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

October 7, 2019 in Online Marketing

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. But is customer acquisition only limited to that? Let’s see. 

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 an 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. If this basic principle is not followed, then the calculations are bound to go wrong, and the entire cost calculation will not be accurate. 

how to calculate customer acquisition cost
Source: https://www.wordstream.com/blog/ws/2019/01/10/cac-vs-clv

Let me give you a small example that will make this concept much more clear and comprehensible. Rohit notices that the sum total of the marketing and sales expenses of his business for the period of one month is ₹ 15,000. He then checks his consumer records and sees that his business had acquired a total of 150 customers in that same month (notice the common reporting period). By the formula given above, the customer acquisition cost for that particular month will be 15,000 divided by 150, which equals 100. Thus, $ 100 is the customer acquisition cost for that month. 

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. 

Consumer Acquisition Cost for a Business Model

There are a few aspects that need to be put under reasonable consideration, which is in addition to the product, the market, and the team. The element which I will be mentioning is the fourth and in fact, an 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 cac

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 fully well versed 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.

Summary

One of the most important essential measures of business metrics is Customer Acquisition Cost. It is used to evaluate 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. 

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Rahul Gupta More posts by Rahul Gupta

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