Every company wants to acquire new customers. After all, a steady flow of new business is a healthy sign your marketing efforts are working and your product or service is catching people’s eye. But an expanding customer base doesn’t always translate into an expanding profit. If you’re spending more to attract each customer than they are bringing in, you may actually be losing money.
This is why it’s so important to keep track of your Customer Acquisition Cost. By calculating this metric, you’ll know whether you’re actually turning a profit – and will know when to make plans if you’re not.
Customer Acquisition Cost (CAC) is a business metric that tracks how much it costs you to bring in new customers. This helps you determine whether your organization is making a profit from the new business it generates, as well as measure the efficiency of your sales and marketing efforts.
CAC is often used alongside Customer Lifetime Value (LTV or CLV) in order to measure the value each new customer brings to a business. Ideally, CAC will be lower than LTV, meaning that the customer is bringing in more money than it cost to attract them in the first place. If CAC is higher than LTV, then your business is losing money. This may mean it is time to reduce acquisition costs by reevaluating your sales and marketing strategies.
CAC is an important metric that is simple to calculate. To do so, just take your total sales and marketing expenses, then divide it by the total number of new customers. Here is the CAC calculation:
Total sales and marketing costs ÷ Total # of new customers = CAC
For example, if you spent $5,000 in the past month in customer acquisition and brought in 250 new customers, then your CAC would be $20.
Let’s look a little closer at the underlying metrics used in this formula.
This refers to whatever money you spent explicitly on acquiring new customers. Typically, it will encompass your marketing and sales costs – including program and ad spend, marketing campaigns, bonuses and sales commissions, employee salaries, and so forth. However, you should be careful to separate out the money spent on attracting new customers versus the money spent on retaining existing customers.
The key word here is “new.” Because you are measuring the cost of customer acquisition, you should only be counting the total number of customers you have recently converted.
Although not an explicit part of the formula, you should also consider the period in which you are measuring CAC. This will affect both your total number of new customers and your sales and marketing costs. Typically, businesses will measure out CAC either monthly or annually, as this allows them to compare it against Monthly Recurring Revenue (MRR) and Annual Recurring Revenue (ARR).
Alternatively, you could use the length of your sales cycle. Especially for SaaS companies, new customers are often brought in as a result of leads sourced from several months prior. This means that measuring out your CAC month to month may not accurately reflect the performance of your sales and marketing efforts. Instead, broadening it to capture the correct timing of your sales cycle may give you much more useful information.
CAC is so useful because it can quickly tell you about the health of your business. While it can’t tell you much on its own, when measured against revenue-based metrics like LTV and MRR, it is a great way to assess both the future profitability of your business and the effectiveness of your sales and marketing efforts.
Here are some other ways measuring CAC can help your business:
Your payback period is the amount of time it takes for you to recover the costs of acquiring new customers.
Typically, the goal is to make this period as short as possible. The sooner you can pay back your acquisition costs and start earning profit from each of your customers, the sooner you can start reinvesting that money back into your business.
By highlighting the length of this period, CAC helps you take the first step toward identifying opportunities to increase the profitability of your various channels and make your sales and marketing efforts more efficient.
CAC is much more than a number. By measuring out and allocating a customer acquisition cost of your various marketing efforts, it can simplify the process of determining what is the most effective method of attracting customers.
For example, let’s say you are running three different ads. Each ad has received 50 clicks and converted 10 customers. Without looking any further, it would seem that all three are identical. But when we look at the cost of each ad (measured as Cost Per Click, or CPC), it begins to look different:
Ad 1: $5 CPC x 50 = $250 ÷ 10 customers = $25 CAC
Ad 2: $7.50 CPC x 50 = $375 ÷ 10 customers = $37.50 CAC
Ad 3: $10 CPC x 50 = $500 ÷ 10 customers = $50 CAC
Even though each ad converted the same number of customers, you spent significantly less per customer using the first ad. By considering marketing spend in relation to the number of customers, CAC can help make difficult decisions much easier.
