CAC, or customer acquisition cost, is a metric that is rising in popularity. If you have heard “CAC” thrown around, it was probably in the context of making advertising, marketing, and sales decisions. Understanding your CAC can indeed help you make decisions related to sales and marketing, but it is also important for a number of other reasons when it comes to running your company. Here, we will discuss exactly what CAC measures, how it can help you, and limitations to consider when using it to make business decisions.
What is Customer Acquisition Cost (CAC)?
Put simply, your company’s CAC is how much it costs the company to add a single customer. This metric should contain both sales and marketing dollars that were utilized in customer acquisition. Companies use a variety of tools to determine which marketing source a sale came from and, after that point, work further to reach an exact value.
Let’s look at a quick example to illustrate how to calculate customer acquisition cost. You run a radio advertisement that costs you $250, and in the week following that advertisement, you see 50 new sales of your product. (Let’s also assume your sales without the advertisement would have been zero.) Because you paid $250 to get 50 new customers, your CAC for this method of advertisement is $5.
CAC = Sales, Marketing, and Advertising Expense / New Customers
Of course, not all customers cost the exact same amount to acquire. Let’s say you only use direct cold calling to sell to customers. One customer might take 3 calls and a total of 2 hours of sales associate time to convert, while another customer might convert almost immediately. So, even within a single and very straightforward area of sales or marketing, CAC is going to be an average. No two customers will take the exact same amount of your resources to convert, but by finding an average number, you can move forward and make important business decisions.
By finding out how much it costs, on average, to acquire a customer, you are able to budget the cost of growth. This is essential for securing the funding necessary to support growth.
It also allows you to pinpoint which areas of sales and marketing have the lowest CAC. When you answer a survey question asking “Where did you find out about us?”, you are helping that company calculate their CAC by identifying the type of marketing that attracted you. For many types of sales, tracking the most recent marketing source is simple, as you can use software to identify and record where customers come from, whether it be banner ads, blog posts, direct searches, or a variety of other sources. But it’s not always about finding the lowest CAC…
Is CAC Enough?
If you have a one-and-done customer acquisition cost model where a customer makes one purchase from you and you have no reason to expect further business from them, CAC is a fairly straightforward metric. Simply compare CAC to the gross profits of that sale, and you understand the economics of your growth model. Of course, as you know, most business models aren’t so simple as one-and-done customers.
When you take other common business models into account, such as those with repeat customers or those operating as subscription services, things get more tricky. In these instances, the CAC can’t just be applied to the first payment the customer makes to you, as this is not representative of the total revenue you will receive from this customer.
Let’s say, for instance, that you run a subscription software service that is priced at $20/month, and have a CAC of $100. If the customer only uses the software one month, this would be a a terrible return. However, whether this $100 CAC is worth it depends entirely on the customer lifetime. If the customer stays with you for less than 5 months, you won’t break even, but if they stay with you for many years, that $100 was more than worth it. The same holds true for all businesses with repeat customers. The total profits received from a customer over their entire lifetime is Lifetime Value, or LTV (or sometimes CLV).
Customer Lifetime Value = Total Profits from an Average Customer Over Their Entire Life
All that to say, customer LTV is another essential calculation that you need to do when looking at CAC for many business models. This calculation is also an average, as different customers will likely provide different total amounts of revenue over their time with your company. (See our article on Lifetime Value Analysis for details on how to calculate this.)
The ratio of customer acquisition cost to lifetime value that will let you know whether the CAC is acceptable when it comes to these business models. This is often referred to as “The Golden Ratio” because of its importance in measuring growth efficiency.
Determining and Evolving CAC and LTV
The concepts of CAC and LTV are both straightforward on their surface. You need to know what it costs to get a customer to buy from you and you need to know how much that customer will buy over their lifetime. But for most businesses, and particularly new businesses or those trying out new sales and marketing tactics or new products and services, determining these numbers is anything but simple.
The key to determining your CAC and LTV is multifold. Firstly, as with any other calculation, garbage in = garbage out. The better your numbers and your tracking, the more helpful your metrics will be. Using great marketing and sales tracking software, keeping track of your sales and churn records, and otherwise keeping as thorough and accurate a record of your business as you can is essential in getting numbers that are not only more accurate, but also will be more convincing to potential lenders and investors.
Segment your data in several ways that make sense for your business. Common groupings are by cohort, marketing channel, customer type, etc. Understanding the economics of each grouping will help your marketing and sales team better target opportunities.
You should build budgets and forecasts using these values. Use “what-if” scenario analysis and sensitivity analysis to analyze the range of your CAC and LTV and can financially prepare for either good or bad circumstances.
Allow these figures to evolve. See whether your numbers make sense, and if they don’t, do some more work to get them to more accurately reflect the reality of your business. Calculating CAC and LTV isn’t easy, and working with a financial professional can be very helpful.
When Do I Need CAC?
The two primary uses of CAC (and LTV) are evaluating sales and marketing strategies and informing financial decisions. If you can accurately determine what sales and marketing avenues various sales come from, you can make informed decisions about what works best and put more of your sales and marketing dollars there (but see our warnings below.)
As mentioned previously, CAC helps you determine how much money you need to sell, and therefore how much you need to grow. If you plan to grow your business by a certain percent, you need to know that you will have the resources to do so. Particularly in cases where you are going to have to invest a lot on the front end, and it will take some time to pay back that investment through sales, it is crucial to know exactly how much you are going to need.
Lenders and investors want to know that you have taken CAC and LTV into consideration before entrusting you with their money. By demonstrating a carefully crafted strategy and financial projections based around CAC and LTV, you are more likely to get the money you need.
It is also an essential figure for anticipating cash flow, as long payback periods (the amount of time it takes for the CAC to be repaid by sales) mean lower cash flow in the interim. You need to be able to anticipate this and not have the shortage take you by surprise.
Some Warnings When Using CAC
It can be tempting to use CAC to drive your entire business strategy, but don’t lose sight of the big picture. When looking at sales and marketing avenues, remember that it is not always the case that only one touch point got the sale. You may see fantastic results from a targeted sales campaign, but have you been spending time establishing your brand through a long social media campaign that familiarized potential clients with your company? CAC can also ignore the importance of long-term marketing strategies, such as an SEO-focused blog campaign. Take everything into consideration when making choices, rather than immediately cutting anything that can’t be directly tied to a sale.
The same is true when it comes to the products and services you focus on. Remember what is at the heart of your company. Perhaps certain products or services have a low CAC and high LTV, but are there other parts of what you offer that tie everything together or are important in allowing you to offer a full range of products or suite of services? Yes, it is important to cut loose areas of your business that are bleeding you dry, or to halt progress on something you project to cause problems for your cash flow, but continue to think holistically and don’t base everything on one set of numbers.
If you are looking to make more sound financial decisions for your business, consider what an outsourced CFO could do for you. We can help you to determine your CAC and customer LTV, while making sure you fully understand how these metrics interact with other important parts of your business’s finances. Contact us today to learn more.