What is customer acquisition cost? How to calculate and improve your CAC
Customer acquisition cost is the amount of money a business spends to gain a new customer. Here’s how to calculate this key metric, plus three ways to improve it.
Published September 23, 2021
Last updated August 19, 2022
Customer acquisition cost (CAC) was on the rise for many companies before COVID-19. According to ProfitWell, CAC for businesses increased by approximately 60 percent between 2014 and 2019. But since the onset of COVID-19, brands have seen a decrease in CAC. McKinsey & Company reports that the shift to digital sales led to 30 percent higher acquisition efficiency for businesses.
Every company wants to decrease the amount of money they spend to acquire new customers, and pivoting to online sales is just one strategy. In this article, we’ll reveal everything you need to know to reduce your CAC and widen your profit margins. First, we’ll define this key metric, then explain exactly how to calculate CAC, and finally offer actionable ways to improve it.
What is customer acquisition cost (CAC)?
CAC definition: The amount of money an organization spends on advertising and sales initiatives to convert a lead into a customer.
Customer acquisition cost describes how much money a company spends to gain a new customer. It helps businesses determine the return on investment (ROI) of their customer acquisition efforts. CAC includes a company’s spending on the following:
- Marketing and advertising: Employee salaries, subscriptions to tools/SaaS, relevant technology (such as data-collection software or Google Ads), production of any creative elements, traditional and/or digital campaigns, etc.
- Sales: Employee salaries, relevant technology (such as lead generation and email management tools), inventory upkeep, travel expenses, gifts for potential new customers, etc.
Importance of customer acquisition cost
Your CAC is a key metric when improving your marketing and sales efforts and analyzing your sales journey. Aside from informing the budget, CACs can also provide valuable insight into potential inefficiencies within a company’s sales funnel. Proper lead management and sales prospecting techniques often translate into a competitive CAC value. But if a phase of your funnel has bottlenecks—such as too few leads coming in—your company may be spending more than average to move more leads through to the next stage. Track acquisition costs by funnel stage to gauge what parts of your sales process have room for improvement.
How to calculate customer acquisition cost (CAC)
The cost of acquiring new customers remains an important sales metric for any company, from scrappy startups to colossal corporations.
The simplest way to calculate customer acquisition cost is by adding up all marketing and sales expenses, then dividing that result by the number of new customers gained during a specific period.
Customer acquisition cost formula
Say Company X spent $150K on marketing efforts and $100K on sales initiatives over the last quarter. During this time, Company X acquired 300 new paying customers. That means Company X’s CAC for that quarter is $833.
The CAC formula helps you gauge whether your company’s money is being well spent, making it one of the essential formulas for sales teams to know.
What is a good CAC?
As with most things in life, a “good” customer acquisition cost is relative. To determine whether your CAC is too high or too low, you need to know the amount of revenue coming in from your existing customers.
For this reason, the LTV:CAC ratio is a better measure of your business’ health than CAC alone. Customer lifetime value (LTV) refers to the amount of money the average customer will contribute to a company over their entire lifecycle, so the LTV:CAC ratio captures expected revenue. An LTV:CAC ratio of 3:1 is typically “good,” though any number of factors across industries can tilt your ideal ratio in one direction or the other.
The LTV:CAC ratio is a better measure of your business’ health than CAC alone.
To calculate customer LTV, multiply your company’s annual revenue by the average customer lifespan (this gives you the revenue earned from one customer). Then, compare it to the initial cost of acquiring that customer.
What factors affect customer acquisition cost?
Like any business metric, there are a variety of factors—within your control and outside of it—that affect your CAC. For example, If you’re breaking into a new market, you’re likely going to have a higher CAC. It takes a larger investment at the start to make your business and marketing strategies profitable in a previously untapped area.
Similarly, the age of your company will affect customer acquisition costs. Established companies have lower CACs because of their tried-and-true strategies, policies, and teams. Newer companies will have higher CACs because they’re still onboarding sales and marketing teams, testing strategies, and establishing their business foundation.
There will always be a learning curve when starting a new business, entering a new market, or embarking on a new strategy. In the short term, these endeavors almost universally raise CACs—but that doesn’t mean they aren’t worth doing. Savvy teams will continue to track CAC metrics so they can ensure that their investments are paying off, and make adjustments if not.
What is the lifetime value formula?
Customer lifetime value (CLV) is the amount of revenue your business generates from each customer throughout a customer’s “lifetime” of purchasing from your company. The formula for calculating CLV looks like:
Say Company Y generates $10K annually, the average customer lifecycle is 10 years, and the CAC is $5K per customer. This means that Company Y’s customer LTV is $95K.
While there isn’t a “right” LTV:CAC ratio, as mentioned before, the agreed-upon sweet spot is at least 3:1. This means that, ideally, you spend approximately 33 percent of the average LTV on acquiring new customers.
H3: How customer lifetime value affects customer acquisition cost
There are many elements of CLV that will affect CAC including:
- The average length of time a person remains a customer.
- The rate of customer retention (what percentage of customers come back and buy again.)
- The average amount of money each individual spends over their lifetime as a customer (the amount each customer spends over their lifetime divided by the number of customers).
- The profit margin per customer (the net income per customer minus the CAC, divided by the revenue from the customer over their lifetime with you.)
- The average gross margin per customer (the profit margin per customer divided by 100 and then multiplied by how much they spend over the course of their lifetime.
When you have accurate information about your CLV, you can better assess what investment in your CAC is worth it. If your customers consistently come back again and again it may be worth investing in more marketing to draw in new buyers, even if your CAC goes up.
