Buyer Acquisition Prices: The one metric that may decide the destiny of your enterprise
Customer Acquisition Cost (CAC) is a metric that has increased with the advent of internet businesses and web-based advertising campaigns that can be tracked.
Traditionally, a company had to deal with shotgun-style advertising and find methods to track consumers through the decision-making process.
Today, many web-based businesses can run targeted campaigns and track consumers as they grow from interested leads to long-lasting loyal customers. In this environment, the CAC metric is used by both companies and investors.
As you probably know, CAC is the cost of convincing a prospect to buy a product or service. In this article, we explain the CAC metric in more detail, how you can measure it, and what steps you can take to improve it.
What is associated with customer acquisition costs?
- Advertising costs
- Your Marketing Team Cost
- Cost of your sales team
- Creative costs
- Technical costs
- Publication costs
- Production costs
- Conservation
What the CAC metric means to you
As mentioned above, the CAC metric is important to two parties: companies and investors. The first party includes external early-stage investors who use it to analyze the scalability of new Internet technology companies. You can determine a company's profitability by examining the difference between the amount of cash it generates to customers and the cost of attracting it.
For example, with regard to the upstream oil market, if an oil supply is in an area that requires high infrastructure investments, the amount used to extract the oil may be higher than the market price per barrel.
Investors look at internet-based companies from the same perspective. They are concerned with the current relationship, not future promises to improve the metric unless they can be justified.
The other party interested in the metric is an in-house operations or marketing professional. They use it to optimize the return on their advertising investments. In other words, if the cost of attracting money from customers can be reduced, the company's profit margin will improve and greater profit will be made.
Investors are more interested in providing the company with the resources they need, partners are more focused on growth, and the company can leverage the improved profit margins to pass the value on to its customers for greater market position.
How to Measure CAC
Basically, the CAC can be calculated by simply dividing all the costs of acquiring additional customers (marketing costs) by the number of customers acquired in the period in which the money was spent.
For example, if a company spent $ 100 on marketing one year and acquired 100 customers in the same year, their CAC would be $ 1.00.
There are some limitations to using this metric that you should be aware of when applying it.
For example, a company may have made early-stage investments in marketing in a new region or in SEO that they expect to see results in a later period. While these cases are rare, they can tarnish the relationship in calculating the CAC.
It is recommended that you make several variations to accommodate these situations. However, we will provide some examples of calculating the CAC metric in its most pragmatic and simplest form using two examples. The first company (example 1) has a bad metric. The second (example 2) has a great one.
Example 1: An e-commerce company
In this example, let's take a fictional e-commerce company that sells organic food. The company spent $ 100,000 on advertising last month and its marketing team said it had placed 10,000 new orders. This suggests a CAC of $ 10, a number that in and of itself has no meaning.
If a Mercedes-Benz dealer has a CAC of $ 10, the management team will be happy about the year-end.
In the case of this company, the average customer order is $ 25.00 and the markup is 100% for all products. This means the company makes an average of $ 12.50 per sale and generates $ 2.50 from each customer to pay for salaries, web hosting, office space, and other general expenses.
While this is the quick and dirty calculation, what happens when customers make more than one purchase in their lifetime? What if they stop shopping at brick and mortar grocery stores altogether and only buy from this company?
The purpose of Customer Lifetime Value (CLV) was specifically designed to address this issue. You can find a CLV calculator by simply searching your favorite search engine. In general, this metric will help you gain a better understanding of what customer acquisition costs mean for your business.
The $ 10.00 customer acquisition cost can be quite low if customers buy $ 25.00 every week for 20 years! However, in this ecommerce company, they struggle to keep customers and most of the customers are only making one purchase.
Example 2: An online CRM (SaaS) software company
The company in this example provides an online system for managing sales contacts for customer relationship management. The cost of distributing the software is low because it is cloud-based and customers require little support.
It is also able to easily retain customers as customers would have trouble uploading all of the contacts, tasks, and events they are tracking to new CRM software.
The company has worked its way up the search engines and has a knowledgeable sales team who work for a minimum wage and operate from their call centers in a rural Midwestern town.
The company also has many strategic partnerships that ensure constant customer supply. In fact, they only spend $ 2.00 to get a new customer with a lifetime value of $ 2,000. Here is the calculation:
- Total Call Center Cost of Selling New Customers: $ 1,000,000 / year
- Total cost paid per customer to strategic alliance partners: $ 1.00
- Total Monthly Search Engine Optimization Spend: $ 20,000 / year
In total, new customers were generated in the year: 1,020,000
Customer Acquisition Cost: ($ 1,020,000 / 1,020,000 customers) + $ 1.00 per customer = $ 2.00
As in our previous example, the amount is only worth the money that has been withdrawn by customers. This company used a loyalty calculation to find the Customer Lifetime Value (CLV) of $ 2,000.
