Every business owner needs to know this.
How much can your business spend to acquire ONE customer?
For example, if you can spend $1,500 to acquire a customer, you have the license to spend up to $1,500 to acquire one customer and STILL breakeven.
Spending more than $1,500 to acquire one customer would result in a negative ROI for your business, while acquiring customers below $1,500 would bring in a positive ROI.
Customer acquisition cost (CAC) is a crucial business metric to ensure you have a profitable customer acquisition strategy and sustainable business model in the long run.
“What gets measured gets managed” – Peter Drucker, Father of Modern Management
Whether you are in the B2B or B2C space, if you know your CAC, you will crush your competitors and acquire quality customers at a faster rate.
And that’s how you win in business!
However, customer acquisition cost isn’t always easy to measure. In this article, we will discuss the step by step guide to help you determine your customer acquisition cost.
This will work for ANY type of business.
So grab a drink, sit back and let’s dive right in!
Customer Acquisition Cost (CAC) Formula
Here is the CAC formula:
(Customer Lifetime Value X Profit Margin) = Customer Acquisition Cost (CAC)
Use this free CAC calculator below for ease of calculation:
Let’s break down each component of the CAC.
Metric 1: Customer Lifetime Value (CLV)
CLV is the revenue you generate from a typical customer over the time span of their relationship with your company.
The key points to note are:
-Price of the product
-Average number of months as a customer
Customer lifetime value = Price of product x Number of months
For example, your initial sale might only bring you $20, but if the customer pays the monthly recurring subscription for 3 years (36 months), your customer lifetime value would be $720 ($20 x 36).
This makes acquiring customers interesting as you can afford to invest more marketing budget to acquire a customer and generate positive ROI months later.
If you have existing historical data, you can analyse the customer lifetime value. If your company is new, estimate the CLV and adjust accordingly in the coming months.
3 Ways to Increase Customer Lifetime Value
The higher your CLV, the better it is for your business in the long run.
Here are 3 ways to increase CLV:
1. Increase Value of Each Sale
Once a customer has purchased your product, the relationship has shifted from a stranger to a customer for your business.
Assuming your product is good, the customer is more likely to continue to purchase other products from you.
Implement upsells, downsells, and complementary products in your sales process to increase CLV.
2. Increase Frequency of Purchases
Increase the frequency of customer purchases by continuously engaging and communicating with them via email or Facebook Messenger.
3. Increase Customer Retention Rates
Acquiring customers mean nothing if you don’t retain these customers.
The lower the retention rate, the lower your CLV.
Provide the best product experience for your customers by knowing their pain points and consistently improve your product to ensure you help solve their challenges.
Use surveys and email to engage existing customers and ask them what features they would like to see in your product.
A happy customer will help spread the word of mouth to your brand and bring you new customers for free!
Metric 2: Profit Margin
The next CAC metric is to factor in the costs and get our profit margin:
-Salaries of marketing and sales team
You can get your profit margin from historical data. If you are a new business, use the industry profit margin as your initial estimation.
For example, if you have a CLV of $720 and your profit margin is 30%, your CAC would be $216 ($720 x 30%).
In this case, your business can spend $216 to acquire ONE customer and still breakeven.
Ideally, if you could spend 20-40% of $216 to acquire one customer, your business will always be profitable in the long run.
Use This Customer Acquisition Cost Calculator to Get An Estimate for Your Business
How Much Should You Spend to Generate a Positive ROI? 5 Key Factors You Must Consider
Following the example earlier, let’s say our CAC is $216.
So next question is, how much of the $216 should you spend?
While there will never be a sure-fire answer, here are 5 key factors to consider:
#1 – Percentage of Ad Spend from Customer Acquisition Cost (CAC)
The easiest method is to allocate a percentage of ad spend from CAC.
20% of $216 = $43.20
40% of $216 = $86.40
60% of $216 = $129.60
80% of $216 = $172.80
For starters, we recommend testing with 20% – 40% of CAC to assess if you can acquire customers from this budgeted ad spend.
#2 – Competency of Sales Team in Turning Leads into Customers
As we are looking at customer acquisition, the sales team play a big role in turning leads to customers.
The competency of your sales team will affect your customer acquisition cost.
Referring to the allocation of the percentage of ad spend earlier:
20% of $216 = $43.20
40% of $216 = $86.40
60% of $216 = $129.60
80% of $216 = $172.80
If your sales team has an average closing rate of 50%, you can afford to pay the following amount to acquire ONE lead.
20% CAC: $43.20 * 50% = $21.60
40% CAC: $86.40 * 50% = $43.20
60% of CAC: $129.60 * 50% = $64.80
80% of CAC: $172.80 * 50% = $86.40
Note: If you are running an e-commerce business, your website is your “sales team” as people purchase directly from the website without having to arrange for a meeting or phone call. This factor is more applicable for B2B businesses.
#3 – Cost Per Click
This would be helpful to determine on average how many clicks do you need to generate one lead.
For example, if your cost per click is $2, and you need 30 clicks to turn a website visitor into a lead, your cost per lead is $60 (cost per click of $2 x 30 clicks).
If your sales team have an average closing rate of 50%, this would mean you need to allocate $120 ($60 / 50%) to acquire one customer.
