Of the many business metrics that are used in the customer success niche, customer acquisition cost (CAC) accounts to be a crucial one. It is CAC that decides the strength of a client base and how to make a profit out of that.
And if you are planning on expanding your business and manifold your revenue, getting hold of CAC and its nitty-gritty is what you should be knowing. Fortunately, you are on the right page. Here is what you shall be veering into today:
- What is Customer Acquisition Cost (CAC)
- Basic CAC Formula
- How to Correctly Calculate Customer Acquisition Cost
- CAC and Customer Success
- CAC Payback Period
- Why Is LTV: CAC Ratio So Useful
- Customer Acquisition Cost by Industry
- How to Improve Customer Acquisition Cost
What is Customer Acquisition Cost?
Customer acquisition cost is the cost to the company for converting a probable prospect into a loyal customer. With the help of this, you can see a comparison between the money you spend on attracting a customer to that of the number of customers gained.
Simply put, the lesser the value is for CAC, the better it is for your company. It shows that your company is judiciously spending money on the right tracks. And you are soon to see a greater return on investments (ROI). Before you learn how to reduce the value, it is imperative to understand the calculation begin customer acquisition cost.
Basic CAC Formula
Customer acquisition cost is designed to show you the finance deployed behind acquiring a single client.
Its basic formula is given by:
CAC: (Cost of Sales + Cost of Marketing) / New Customers Acquired
In most of the B2B SaaS companies, the CAC is driven majorly by two elements. First, is the marketing expense or the cost required to generate a lead. And second, the sales expense, or the cost required to convert that lead to a customer.
Let me give you an example here.
Say, you charged $3000 on marketing on a given month, and $4000 on sales. In the same month, you closed 7 new clients, then the month’s CAC will be:
Customer Acquisition Cost: ($3000 + $4000)/7 = $1000
How to Correctly Calculate Customer Acquisition Cost?
It is a given that CAC is a vital element in figuring how well your company is performing so far. Hence, it is imperative to ascertain how to correctly calculate the same.
To begin with, determine the extent of time that you wish to evaluate. You can take this on a monthly, quarterly, or even yearly basis. This will help you narrow down your scope a little.
Then comes the next step, here you add on your total expenses just from the marketing section. And then add it to the total expenses from the sales section. Once you do that, get hold of the number of customer accounts that you have acquired during this time frame. Add the total expense acquired by marketing and sales and divide the sum by the number of acquired clients.
For instance, you had a total sales expense of $8,000 and $10,000 on marketing expenses. Additionally, you could generate up to 900 new clients. Now let us assume the total time period as one fiscal year. With the value we have, the CAC for your company would be:
($8000+$10000)/900 = 20
As I mentioned, the lesser is your CAC value, the better it is for your company. This metric will also help you unearth vital insights about your overall marketing campaigns, sales, and customer satisfaction figures.
CAC and Customer Success
By now, you would be wondering how come CAC being a customer success metric, does not include the customer success expenses in its calculation. Yes, almost every customer acquisition cost calculation steer away from including the sales and cost linked with customer success.
Even though customer success has the leverage to bring in significant revenue and boost up the scale, due to upsells and cross-sells, it is excluded.
It is because CAC measures your capability to produce new revenue from marketing and sales expenditure. When you input customer success into that, it can lead to inaccurate results, hence, that explains the exclusion.
CAC Payback Period
In simpler terms, the CAC payback period is the time taken by your company to redeem back the money spent on acquiring your clients. It also indicates how much money your company needs to grow on profitably.
Its formula is given by the cost of acquiring a customer divided by the monthly recurring revenue (MRR) in a given period to break-even.
Payback Period = CAC/ MRR (per client)
Let’s assume, the cost required for acquiring a customer is $300, and the average MRR provided is $15. In that case, the payback period will be:
$300/$15 = $20.
That means it will take close to two years for each of the clients to gain profits.
Why Is LTV: CAC Ratio So Useful
LTV stands for Lifetime Value. The LTV: CAC ratio is used to showcase the expense rate for marketing, sales, and customer service too. This ratio is a quick indicator that brings in the relativeness of a customer’s value and the expense behind acquiring them.
It is always better to strike out the right balance in this ratio. This way, you ensure that you are on the right path and making the most out of your financial investments. Ideally, the lifetime value of a customer should be three times the cost of acquiring them (3:1).
Customer Acquisition Cost by Industry
Here are some of the typical industry records given by their respective customer acquisition costs. Also, note that each of these industries spends depends on the average of their sales and marketing used to acquire just a new client. Various sources have been referred to gather these insights.
How to Improve Customer Acquisition Cost
- Gather customer feedback: Whether it is a brand-new facet or a complementary feature to go along with your product, collect some feedback from your clients. This is how you can render value to your customers. Give them your best service, and see how the stickiness bar rises.
- Say yes to loyalty programs and customer rewards: When a client refers you to a lead, who might be interested in using your service, upon conversion, their CAC will be zero. Bringing in these clients will help reduce your overall CAC effectively. Hence, building a loyalty program or deploying a customer reward system will enable your customers to participate in and lessen CAC.
- Rationalize your sales phase: When you reduce the length of a sales phase or duration, you automatically augment the number of sales you can develop over the period of time.
Customer acquisition cost is an important metric that should not be avoided at all. It tells you a lot about how good, bad, or ugly you are performing financially. Hopefully, this blog has walked you through the vital in-bits that is a must in the chapters on customer acquisition cost.