How to improve your customer acquisition cost
To improve CAC, you must listen to your target buyer. Pay attention to how leads are engaging with you, and implement feedback from existing customers so you’re better equipped to attract more leads. At the same time, monitor your marketing campaign performance to figure out which aspects of your promotions are working.
Align your sales strategy with your customers’ buying preferences
Consumers’ buying behaviors have become increasingly digital since COVID-19, and businesses are responding accordingly. According to a McKinsey Global Survey, executives have “accelerated the digitization of their customer and supply-chain interactions by three to four years.” Additionally, the speed at which businesses are creating digital or digitally enhanced offerings has increased by seven years, on average.
To engage potential customers, companies need to adopt a digital-first mindset—and fast.
- Give decision-makers online sales autonomy. Recent McKinsey research shows that more than three-quarters of buyers and sellers say they “now prefer digital self-serve and remote human engagement” over in-person sales.
- Don’t shy away from selling big-ticket products and services on the Internet. Of the decision-makers surveyed, 70 percent said they were willing to make new, fully automated remote purchases of $50K or more. Twenty-seven percent said they would spend more than $500K. Try cross-selling online while utilizing strategies like sales process mapping to help plan tactics.
- Embrace digital communication. In 2020, 64 percent of customers used a new support channel—such as video, live chat, or messaging—and 73 percent plan to continue using it. And between April and October 2020, total revenue generated by video-related interactions increased by 69 percent.
By meeting leads where they are and providing them with the digital experiences they expect, you can improve your lead conversion rate and, as a result, lower your CAC. Value chain analysis can also help with B2B lead generation and ultimately, lower CACs.
Keep your ear to the ground
CAC depends on your marketing and sales efforts, but it’s also tied to the quality of your product or service. When your sales team pitches to leads, they’re more likely to see conversions if they’re promoting a product or service that meets the potential customer’s needs and solves their problems.
Attract more leads by sharing valuable feedback from current customers with your engineering and product development teams.
- Listen like you mean it. When customers provide input, it’s important to let them know you’re listening. So, if you hear customer feedback in a sales demo or call, be sure to pass it along to the teams in charge of building your product or improving your service. Feedback can help teams identify areas for improvement, spot emerging customer needs, and incorporate new offerings into longer-term business roadmaps.
- Encourage support agents to share feedback with product teams, too. Strengthen your company’s customer-driven culture by encouraging your support team to send valuable feedback—from survey responses to social media messages—to the product team. From there, product team members can determine what additional features would create more value for users.
By actively listening to your leads and passing along their feedback to the appropriate team, you’re building trust that pays off in the long run.
Analyze available data to maximize ad spend
During this time of economic uncertainty, many businesses have minimized marketing expenses. But even with less to spend, you can find success by monitoring performance on advertising platforms to determine which ones offer the highest ROI.
- Track acquisition costs per marketing channel using the CAC calculation. Instead of dividing the total sales and marketing spend by new conversions, isolate the cost spent on a specific channel—like pay-per-click. Divide that cost by conversions earned within a particular time frame.
- Watch your LTV:CAC ratio. If you’re spending efficiently, your ratio should remain close to 3:1. If it isn’t close to this figure, it’s time to troubleshoot and optimize. You might create new engagement opportunities for customers, provide loyalty discounts, develop a subscription model, or brainstorm other initiatives.
If businesses don’t do their homework, they can end up hemorrhaging money in dead-end marketing channels—significantly increasing the cost of acquiring new customers. Let your data lead the way, and then optimize your campaigns accordingly.
Customer acquisition cost examples
Customer acquisition costs can add up in multiple areas across your organization, depending on your strategies, channels, and campaigns.
- Promotional examples:Some CACs are promotional — general advertising, in-store displays, point-of-purchase promotions, email outreach, snail mail campaigns, sponsorships, online activities, events, etc. For example, a cookie company sponsoring an event with free cookies would constitute a CAC. In this case, the event and the delicious cookies ideally attract new confection-loving customers.
- Online expenses: Social media costs and website maintenance costs are also considered CACs. An IT company running an Instagram campaign that highlights the benefits of investing in tech insurance is a clear example of a cost intended to convert prospects into customers.
- Discounts and pricing incentives: New client discounts and referral discounts qualify as CACs. For example, let’s say you sell farm-to-customer produce boxes and provide every customer with a referral code. When a current customer shares that code with a friend who signs up for deliveries of seasonal vegetables, the $20 discount is a CAC.
- Employee time and wages: The cost of your sales team’s time is an often-overlooked CAC. For example, if an architectural firm pays a member of their staff to bid on designing a new building for a potential client, the cost of their time is a CAC.
- Installation and supply of equipment: Product and service fulfillment often qualify as CACs. One such example would be a satellite TV provider installing a satellite on a customer’s home. If not offset by an additional fee, the cost of installation is a CAC. Similarly, an internet company supplying a router to a customer free of charge would be a CAC.
- Data and analysis: Market research and data analysis are also considered CACs if the acquired data is used to identify and better appeal to prospects. For example, money spent by a hair care product company to conduct a case study on which shampoo works best on curly hair (with the hopes of drawing in more curly-haired customers) would be a CAC.
Acquire customers more easily with a CRM
The tactics for reducing customer acquisition cost all fall under the umbrella of a larger strategy: creating a high-quality sales process. A customer relationship management (CRM) system can help you build a seamless sales process and better understand your audience’s needs.
With an integrated CRM like Zendesk Sell, you can monitor leads and their movements through the sales funnel, automate emails and data capture, discover new opportunities, and track performance. You’ll be better equipped to increase sales pipeline productivity and improve customer satisfaction rates overall.