Cost per click > Cost per lead > Cost per customer.
Once you have invested the ad spend for a couple of months, you would be able to know the following:
- Number of clicks to turn website visitors into a lead
- Sales team closing rate of turning a lead into a paid customer
- Most importantly, the amount you can pay to acquire a customer
These are important data to know before you can scale your business.
#4 – Sales Cycle
Another thing to consider is the average sales cycle of your business.
A common mistake would be to increase the ad spend too soon for businesses with long sales cycle.
Remember, it takes time for ANY marketing campaign to start generating revenue.
If it takes an average of 60 days to convert a new website visitor into a paid customer, you will need to wait 60 days before assessing if you should increase the CAC ad spend.
For example, say you launch a marketing campaign at the start of June with a budget of $20,000. At the end of June, you managed to acquire 200 customers, giving you a CAC of $100 ($20,000/200).
However, 60 days later, your new customers increased to 400. This means that your actual CAC is only $50 ($20,000/400).
This would have been overlooked if the sales cycle of your business was not taken into consideration.
#5 – Timing of Cash Flow
Can your business wait say 6 months before generating a positive cash flow?
For companies with large capital and a focus on customer acquisition, this would not be a problem.
But for small businesses with no funding, it may not be viable to spend a lot upfront to acquire customers.
If cash flow is a problem at the early stage of your business, start off by acquiring lesser customers and focus on increasing existing customer value. As you scale, you can allocate more budget to acquire new customers.
Ultimately, the financial state of your business will determine how many customers you can acquire and still play the game.
You have to answer this: How long can you afford to wait before seeing an ROI for your marketing campaign?
5 Strategies to Reduce Customer Acquisition Cost
Once you have estimated your CAC figure based on the 5 factors above, here are 5 strategies to help you maximize your ad spend, increase conversion rate and reduce customer acquisition cost.
Strategy 1: Improve Website Conversion Rate Using Heatmap & Split Testing
Most websites have a conversion problem, and NOT a traffic problem.
If people are not converting to a lead or sale on your website, it does not matter how many traffic you send to the website, it will be a waste of money.
Discover real-time user behaviour on your website using Hotjar’s heatmap tool. You can get started using their free plan of 2,000 page views per day.
Once you have the recordings of the user behaviour, perform split testing by sending traffic to a few versions of your web page.
Run the split test by changing variables such as product offers, colours, copy, and call to action. Track and measure the performance of your main page before sticking to the best-converting page.
The higher the conversion rate, the lower the customer acquisition cost.
For example, if you spend $100 to send 100 people to your website:
At 40% conversion rate:
Cost per customer = $2.50 ($100/40)
At 20% conversion rate:
Cost per customer = $5.00 ($100/20)
And these numbers will add up pretty quickly to inflate your cost per customer.
Strategy 2: Design a Beautiful and Easy to Navigate Website
Your website plays a big role in displaying your brand.
And you will not get a second chance to make a good first impression.
Use an aesthetically pleasing and beautiful theme to impress your website visitors. If you are using WordPress, we recommend investing in web design and grab a premium theme from Theme Forest.
People are more likely to trust and buy from a nice website than a website that looks cluttered and dull.
Strategy 3: Get Business Referrals
Ask your existing customers to refer businesses to you. Our rule of thumb is to only ask customers who have been purchasing from you for at least 6 months.
Given the frequency of purchase, these customers are likely to be a fan of your product and it’s easier to ask for referrals.
This is one of the quickest way to acquire a customer without having to pay for ads.
If your business is based on recurring subscriptions, you can afford to pay a sales commission of 60% or even 100% for the first month and make your money back in the subsequent months.
Strategy 4: Use Chatbot to Increase Customer Engagement
Have a chatbot on your website to increase customer engagement and ensure they stay on your website longer.
The chatbot can also direct people to the relevant pages on your website.
For example, with the Axcel Bot on our homepage, we can “speak” to the customer without having to be on the live chat 24/7:
Once the website visitors clicked to chat with the bot, they are presented with three options:
Based on the different selection, the chatbot will show pre-defined personalised messages and give the customers what they need.
When people feel like they are involved in the buying process, they are more inclined to purchase.
Strategy 5: Retarget Website Visitors
We have saved the best for last.
Retargeting is a strategy where you capture customers data on your website and show them your ad again when they return to Facebook or other websites. This will enable you to “follow” your target customer around the web.
To capture the data, you need to install the Facebook pixel and Google remarketing tag.
Here’s the guide to set it up:
You can either set it up yourself or pass the instructions to your web developer.
We often require multiple touch points before making a purchase decision. Retargeting helps to automate the follow-up process and convert your website visitors into customers.
Retargeting will increase your conversion rate by bringing back people who had earlier expressed some form of interest in your product.
Another cool feature about retargeting is you will be able to exclude customers who already purchase from you and only include people who left your website without signing up for an offer or making a purchase.
And that’s a wrap!
You now have an estimate of your customer acquisition cost and the best practice to maximize the customer conversion rate.
Once you have sufficient data, you can then tweak and get a more accurate number. Knowing this number will help you estimate your marketing budget, scale your business and avoid a negative ROI for customer acquisition.
If you have any questions, please feel free to leave them in the comments below or email us at firstname.lastname@example.org.