CAC: how to calculate the cost of customer acquisition

What is Customer acquisition cost?

Customer Acquisition Cost (CAC) is the total cost of a new customer. In other words, it is the amount that each new customer costs. It's important to analyse CAC in the context of different marketing channels to properly assess their effectiveness.

CAC is often mistakenly confused with CPA (cost per action). CAC focuses on the cost of acquiring a customer, while CPA reflects the cost of a specific action taken by a user.

Consider the example of an online cinema that offers personalised movie selections based on user interests, with a $10 per month subscription that provides unlimited access to high quality movies. Without a subscription, access is limited to free movies without personalised selections.

If two advertising campaigns are launched, one to sign up to the service and the other to purchase a monthly subscription, the cost of user acquisition for the first campaign is classified as CPA (cost-per-action), while for the second campaign it is classified as CAC, since each new customer pays for a subscription.

In short, CPA refers to the completion of an action and CAC refers to the acquisition of a paying customer.

Why calculate the cost of customer acquisition?

Determining the cost of customer acquisition (CAC) is key to developing a marketing strategy, evaluating the performance of different promotional channels, and adjusting and optimising marketing spend to maintain the customer base without unnecessary financial outlay. This indicator has a direct impact on financial health and business development.

How is the CAC calculated?

There are two ways to calculate CAC: simple, to simply estimate it, and advanced, to find a specific figure and work with it.

Simple level

The basic formula for calculating the cost of customer acquisition (CAC) is an effective tool for assessing the effectiveness of marketing efforts. It allows you to obtain an indicative figure to help you make decisions about investment in advertising.

To apply this formula, first select a period for analysis, for example one month. Next, add up all the marketing spend for that period and determine the number of new customers acquired as a result of that spend. The cost per customer is calculated by dividing the total marketing spend by the number of new customers.

For example, if you acquired 40 new customers in a month and your budget for an advertising campaign was 50,000 UAH, the cost of acquiring one customer is 1,250 UAH (50,000 UAH divided by 40). This metric is important for analysis, but it requires additional interpretation to fully understand its meaning in the context of your business.

It's important to note that this basic formula only gives a general idea of the cost of customer acquisition and doesn't take into account many other factors that can affect the effectiveness of marketing investment, such as the quality of customers acquired, long-term customer value (LTV) and other important metrics. Therefore, while this formula is a useful tool for quick analysis, more detailed analysis may be required to gain a deeper understanding of the effectiveness of marketing efforts.

Why doesn't the simple formula work?

When it comes to attracting customers, the costs often exceed the fixed budget for an advertising campaign. It is important to consider not only the overt costs, such as the advertising budget, but also the hidden elements, such as the salaries of specialists, the cost of subscriptions to specialist services they use, and other related costs. These additional costs are often substantial and have a significant impact on the true cost of customer acquisition (CAC).

It's also worth noting that CAC is calculated separately for each marketing channel, which requires different specialists, software, outsourcing services, etc. It is therefore more efficient to use a more complex formula to calculate CAC in order to accurately account for all possible costs.

Advanced level

This formula is more complex and requires knowledge of many other indicators.

CAC = (advertising costs + staff salaries + software costs + ancillary costs) / number of new customers

So you still have 50,000 UAH and 40 new clients. Let's calculate the CAC for targeted advertising. First, let's list all the costs:

• the salary of a marketer who set up advertising was UAH 30,000;
• the campaign budget is UAH 50,000;
• subscription to the social media promotion service - UAH 2,475;
• outsourced copywriting services - 3000 UAH.

Obviously the result will be completely different now:

(30000 + 50000 + 2475 + 3000) / 40 = 2136.8 UAH

This number can already be used for analysis.

What is a good CAC?

It all depends on the size of the average cheque and the volume of business. For example, if the average cheque in your business is $30, then a CAC of $35 could be a sign of serious problems. At the same time, if the average cheque is $1,000, a CAC of $35 could be considered a good indicator.

The cost of customer acquisition is directly related to the lifetime value (LTV) of the customer. Understanding the balance between how much you earn from each customer and the cost of acquiring them is a key aspect of business performance management.

How do you reduce the cost of customer acquisition?

Our goal is to reduce the cost of customer acquisition without reducing the size of your paying audience. While there is no one-size-fits-all solution, there are strategies that can point you in the right direction.

Work on conversion

Experiment with anything that lends itself to testing: run A/B tests, tweak your lead generation process and track views and abandoned carts. Initially, expect your cost per acquisition (CAC) to increase - you need to be prepared for this. Over time, however, you will be able to identify and focus on the most effective engagement methods for your business.

Increase loyalty

Listen to the needs of potential customers: improve your product, be open to feedback and work actively on your brand. This does not require significant financial investment (and is not included in the cost of customer acquisition), but can significantly improve the perception of the business. In addition, customer loyalty is a key element of customer retention, which is also an important consideration.

Automate processes

Integrating a Customer Relationship Management (CRM) system will allow you to get closer to your customers by providing deeper knowledge about them and improving communication. This will help to reduce the time needed to develop offers that encourage purchases.

In addition, the development of an automated sales funnel will allow you to engage users, convert them into paying customers and reduce acquisition costs by reducing the need for human resources.

Conclusion

To effectively manage customer acquisition costs, you should take the following steps

• List all the tools and resources you use to promote through each marketing channel, and then determine the total cost of those resources.
• Calculate the cost per acquisition (CAC) for each channel. Identify the most effective channels and those that are not delivering the expected results. Consider reallocating budget from less effective channels to more effective ones.
• Calculate customer lifetime value (LTV) and the ratio of LTV to CAC. This ratio should be greater than or equal to 3; if it is not, it indicates potential problems.
• Set a timeframe for regular reviews of these metrics. Analyse changes in dynamics between periods and take appropriate corrective action to improve results.