In general, a lower CAC is better for your business – but it’s also important to remember that not all costs are bad. By pairing CAC with LTV, you can optimize your sales and marketing spend to maximize your long-term profitability.
Let’s consider our ad example again. Although the third ad had the lowest CAC, what happens if each ad is targeting different customer segments. We’ll call these segments Mini, Mid, and Max. Because these each of these segments spend different amounts, they have different LTVs:
Mini (Ad 1): $1,000 LTV
Mid (Ad 2): $2,000 LTV
Max (Ad 3): $4,000 LTV
You can compare LTV with CAC by looking at their ratio. To do this, simply divide LTV by your CAC:
LTV ÷ CAC = LTV/CAC Ratio
Using this formula, we can clearly see which has the most profitable ratio:
Mini (Ad 1): $1,000 LTV ÷ $25 CAC = $40
Mid (Ad 2): $2,000 LTV ÷ $37.50 CAC = $53.34
Max (Ad 3): $4,000 LTV ÷ $50 CAC = $80
So for every dollar you spent on advertising to the Mini customer segment with the first ad, you received $40 back. In contrast, you got slightly more back with the Mid segment using the second ad, and twice as much back with the Max segment using the third ad. In other words, although the third ad had the highest CAC, it generated twice as much profit.
Ideally, you want to have a LTV/CAC Ratio of about 3:1. This means the cost of acquiring a customer will only be one-third (or less) of their eventual value.
That 3:1 ratio is often considered the sweet spot to balance investing more in acquisition and keeping it profitable.
Over 3:1: you could spend more on acquisition and might leave growth opportunities on the table
Below 3:1: you either need to reduce CAC or increase LTV as your current costs of acquiring a new customer are making it hard to turn a profit
Knowing how to drill down into this number further can reveal new acquisition strategies that optimize your sales and marketing spend, as well as increase profit. Here are some methods you can use to start analyzing and reducing your CAC:
Segment your CAC. Making your CAC more specific can help you measure the performance of individual segments, identify possible issues, and discover opportunities. There are countless ways you can do this. For example, you could measure the cost of renewing or reactivating customers, the cost of acquiring customers within a specific geographic region, or the cost of acquiring customers for specific products.
Optimize your funnel. Make sure your sales team isn’t wasting time or money chasing down leads that go nowhere. You can do this by analyzing, understanding, and quantifying every step of the conversion process. It should be as simple as possible to convert prospects, website visitors, and other leads into customers.
Reassess your pricing strategy. Are you leaving money on the table? Are there any unrealized opportunities to turn a profit? It may take some experimentation to get right – you don’t want to repel potential customers with high prices or anger existing ones – but optimizing your pricing in order to earn more cash upfront can be a quick way to reduce your CAC.
Implement a customer referral program. Word of mouth has long been the most effective way to bring in new customers. A referral program helps you take advantage of this. Make sure you give your existing customers rewards that will incentivize them to bring you leads, and you can start converting and acquiring new customers at little to no cost.
The ideal CAC varies by industry and the nature of your product, so it's essential to benchmark your CAC against industry standards as well as your own historical data. Generally, a lower CAC means a more efficient sales and marketing process and healthier margins, but it's important to balance reducing CAC with maintaining growth and customer satisfaction.
Customer Lifetime Value (LTV) is the total revenue you expect to receive from a customer throughout their relationship with your company. A healthy LTV/CAC ratio indicates that you're acquiring customers at a cost that makes sense for your business, taking into account the revenue they'll bring in over time. Aim for an LTV/CAC ratio of 3:1 or higher to ensure long-term profitability.
It's important to evaluate your sales and marketing efforts to ensure they're efficient and targeted, but drastic budget cuts can have negative consequences on your customer acquisition and overall growth. Focus on optimizing your sales and marketing strategies, identifying inefficiencies, and improving targeting to reduce CAC while maintaining healthy growth.