Recently, I talked to a friend who just started his first e-commerce business.
So, when I asked him how things were going, he seemed pretty enthusiastic. He bragged with an increasing number of visitors, sky-rocketing engagement, satisfying conversion rates…
“Ok, what about profits?” I asked then.
And that’s where his enthusiasm dropped. Somehow, his great-performing freshly started business didn’t really bring the profits he expected for the engagement he witnessed.
After a detailed analysis of his business, we figured out what the problem was.
Not only were his customer acquisition costs at a not so great level but his way of calculating them didn’t resemble at all the real image of his business. He was gaining a large number of customers indeed, but he also kept spending a lot of money trying to attract them.
And he’s not the only business owner to experience this difficulty. Normally, customer acquisition costs can be up to 7 times higher than the expenses of a customer retention strategy. So, if you’re not careful enough, they may get even higher and dramatically jeopardize your performance.
This is why I’ve decided to talk you through the most important things you should know about customer acquisition cost, its calculation, and the main ways to keep it at an optimal level.
What Is Customer Acquisition Cost: Understanding Its Complexity
What makes CAC an extremely important aspect not only in your customer acquisition strategy but in your general business performance is that it helps you figure out the relation between the money you invest and the money you gain by acquiring customers. Accordingly, customer acquisition cost helps you realize how profitable your strategy is, and that’s its main role.
Now, from my point of view, the majority of issues that appear when calculating CAC are owed to focusing on direct advertising expenses only. And customer acquisition cost represents way more than that.
Customer acquisition cost represents any financial investment that you have to make to turn interested people into customers.
So, practically, the expenses of customer acquisition also refer to the salaries of your employees who participate in the new client acquisition, such as marketers, salespeople, copywriters, social media administrators, etc.
How to Perform Customer Acquisition Cost Calculation
If you’re still struggling to figure out how to calculate customer acquisition cost and get a realistic result, here’s what you should know:
#1 Customer acquisition cost formula
To calculate your CAC, you should calculate the total sum of your sales and marketing costs and then divide it by the number of freshly acquired customers.
#2 The structure of your sales and marketing costs
While the formula itself doesn’t seem complicated, my experience has shown that people frequently struggle with defining their marketing and sales costs. Now, to make it easier for you to realize what areas of costs you should consider here, I’m providing you the insight into five major types of expenses that practically every business deals with:
(i) The costs of your advertising campaign
(ii) The costs of the technology used to attract customers (which commonly includes automation, chatbots, help desk software, live chat support, etc.)
(iii)The costs of your human resources working on customer acquisition
(iv)The costs of promotional content creation
(v)The costs of launching your marketing campaign
#3 What not to include in the cost of acquiring a new customer
While you may get to hear that some businesses do include the costs of customer success in the calculation of customer acquisition cost, I firmly believe that you should avoid this practice.
I understand that it may seem relevant as it brings up certain expenses that you’ll have to count on when acquiring customers. However, customer success isn’t precisely a metric that can help you understand your latest conversions. It’s quite the opposite, as it actually primarily focuses on your expansionary revenue.
Now, if you still want to make use of your customer success in the light of analyzing your customer acquisition cost, the only meaningful way that I can recommend is using it to measure your CAC ratio. This way, you can get insight into the efficiency of your acquisition team.
Should You Calculate the Cost of Customer Acquisition Daily
Undoubtedly, the customer acquisition cost is a valuable metric in the long run. Now, periodical calculations aren’t the only way of staying on top of this metric. Moreover, if you want to make sure that your periodical CAC reports show the realistic image of your acquisition strategy performance, you may want to stay on top of your acquisition costs on a daily basis, as well.
So, to make sure you’re handling your CAC calculation properly, work on it daily by monitoring your current acquisition expenses. For instance, these could be:
(i) the daily costs in your sales department, including wages, commissions, etc.
(ii) the ad placement strategy costs if you have a marketing agency working on it
(iii) the payment processing fee on your e-commerce website
(iv)the costs of creative promotional tasks such as creative writing, drawing, designing, etc.
While this daily analysis of customer acquisition cost is not a necessity for all businesses, it can definitely be a great help. By taking care of these tiny pieces of your CAC puzzle in the short run, you obtain more precise and reliable data for your long-term calculations.
How to Know If Your Cac Bring’s the Optimal Results
To be able to realize if your acquisition costs provide the expected outcomes in the long run, apart from calculating it, you should compare it with some other relevant parameters. And Customer Lifetime Value (LTV) is one of the essential metrics to help you figure out if your financial efforts are paying off. This parameter is usually calculated for one to five-year periods and it estimates the revenue you can obtain during your relationship with a customer.
Now, what surprised me about this metric is the fact that only 42 percent of companies measure their LTV properly, so, let me briefly show you steps to follow to get accurate results.