This means that this company is able to convert a $ 2.00 investment into $ 2,000 in revenue, which is attractive to investors and signals to the marketing team that an effective system is in place.
What about CAC per marketing channel?
Knowing the CAC for each of your marketing channels is what most marketers want to know.
When you know which channels have the lowest CAC, you know where to double your marketing spend. The more you can divide your marketing budget into lower CAC channels, the more customers you can get for a fixed budget amount.
The simple approach is to split up your spreadsheet and collect all of your marketing receipts for the year, quarter, or month (however you choose to do that) – and add those amounts by channel.
For example, how much did you spend on Google AdWords and Facebook advertising? In that case, you can put this in a column called "PPC" or "Pay-Per-Click". How much did you spend on SEO and blogging? This could go into a column called Inbound Marketing Costs.
Now that you know how much you spent on each channel, you can use a simplified formula and assume that each channel “worked” to get the same number of customers as the next channel. This would be an averaging method.
The only problem is that it can be difficult to know which channel is responsible for which customers. You can easily see where this approach becomes useless.
For example, let's say you only ran one pay-per-click ad in a day – just as a test. You spent a total of $ 10 and that's all. If you look at your spreadsheet, Pay Per Click seems like the best marketing channel because of its extremely low CAC. It would be unwise to double up Pay-Per-Click knowing that you really haven't used it all during that time.
For e-commerce companies selling physical products, it is easy to see which pay-per-click ads lead to direct sales due to the conversion tracking method provided by the advertising platform.
In this case you can determine this value and note it in your table. That way, you will get a better idea of how your pay-per-click campaigns are doing in relation to the rest of your marketing spend.
With tools such as customer analytics, you can also trace paying customers back to their “last touch” attribution source. This means that you can see the last channel the customer visited before making their first sales with your online business.
For example, if a customer comes from an organic search result, you know that SEO is responsible for that customer acquisition.
This is where marketing becomes philosophical.
One mindset is that each marketing channel supports the next channel – it's a combined effort. Your blog posts reinforce your pay per click ads, and all channels work together to get customers.
This is a common term used in outdoor advertising. Billboards amplify TV campaigns, amplify radio spots, and so on. Ultimately, it depends on the philosophy of your own company as to how customer acquisition can be assigned.
If you think the last touch is “good enough,” you can use this model for your CAC calculations.
However, you may have extremely popular viral videos (think Dollar Shave Club) or a blog that generates a lot of word of mouth recommendations. These obviously support all of your marketing efforts and are usually more difficult to track and relate to customer acquisition.
How you can improve the CAC
We all want the cost margins for customer acquisition to be like Example 2. The reality is that our advertising campaigns can always be more effective, customer loyalty can always be improved, and more and more value can be deprived of consumers. There are several methods your company can use to improve customer acquisition costs in its industry:
- Improve on-premise conversion metrics: You can set goals in Google Analytics and A / B split tests with new checkout systems to reduce cart abandonment and improve landing page, website speed, mobile optimization and other factors to improve the overall performance of the website.
- Improve user value: By the highly conceptual term “user value” we mean the ability to generate something that users like. These may be additional functional improvements / qualities that consumers have expressed interest in. Something may be implemented to improve the existing product for better positioning, or new ways to make money with existing customers may be developed. For example, you may find that customer satisfaction ratings have a positive correlation with retention rate.
- Implement customer relationship management (CRM).: Almost all successful companies with repeat buyers implement some form of CRM. This can be a complex sales team that uses a cloud-based sales tracking system, automated email lists, blogs, loyalty programs, and / or other techniques to track customer loyalty.
Customer Lifetime Value
In addition to knowing your customer acquisition costs, you should also be interested in knowing the value of your customer lifetime. This infographic will help you.
Would you like to learn more about LTV? Check out this video:
Conclusion
Measuring and tracking customer acquisition costs is important for both investors and your company.
Investors can use CAC to decide whether they think your company is and will continue to be profitable.
Companies can use it to allocate resources and funds, strategically plan marketing campaigns and support them in their hiring and salary process.
We'll help you identify factors that should be included in your CAC calculation or other digital marketing guides.
About the author: Chase Hughes has six years of consulting experience and three years of private equity experience for large multinational corporations and emerging startups. He is a founding partner of a service that creates debt and equity business plans for startups.
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