What is Customer Acquisition Cost? (How to Calculate CAC & Reduce it)

Often known as CAC, Customer Acquisition Cost is the cost that is accompanied by convincing a potential buyer to buy a particular product or a service. When we think about what is customer acquisition in its actuality, the thought of acquiring or gaining a customer appears in our heads. In this article, we will delve into the world of CAC and learn how to calculate the cost of acquiring a customer.

In this article, we will delve into the world of CAC and learn how to calculate the cost of acquiring a customer. We have mentioned the types of expenses in a CAC formula; they are Ad Spend, Employee Salaries, Creative Costs, Technical Costs, Publishing Costs, Production Costs, and Inventory Upkeep. 

Keep reading to discover tips and insights on reducing CAC and unlocking the potential for sustainable growth. 

How to calculate Customer Acquisition Cost?

The first and foremost step in commencing the process of calculating the Customer Acquisition Cost is determining the reporting period. This is an important step because it lays down the foundation of how a business may typically calculate its costs and how much frequency should a review happen, i.e., monthly, quarterly, bi-annual, or annual basis. The CAC formula is as follows:

CAC = Total Marketing + Sales Expenses / # of New Customers Acquired

While using this formula, it is important to ensure that the values put down in the numerator and denominator must be of the same reporting period. It is essential to follow this basic principle otherwise the calculations will go wrong, and the entire cost calculation will not be accurate. 

What is all-inclusive in Customer Acquisition Cost?

As discussed earlier, the total marketing and sales are the premise of customer acquisition. This is inclusive of:

1. The salaries that have to be paid for the employees engaged in the marketing and sales wing. 
2.  The equipment and resources used by the marketing and sales employees in order to facilitate work. This equipment may include printers, fax machines, cellular devices, or landline sets. 
3. The software applications that are needed for purposes like CRM (Customer Relationship Management) and automation of online marketing. 
4. Advertising and marketing also may need third party agencies or third party consultants for the company’s creative needs. They are one of the main requirements and a vital part of what is inclusive in Customer Acquisition Cost.
5. Advertising and growth of the business, which also includes online ads, digital marketing, SEO, Advertising via television and cable channels, and out of home advertising, door to door sales. 
6. Event management and conferences for advertising of a business. 
7. In respect to the previous point, sponsorship and overhead funds are also required for the commencement and facilitation of events. 
8. Many a time, initially some of the prices are reduced and quoted to a potential customer just so that the customer can be acquired by the company and the business. The discounted price, which is done in these scenarios, is also an amount that is subsequently accumulated and compiled with the customer acquisition costs.

See Also: The SWOT Analysis of Zomato

Types Of Expenses In A CAC Formula

The following are the different CAC costs:

Ad Spend

Your ad spend is the amount you fork over for adverts. Advertising is a terrific strategy to draw in new clients for some firms. Your target audience must connect to your efforts. If you’re unsure whether you’re getting a decent return on your marketing investment, you can estimate its value. You can do it by dividing the revenue generated by advertising by the sum of the campaign’s costs.

Employee Salaries

A good investment is always a great employee. Consider your method carefully if you feel that this cost is too high. Other than imposing pay cuts or laying off employees, there can be various ways to reduce the amount spent on salaries. Chatbots and marketing automation, for instance, can enhance your team’s workflow and raise productivity levels across the board for your business.

Creative Costs

You invest your creative costs in content creation. This may be money you spent on hiring people to help promote your business or on lunch for your team meeting. The production of content includes all of these expenses.

Technical Costs

The technology used by your sales and marketing teams is technical costs. A technical expense can be the cost of a reporting tool you bought to keep tabs on the status of your open deals, for instance.

Publishing Costs

Publication costs are what you spend to make your marketing effort available to the general audience. This can involve the cost of TV airtime, paid social media advertisements, or ad space in a newspaper or magazine.

Production Costs

Production costs are the expenses related to actually producing content. For instance, if you’re producing a video, you’ll need to get a camera, build a set, edit the footage, and so on. These expenses mount up, particularly if you pay a third party to create your content.

Inventory Upkeep

You will need to invest money in upkeep and product optimization even if your company provides software as a service. This expense might include utility costs and facility storage fees for companies that sell tangible goods. To improve the customer experience, you would spend this money on updates and patches if you were selling software.

Examples of the cost to acquire a customer

 Let’s look at several instances that show how to compute CAC.

Example 1: A Software Company

Assume a CRM software provider spends $30,000 on advertising. Following the campaign, the business learned that 2,000 new clients had begun using their service on a subscription basis.

The company anticipates adding $50,000 in annual technical and production costs to serve these additional clients.

For this software firm, the CAC would be as follows: CAC = ($50,000 + $30,000) x 2,000 = $80,000 x 2,000 = $40

This indicates that the software company spent $40 to bring on a new client.

Example 2: A Manufacturer of Consumer Products

Consider a corporation that sells consumer products investing $5,000 in sales and $1,000 in marketing to bring in 1000 new clients. Thus, the following formula is used to determine the company’s CAC:

CAC = ($5,000 + $1,000) ÷ 1,000 = $6,000 ÷ 1,000 = $6

Example 3: A Real Estate Company

Spending $25,000 on marketing and $10,000 on sales, a real estate company that sells duplexes. The company added 70 new consumers as a result of running their commercials.

CAC = ($25,000 + $10,000) x 70 = $35,000 x 70 = $500 for this real estate firm.

Comparison between LTV and CAC

The lifetime value of a customer is one statistic to examine in connection to the cost of customer acquisition (LTV). LTV is the estimated amount of money a single customer will bring in for their relationship with a business.

