Recently while mentoring, a business owner asked how to calculate the customer acquisition cost (CAC) and customer lifetime value (CLV). CAC is the cost incurred in acquiring a new customer. The first step to creating a customer acquisition strategy is to understand your customer acquisition cost (CAC). CAC is the cost of acquiring a new customer through marketing and sales efforts. It is an important metric that helps businesses understand the return on investment (ROI) for marketing’s customer acquisition efforts. CAC is calculated by dividing the total sales and marketing expenses by the number of new customers acquired.
- Here is a simple example: if an Instagram page brings in 50 customers a month and marketing spent $500 creating content then the customer acquisition cost would be $10: marketing cost ($500) / new customers (50) = CAC ($10 per customer)
- By calculating the customer acquisition cost, a business can gain understanding about the profitability of their marketing approach. Using the previous example, if each customer is spending $50 on average on their first purchase from your business and the gross profit margin on each order is 50%, the profit would be $15 on each order: (average order value ($50) x gross profit margin (50%)) – customer acquisition cost ($10) = profit ($15).
Customer lifetime value (CLV) is the estimated revenue a customer will generate for a business over the course of their lifetime. CLV can be calculated by multiplying the average purchase value by the number of purchases a customer makes in a year and then multiplying that figure by the average customer lifespan.
- For brands with a higher customer lifetime value (LTV), it may be a sound strategy to have an unprofitable customer acquisition cost on the first purchase.
- In other words, when the customer data suggests that acquired customers will likely continue buying from the business after the initial purchase, the business adopt a marketing strategy to spend more to acquire each new customer.
To use CAC and CLV effectively, businesses can:
- Compare CAC to CLV: If CAC is lower than CLV, it is a good sign as it means the business is spending less to acquire a customer than the revenue that customer will generate.
- Identify profitable customer segments: By knowing CAC and CLV, businesses can identify which customer segments are the most profitable and allocate resources accordingly.
- Optimize marketing and sales spend: By monitoring CAC and CLV, businesses can make informed decisions on where to allocate marketing and sales resources and adjust their strategies accordingly.
- Improve customer retention: By knowing the value of each customer, businesses can focus on improving customer retention and maximizing the CLV of each customer.
Here is some research to provide a better feel for average CAC values using e-commerce industry brands with less than four employees:
- Arts and entertainment: $21
- Business and industrial: $533
- Clothing, shoes, and/or accessories: $129
- Electronics and/or electronics accessories: $377
- Food, beverages, and tobacco products: $462
- Health and beauty: $127
- Home and garden: $129
Once you know your CAC, you can then focus on customer acquisition strategies that yield the best ROI on your investment. There are several customer acquisition strategies that should be tested which include:
- Email — Lead generation is often the first step to customer acquisition. Generating leads involves collecting information from potential customers in order to nurture them to eventually convert them into a customer.
- Most first-time visitors to a website won’t buy on the spot so make the elevator pitch end with an ask focused on information gathering. Collecting email addresses is seen as one of the best lead generation investments for customer acquisition.
- According to a survey by Campaign Monitor, 59% of marketers see the most ROI from email. There are plenty of ways to build an email list, from driving paid traffic to a page with an email capture form to offering a welcome discount on the website for new subscribers.
- Once your email list is built, run email campaigns and set up automated emails to send targeted messages to the list through email marketing services like Omnisend or Constant Contact. These emails can be personalized and triggered based on behavioral data to help turn leads into customers.
- Third-party endorsement or word-of-mouth — The key to this marketing strategy involves finding the right endorsor to promote the offering.
- This might include influencer sponsorships. Search for influencers who have an active, engaged following that would be interested in the product offering, as well as the creative ability to produce content that reflects well on the business brand. Be sure to provide incentives that will help build their audience and brand.
- Search loyal customers for endorsement. The business owner should make it easy for them to recruit their friends. Nelson research has shown that word-of-mouth referrals are one of the most influential forms of marketing. People trust those they know, so when a friend tells them to check out a new product or brand, they listen. Perhaps set up a referral program in which existing customers are rewarded each time they get someone new to purchase the product offering. Apps like ReferralCandy and LoyalLion offer ways to encourage customers to refer friends through marketing emails, discounts, and incentives for both the customer and their new recruit.
- Paid advertising — Many e-commerce brands turn to platforms like social media, market place or search engines to run ads is because of their extensive measurement tools that allow optimization of ads to get the most out of the marketing budget.
- Deciding which platform to use is a matter of understanding the target customer and where they spend their time online.
- Each paid advertising platform usually charges for user impressions (how many times the ad is seen), using a metric called CPMs (cost per one thousand impressions).
- The platforms usually allow advertisers to choose the target, based on demographics, interests, and other traits. By using these targeting parameters, a business can focus on a specific target market for prospective customers.
- Traditional advertising — With the ubiquity of display ads, digital marketing efforts have become easier for consumers to ignore or opt out of through ad blockers.
- Traditional media, from small scale efforts like printed flyers to billboards can be a good way to diversify customer acquisition channels to reach a new, targeted audience.
- Search engine optimization — Doing key word research and implementing the findings into a content strategy for website pages can build an audience. An online following produces brand authority and it also creates an audience of customers that can be reached whenever a business wants to promote a new product or increase sales.
- Blogging can help businesses climb the search engine rankings, bringing search traffic filled with potential customers to the website. Posts need to be full of useful, well-researched information and expert interviews that help readers make healthier life choices.
- There are several ways to build an online audience on social media. Almost all of them require time, consistency, and content to attract new followers and keep them engaged.
Overall, by using CAC and CLV, businesses can have a better understanding of their customer acquisition and retention costs and make data-driven decisions to improve their bottom line.
For more thoughts on customer acquisition strategy and retention strategy, view the free micro-thought video entitled Marketing For Business Owners, Session 1.
Copyright ©John Trenary 2022
One response to “Calculating Your Customer Acquisition Cost: A Step-by-Step Guide to Understanding Your CAC”
[…] a previous post entitled “Calculating Your Customer Acquisition Cost: A Step-by-Step Guide to Understanding Your CAC”, I discussed how to go calculate a customer acquisition cost (CAC). In this blog post, I […]