To be able to calculate LTV for a certain period, you have to obtain the value of four essential metrics for the same period, which are:
1. Average Purchase Frequency (divide the number of purchases by the number of unique customers)
2. Average Purchase Value (divide your revenue by the number of purchases)
3. Customer Value (multiply the Average Purchase Frequency by the Average Purchase Value)
4. Average Customer Lifespan (the average duration of your relationship with customers expressed in years)
Once calculated, these metrics can be employed in a simple LTV formula.
All you have to do is multiply your Customer Value by the Average Customer Lifespan.
Interpretation: The value you obtain refers to the expected revenue from an average customer during their lifespan (their relationship with your brand).
Evaluate your acquisition efficiency with LTV to CAC ratio
Contrasting LTV to CAC lets you make your business projections more reliable and realistic. What’s considered an ideal LTV to CAC ratio is 3:1, which means that your customers’ lifetime value should be three times higher than the value of your customer acquisition cost.
However, this ideal ratio is not always easily reachable and that’s why you should be cautious. While you should know that you’re on the right path as long as your LTV value is higher than your CAC, you should also take care not to have your LTV too high, as it would mean that you’re not investing enough and, accordingly, you are losing potential customers.
How Much Does It Cost to Acquire a Customer in Different Industries
Before we get to some exact, real-life examples of customer acquisition costs, you should know that cost per customer acquisition may be extremely different, and it primarily depends on the type of industry you work in. So, if you’re trying to compare your cost per customer acquisition with businesses from different industries or niches, you may be wasting your time.
Now, to help you figure out if your customer acquisition cost is at an acceptable level for your industry, I’ve made a small research on the cost of customer acquisition in some of the major industries. The provided facts are mostly based on Entrepreneur’s research, and here’s what I found:
1. The industries with the lowest customer acquisition cost are travel ($7), retail ($10), and consumer goods ($22).
2. Manufacturing and transportation CAC is below $100, while the cost to acquire a customer in the marketing, financial sector, and hardware industry goes anywhere between $100 and $200.
3. The industries with the highest cost per customer acquisition are the software industry ($395), followed by telecom ($315), banking and insurance industry ($303), and real estate ($213).
How to Achieve Optimal Customer Acquisition Costs: Top Seven Customer Acquisition Measures
1. Use customer support software to improve engagement and conversion rates.
Customer support software consists of diverse solutions that can help increase customers’ interest in your brand and their likeliness to convert. For instance, using live chat, help desk ticketing system, a knowledge base, or a similar solution, you make your brand more open to your customers both offering them your agents’ instant help and letting them find the information on their own.
2. Have in mind your customers’ feedback.
From website visuals to product fixes, no matter what type of change you want to introduce, make sure to first test it with your loyal customers. If they seem frustrated or uninterested, you should definitely consider undoing the changes as they are pretty likely to be unfavorable for your business. Always remember customer feedback is responsible for the continued success of a new business.
3. Make your customers’ conversion path as simple as possible.
Avoid overwhelming your customers with complex processes and slow loading times, as it will only lead you to the increase in your bounce rate. And this will negatively impact the efficiency of your customer acquisition costs.
4. Work on your referral system.
If you establish a great referral system, you’ll be acquiring new customers without really increasing financial investments. Your satisfied customers will be spreading the word about your brand and attracting new potential clients for your business.
5. Prove that your brand is trustworthy.
Apart from creating a strong referral system, adding testimonials, ratings, and other types of social proofs can also increase the efficiency of your CAC. Again, this is owed to the fact that testimonials creation and placement require little to no financial effort while at the same time leading to a significant revenue increase.
6. Create content that attracts customers.
You can’t expect your customers to engage with your website and convert if you can’t keep them entertained. There’s a diversity of ways in which you can try to increase their interest in your brand and tell them your story. Depending on the nature of your business, you can attract them with different types of educational, amusing, or inspiring content which may have a form of podcasts, videos, slide shows, etc.
7. Make smart investments.
If you’re willing to invest in your customer acquisition costs, then make sure to invest in the marketing and sales channels that are proved. Don’t waste your time and money trying to revive your low-performing channel as it may only negatively impact your LTV to CAC ratio.
Customer Acquisition Cost: One of Your Essential Acquisition Performance Metrics
As you can see, you have to be very careful when calculating customer acquisition cost, as its poor calculation and interpretation can have a huge impact on your business performance. So, before you start analyzing this metric within your customer acquisition strategy, be sure that you’ve figured out how to calculate CAC as precisely as possible.
I particularly emphasize this cost selection as numerous businesses make mistakes right at the beginning when deciding what costs (not) to include in their calculation. Consequently, they become incapable of figuring out that their cost per customer acquisition is excessive or insufficient. And I probably don’t have to mention how useless, and even dangerous, the erroneous CAC calculation may become. So, if you want to do things right from the start, you should monitor all your relevant marketing and sales expenses daily and then use them to obtain plausible reports in the long run.
Finally, to take your CAC monitoring to a higher level, I absolutely recommend keeping track of LTV to CAC ratio. With this metric, you’ll easily get to understand how far you are from the optimal CAC performance, as well as realize in which direction you should go to achieve satisfactory performance.