What is your Customer Acquisition Cost (CAC) and why is it important to know?
Many businesses think about common elements when starting or running a business- they know they need a suitable and experienced team, a product/service that fits in the market, and capital to maintain their day to day operations. While all of these are very important, perhaps something that most business owners miss is the cost of doing business, or more specifically, knowing their customer acquisition cost. A lot of businesses tend to fail because they do not understand just how much it costs to turn a prospect into a paying customer, and most of the time, they don’t spend enough for marketing their business.
To make sure that your operational dollars are spent efficiently, you should be calculating your CAC before starting any marketing strategies.
Another component that is important to understand is your customers LTV. More precisely, how much your customer is worth (in terms of revenue) to your business- the amount of revenue one customer can bring to your business in their lifetime. This is referred to as Lifetime Value (or LTV). For some business models, this may be a single large transaction, for others this may be numerous transactions over a period of many years.
In order for any business to be successful, the CAC needs to be significantly less than the LTV (think Expense – Revenue).
How to Calculate CAC
Calculating your CAC is straight forward. All you do is take your costs associated for bringing you your sales (marketing expenses) over a given period and divide it by the number of new customers that you acquired over that same time frame. Your total costs associated with acquisition would be any marketing expenses you spent in a given time, such as: search engine marketing, social media marketing, mobile advertising, promotional flyers, banners or newspaper ads.
For example: let’s say you spent a total of $5000 on your marketing and you acquired a total of 50 new customers
$5,000 ÷ 500 customers = $100 to acquire each customer (cost per conversion)
How to Calculate LTV
The LTV of each customer would be the amount of revenue you would expect from that customer over the course of your entire business relationship with them. While this figure can vary, every business should still be able to track how much revenue they are generating vs how many customers are required to generate that revenue. The key to calculating LTV is to know how much each customer spends on average over the lifetime of your business relationship.
LTV = Net Profit/Number of clients over a period of time
For instance: if you are the owner of a business and you know that one customer can bring in revenue of $2000 over the course of 1 year (or however long you think they will be your customer for) you can see that a $100 investment per customer is well worth the $2000 value. If however one customer will only bring you $120 of revenue for that year, the $100 dollar CAC may not be worth it.
Your costs will vary pending on the products and services you offer, the type of industry you are in, and the nature of your business. It’s very important to know your customer acquisition cost before allocating a budget towards marketing.
What Next?
Once you determine your CAC and LTV, you will then be in a better position to decide how much you should be allocating to your marketing budget.