Customer Acquisition Cost

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21 Aug, 2024

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Customer acquisition cost, also known as CAC, is a company's total expense to earn a new customer over a particular period. It measures how much a company spends to make a customer successfully buy its products or services.

It includes marketing expenses, promotions, programs, salaries, commissions, bonuses, and other overheads used to convert a potential lead into a customer. This metric is related to Customer Lifetime Value or LTV. CAC and LTV calculate the value a new customer originates in the business.

What Is Customer Acquisition Cost (CAC)?

Customer acquisition cost (CAC) is the company's expenses to acquire a new customer during a particular period.
It is the total of all the sales and marketing expenses incurred to convert a potential lead into an actual customer.
Ideally, a lower CAC indicates a more profitable business. It reflects a company's effectiveness in its marketing and sales process.
It is instrumental in planning and strategizing cost-effective methods of customer acquisition. As a result, it helps to maintain a good balance between investment and its returns. It is also used to maintain a higher profit margin.

Customer Acquisition Cost Explained

Customer acquisition cost, or CAC, is the money and resources a company spends to convert a potential customer into an actual customer over a specific period. This cost measures the total sales and marketing expenses that go into the process, from attracting a lead to turning them into a customer. It includes programs, promotions, marketing costs, commissions, bonuses, salaries, and other related overheads.

This metric is a crucial factor that determines the profitability of a business. CAC, along with LTV, helps a company identify whether the cost of acquiring a new customer is worth the value they generated in the industry. Companies should ideally keep a low customer acquisition cost. It indicates a higher profit margin. It also shows the cost-effectiveness of a company's marketing, sales, and customer service programs.

CAC is used to identify, target, and attract the right customers in the right way, leading to the company's overall growth. The insights gained from this metric can be used to plan and strategize the sales and marketing process. It helps to identify if the business is viable. If the CAC is not worth the value a customer generates in the industry, it would adversely impact the returns. It helps check the funds spent, ensuring a company can maximize its profits. It is instrumental in maintaining a healthy balance between the company's investment and ROI.

Formula

The customer acquisition cost formula is as follows:

CAC = Cost of sales + Cost of marketing / Number of new customers

Where,

Cost of sales + Cost of marketing is the total expenses incurred for sales, promotions, marketing, and other associated overheads, and

The number of new customers is the total number of customers earned during that specific period.

Examples

Let us understand the concept of CAC with the following examples:

Example #1

Rose Valley is a company that sells cosmetics. Between January-March 2022, they ran several new campaigns, spending $40,000 on sales and $20,000 on marketing their products. During that period, they earned 300 new customers. Thus, according to the customer acquisition cost formula,

CAC of Rose Valley during that period = ($40,000 + $20,000) / 300

= $60,000/300

=$200

Therefore, the cost incurred by Rose Valley to acquire each customer during that period is $200. This is an example of customer acquisition cost.

Example #2

Borzo, a logistics brand, has revealed in its study that human-designed advertisements are more effective than AI-generated advertisements. It ran two ads parallelly on Google, Instagram, and Facebook. AI tools designed one ad entirely, while designers and copywriters created another. The campaign revealed that the human-designed ad was more effective than the AI-designed ad. In addition, although the AI-generated ad had a higher click-through rate, the human-designed ad had a higher conversion rate.

Furthermore, the AI-generated ad had a comparatively higher cash burn. This implies that the human-designed ad had a lower CAC, which is more profitable for the business. This is an example of customer acquisition cost.

Importance

The importance of CAC has been discussed below:

The CAC metric helps to identify the most cost-effective methods of attracting new customers. It allows a business to utilize its resources optimally. This ensures the business can reap the maximum benefits with the least possible investment. As a result, it helps the company maintain a healthy balance between the expenses incurred and its Return on Investment.
This metric is used to plan and implement strategies to minimize costs while increasing sales. It also helps to identify and eliminate the expenses that do not bring about the desired returns. Thus, it is a valuable tool for expanding the company's profit margin. A company's profitability is reflected in its low customer acquisition cost.

How To Reduce?

A few ways to reduce CAC are as follows:

Understanding a customer and his needs helps reduce CAC as they can be attracted to a customized experience per their taste.
Keeping the customer engaged, especially in the earlier stages of marketing, helps reduce the CAC per customer and average customer acquisition cost.
Providing customers with a positive experience with the purchase and after-sales services ensures they return to the company. In addition, this reduces CAC as the cost of attracting a new customer is higher than that of retaining an existing customer.

Customer Acquisition Cost vs Lifetime Value vs Retention Cost

The differences have been discussed below:

CAC is the expenses incurred by a company to convert potential customers into actual customers over a specific period. Lifetime value is the average revenue a customer can originate throughout their account. Retention cost is the expense a company bears to retain its existing customers.
CAC and Lifetime Value are inversely related. Therefore, a lesser CAC indicates a customer's higher lifetime value.
Retention cost is always lower than CAC. Generally, the acquisition cost is five times higher than the retention cost. This implies that retaining an existing customer cost lesser than acquiring a new one.

Frequently Asked Questions (FAQs)

What is a good customer acquisition cost?

There is no specific good CAC. However, the generally accepted idea is that the LTV:CAC ratio should ideally be 3:1. This implies that a business should spend around 33% of the average lifetime value on acquiring a new customer. Additionally, a company should be able to retrieve the acquisition cost within a year.

Are customer acquisition costs rising?

Yes, over the years, the CAC has been rising at a drastic rate. For example, from losing $9 per customer on average in 2013, businesses lost approximately $29 per customer for acquisition. This indicates a 222% increase in the CAC, which has adversely impacted profitability.

What are the types of customer acquisition cost?

CAC are of two types, namely, simple and complex. In simple CAC, the total marketing expenses associated with the acquisition are considered while calculating the cost. In complex CAC, the whole marketing expense, the wages related to marketing and sales, the price of all sales and marketing software used, any other professional service used for sales and marketing, and other associated overheads are all taken into account for the calculation.