of this specific ad campaign, and customers is the number of customers attracted by this campaign.

A more complex or holistic formula may take into account several more factors. An example method of calculating Customer Acquisition Cost like so:

CAC = (Marketing Cost + Wages + Software + Contractors + Overhead) / Customers Acquired
CAC = (Marketing Cost + Wages + Software + Contractors + Overhead) / Customers Acquired

This formula gives a bigger picture look at Customer Acquisition Cost, and is less reductive towards the cost of marketing. While the simpler formula may be useful for understanding the cost-effectiveness of a single ad campaign, this formula allows a company to better measure the effectiveness of their overall marketing strategy.

Essentially, CAC calculation should be manipulated to fit whatever factors a company thinks is best to take into account to give the most accurate picture of their marketing strategy.

The Importance of CAC

An understanding of its Customer Acquisition Cost is essential if a company wants to advertise effectively. CAC allows a company to measure the effectiveness not only of their marketing as a whole, but also the effectiveness of specific campaigns.

Understanding CAC, expanding and building on campaigns with low CACs, and ditching projects with high CACs allows companies to market more effectively.

The goal of advertising is to acquire as many customers as possible as cost-efficiently as possible. Therefore CAC is the ideal metric for measuring the effectiveness of marketing strategies.

Lowering Customer Acquisition Cost

Once a company understands CAC, its next step should be to lower it. A conceptual understanding of how to reduce CAC is relatively simple, especially having seen the equations for calculating it. Naturally, to reduce Customer Acquisition Cost, companies must find a way to increase the ratio of acquired customers to marketing costs.

Essentially, there are two basic ways of doing this. One is to reduce marketing costs without seeing a dropoff, or at least not a significant dropoff in customers acquired. The other is to increase or maintain spending on marketing while increasing acquired customers by an even greater factor. While this conceptual understanding may come easily, a more concrete understanding of how to decrease CAC can be more challenging and more situation-dependent.

Ways to Reduce CAC

Know your customer: Companies that know their target customer will not waste money trying to make customers out of people who are unlikely to be won over. Additionally, even if non-target audience customers are won over, they may not have high customer lifespans.

The importance of customer lifespan will be covered while discussing Customer Lifetime Value. For a more in-depth look at knowing your customer, read our blog post on social media demographics!

Mindfulness of CAC: Being aware of your CAC, especially for individual marketing efforts allows a company to better understand what marketing strategies are the most effective. This awareness allows a company to phase out ineffective marketing strategies while expanding more effective ones.

By favoring effective marketing strategies, companies can decrease their CAC. This means that companies will be able to bring in customers more cost-effectively.

Improve your Product: While this has little to do with marketing, having a good product is important to CAC. Quite simply, if you are selling a good, appealing product, people will be more likely to buy it, and they will be easier and less expensive to bring in as customers.

Additionally, a good product will increase Customer Lifetime, an essential element of Customer Lifetime Value, which will be discussed later.

Going Beyond CAC

While CAC is hugely important, it must be used in the context of other metrics. Another metric essential for contextualizing CAC is Customer Lifetime Value (CLV).

Customer Lifetime Value

Customer Lifetime Value is the amount of money a customer spends on purchases from a company in their lifetime. Comparing CAC to CLV is critical in determining the effectiveness of marketing based on CAC. If a customer’s CLV is lower than their CAC, the money spent to bring in this customer is not worth it, because their CAC is not being recouped in sales and other elements of CLV.

This means that even marketing campaigns with low CACs can be ineffective if they produce customers with low CLVs. On the other hand, marketing campaigns with seemingly high CACs can be effective if the customers they bring in have high CLVs. Essentially, CLV can be used to determine whether the CAC of a customer is “worth it.”

Elements of CLV

  • Customer Lifespan: How long the customer remains a customer
  • Retention Rate: The rate of customers who become repeat customers
  • Profit Margin Per Customer: The average profit margin for sales made to the customer
  • Total Spending: The amount of money spent by the customer over their lifetime

These metrics allow a company to determine the total amount of money made from a customer, their CLV.
By subtracting the CAC from this metric, a company is able to determine their return on investment from their marketing.
By combining CAC and CLV, a company is able to determine whether their marketing has been bringing in customers profitably and sustainably.

For a more in depth look at CLV, check out this incredible resource on Customer Lifetime Value and Customer Acquisition from Qualtrics.

An Example of Combining CAC and CLV

The best way to explain the importance of CLV to understand CAC is to imagine two companies with identical CACs. One company is a jeweler who in the last month acquired 100 customers while spending $5,000 on advertising last month, for a CAC of $50. The other is a shoe store with the same CAC.

While both companies spend the same for each acquired customer, the jeweler has the much more favorable CAC. This is because the jewelers customers have a much higher CLV; each customer will have a far higher profit margin and total spend.

The customers may have similar retention rates and lifespans, but the amount of profit each customer generates will be much higher for the jeweler. This means that despite their identical CACs, the jeweler is acquiring customers in a more cost-effective, sustainable manner.

The Big Picture

Customer Acquisition Cost is an essential metric for all businesses. In tandem with Customer Lifetime Value, it allows companies to measure their marketing and their business model effectiveness. Innovative companies will use CAC to determine who they market to, how they market to them, and how much money they will spend on their various marketing campaigns.

This will allow these companies to refine their marketing strategies based on data that will allow them to make informed, effective decisions that will steer their business in the right direction.

We hope that you find this article helpful. For more tips on how to market cost-effectively, check out this blog post on ROI! Please follow us at Stiddle.com for more marketing blogs like these! Until next time!

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