You’ll need a few inputs for the formula to compute LTV, including

Average purchase value: Compute this amount by dividing the total revenue your business generated in a given period (often one year) by the total number of purchases made during that same period.

An average number of purchases: Divide the total number of transactions by the total number of distinct customers that made transactions during the calculation period to arrive at this figure.

Customer value: Multiplying the average purchase value by the typical buy frequency yields this result.

Customer lifespan average: Average the number of years a consumer has been a customer of your business to arrive at this figure.

The LTV is then determined by dividing the customer value by the typical customer longevity. This will provide you with a ballpark figure for the amount of revenue you can expect the typical customer to bring in for your business for their dealings with you.

As a result, your company’s LTV to CAC ratio, often known as LTV: CAC, provides a rapid indication of a customer’s value about the cost of acquiring them.

Consumer Acquisition Cost for a Business Model

A few aspects need to be put under reasonable consideration, which is in addition to the product, the market, and the team. The element I will be mentioning is the fourth and equally important component of the corporate world, especially start-ups. This is the prerequisite and dire need for a feasible, practical, and workable business model. The viability of a business model is mostly balanced on two major variables, in a major chunk of the business start-ups. The two variables that are balancing factors for a successful business are:

1. The cost incurred to acquire and gain a new customer for the business (acquisition cost)
2. The capability of devising a way of monetizing the customers which are also known as LTV (the Lifetime Value of a Customer)

These measures are very well understood and acknowledged by some of the good standings and established web businesses since they are privy and well versed with how the functionality and facilitation of the work. Nonetheless, there is a lot more value within these metrics, which can be used for all of the other businesses too. Hence, it is a good idea to apply them in other categories of businesses as well as the web-based ones. 

How to Calculate the Cost of Acquiring a Customer and LTV?

To calculate the cost of acquiring a customer (calculating customer acquisition cost), one would need to find the total of the complete costings of the marketing and sales wing of a given time period (also known as the reporting period). This will also be inclusive of the salaries paid to the employees and the other overhead expenses. This sum total would then be divided by the number of customers that were acquired by the business in that same period (reporting period).

To calculate the LTV (Lifetime Value of a Customer), one is required to have a view of the gross margin that the business would expect to monetize out of that customer in due course of the lifetime of your relationship with the customer. Thus, it is important that gross margin takes into consideration any or all installation, support, and servicing expenses. 

Now that we have discussed the premise and the basic information about Consumer Acquisition Cost, we can easily comprehend that a business model or a start-up is failing when we see that the CAC (Consumer Acquisition Cost) has exceeded the LTV. This means that the cost to acquire the consumers has gone par the capability to the business to monetize the same consumers. On the other hand, you will notice that in a balanced and oiled business, the Consumer Acquisition Cost will always be expressively less than the Lifetime Value of the Customer.

The Importance of Consumer Acquisition Cost

CAC is the one vital business component metric that investors and businesses make it a point to look at. A lot of companies end up on the verge of failure of their business because they do not completely comprehend the importance of CAC and what role it is supposed to play in the successful running of a business. Here are some pointers to look into as the deciding factor for your business’s Consumer Acquisition Cost:

• Refining the Return on Investment (ROI) of your business

Getting the hang of how CAC works and comprehending the new costs of acquiring new and prospective consumers is a pivotal part of examining and scrutinizing the return on investment for marketing. 

By adopting CAC, a business is successfully able to regulate and govern the highly economically efficient courses to gain new customers. Some businesses spend a certain amount (for instance, ₹ 500) and gain a particular number of new customers (for instance, 100). When the CAC is calculated in this scenario (500 divided by 100), we see that the Consumer Acquisition Cost comes down to 5.

More often than not, this cost is way less than that which is deduced of commercial events, advertisements, and posters or banners. If similar data is boiled down in the books of some companies, they may prefer to contemplate at least using marketing via social media to engender more and more consumers. 

• Improving Profit Margin and Profitability 

When a business is a privy and up to date with its Consumer Acquisition Cost, it provides the business with the capability to completely scrutinize the value to be monetized per customer, in order to expand and rally its profit margins. 

Ways to reduce the Customer Acquisition Cost

Often a lot of product marketing is easily understood, but some products may require a deliberate and thorough workup by the sales personnel to the potential customer. There may also be scenarios where a customer may ask for a trial of the product using their own personal data just so that they know the authenticity and the working capacity of the product.

With the more complicated products, this request will have to be fulfilled by an installation that will be done on the site by an engineer. This particular action will pull the costs through the roof. Thus, it is very important to understand ways that we can minimize these costs. For instance :

1. Creating and marketing demonstrative videos that will be useful for clearing any doubt which may be there in the minds of the consumers. It will be a self-explanatory tool in this field of sales. 
2. The common sales obstructions, which may subsequently pop up in the cycle of marketing and sales, can be listed, and the answers pertaining to these should be on the web page as FAQs.

FAQs

Summary

Customer Acquisition Cost is one of the most important essential measures of business metrics. It evaluates the prospective costs of gaining a new consumer. In simple measures, it is calculated by adding the marketing and sales expenses and then dividing the sum total by the number of new customers that have acquired in that period of time.

This one-liner definition can provide one with the thorough understanding of what CAC is and how it is so helpful in running businesses. To my point of view, calculating your potential CAC before starting the business can help you plan better. Understanding the role and purposes of CAC can also help a company drastically improve the Return on Investment (ROI) of marketing, the profit margin, and profitability.