Companies that want to grow and maintain growth for the long term need to understand what it costs them to find and keep customers. Over the course of my career I’ve noticed that there are really only two options for most companies, grow or die. Maintaining the status quo is just something that doesn’t happen. So, for most companies, the option they choose is to grow.
Although growth is critical to company survival, that doesn’t mean that growth at any cost is a good strategy either. The long-term approach to paying attention to the costs of customer acquisition, managing those costs, and trying to reduce costs when you can is the strategy for viability.
What is CAC?
CAC is accounting speak for Customer Acquisition Cost, and there is a formula to calculate what CAC is for your organization.
This is a really important number because if your customer acquisition costs are greater than the revenue a new customer will generate, you’ll lose money and ultimately ring the death knell for your business.
What should be included in the CAC calculation?
Depending on your sales and marketing organization, some of these expenses may or may not apply to you, but this is a good list to consider when doing the CAC calculation.
Marketing Costs
Ad Spend: If you’re spending anything on advertising this would be included in the marketing expenditure. The cost of print ads, digital ads, billboards, or any other type of advertising should be included.
Technology Costs: If your marketing team uses and technology like software to help report on results, that would be considered a technical expense.
Creative Costs: The cost of creating content. If you create content inhouse, this would include any employee salary. If you use an agency or contractor, it would include what you pay them.
Publishing Costs: Any media costs would be included in this number, including the cost of releasing a press release, for example.
Marketing Employee Salaries: The salary expense of your marketing department would also be included in this calculation.
Sales Costs
Technology Costs: Like your marketing team, many sales teams use technology tools in their day-to-day sales efforts. The cost of a phone system dialer might be an expense if your sales team is primarily a phone team. The costs associated with keeping a sales field sales rep on the road (travel, accommodation, meals, etc) would also be an expense that would be included.
Sales Commissions and Salary Expense: Whether you pay your sales team with commissions or with salary (or some combination of the two) those would be factored into the calculation.
Once you have determined your sales and marketing costs, the next step is to count the number of customers acquired. When figuring costs and counting customers, it’s important to determine the time frame for the calculation. Most organizations are tracking their CAC on a monthly, quarterly, and annual basis. It is one of the metrics companies use to ascertain financial health.
What is a healthy CAC ratio?
The Customer Lifetime Value to CAC ratio measures the lifetime value of a customer and that relationship to the cost of acquisition. If you divide the Lifetime Value (LTV) by CAC you’ll come up with a ratio.
A 3:1 ratio is a good place to start. In other words, your average customer over his or her lifetime will generate three times as much revenue as it costs to acquire a new customer. A 4:1 ratio implies that you have a very strong business model, but anything more than that suggests you could be growing faster and likely aren’t investing enough in marketing and sales.
Does your CAC make sense for your business?
There are a number of reasons why your CAC might be higher or lower than optimal. In order to determine how you're doing, here are some questions you should ask yourself.
Are you spending too much money on sales and marketing? If your ratio is low, 2:1 or 1:1, that will be a good first indicator of trouble. You can also look at your marketing and sales process to make sure you are as efficient as you can be. Spend money where it does the most good and regularly test to see if you can improve.
Is your pricing strategy right? Believe it or not, how you price your products or services can make a big difference. Of course, it’s possible to have prices too high, but it’s also possible to be priced so low that potential customers don’t take your products seriously.
How long does it take for your customers to fully engage with your product? The faster your customers can start using your product the lower your acquisition costs will be.
