What is Customer Acquisition Cost (CAC)
Customer Acquisition Cost measures the amount of money a company spends to acquire new customers. It involves all the costs associated with obtaining a customer, such as advertising, endorsements, or using any asset, among other things.
Customer Acquisition Cost and Lifetime Value and Recurring Revenue form a blend of financial study that finds how effectively a company performs in the market. A successful business indicates a higher value of Customer Lifetime Value than the Acquisition Cost. Conversely, one primary issue with unsuccessful companies is their higher value of Customer Acquisition Cost than the Lifetime Value.
SaaS companies that develop online customer software are most likely to use the CAC and Lifetime Value metrics. These companies use this metric to manage their ROI (return on investment) on each customer. Hence, no company would invest more in CAC than the Lifetime Value.
Customer Acquisition Cost includes advertising costs, technical costs, the cost of creatives, inventory costs, and the cost of publications.
CAC is a unique target campaign that allows companies to manage their cost over revenue for each customer. Many venture capitalists and angel investors use this metric to scale the profitability of technology companies. They analyze the sales a company provides with its current short-term investments and how much additional investment it requires.
The Idea behind Customer Acquisition Cost
Customer Acquisition Cost (CAC) and Lifetime Value (LTV) are essential metrics for cost-benefit analysis. Companies and investors use these. For example, when a new company acquires new customers, it uses these metrics to look at the margin between the acquisition cost and the value of customers. If the margin is negative, the company needs to revise its budget.
CAC can transform into different forms depending on the nature of the product. For example, Netflix uses subscriber acquisition cost (SAC), while Google uses traffic acquisition cost (TAC). Companies develop different CAC versions for applications containing in-app purchases and subscription models to control expenses.
It is crucial because it defines how costly a customer is to the business. For developing companies, investors look into all the CAC models from the company’s beginning before investing. However, companies can’t entirely rely on the CAC metric. For example, the churn rate is high if the company keeps investing in new customers. Eventually, the company will face failure in the long run. Therefore, a company’s Customer Acquisition Costs will increase with time. In addition, the cost of retaining customers is always low compared to acquiring new customers.
Benefits of Customer Acquisition Costs
Marketers and business analysts always have a keen interest in developing long-term growth for their businesses. This is because it helps keep the company stable and profitable in the future. Likewise, small businesses and startups create short-term goals and access them regularly. The idea behind these short-term goals is the expansion of business, no matter what conditions.
Customer Acquisition Costs benefit the company in analyzing their expenditure on an individual level. It also helps identify the type of advertisements or marketing campaigns that bring in more customers. The CAC metrics help in the decision-making process and attract more investors.
How to calculate the Customer Acquisition Cost?
We calculate Customer Acquisition Costs by dividing the marketing and expense costs by the total number of customers acquired. After calculating CAC, we develop the relationship between Lifetime Value and Customer Acquisition Costs.
To find the LTV/CAC value, we divide the Lifetime Value of a Customer by its Acquisition Costs. A higher LTV CAC value represents that a company can generate higher returns with low investment.
Examples of Customer Acquisition Cost
Let’s look at two examples of CAC, an online jewelry store and a mobile app company.
1. Customer Acquisition Costs for a Jewelry Merchant
An online jewelry store operates on Instagram. The company invested $5000 in advertisements last month. The company reports 400 orders in the previous month. Now this gives us a CAC of $12.5 per customer. However, whether this CAC is suitable for the company is still under consideration.
To find the acquisition cost accurately, we look into the average purchase price by the customer. The average order price is $30 with a 60% profit margin. The company gets $18 on every order with $12.5 as CAC. The company receives the remaining $5.5 to manage expenses such as rent, debt, office supplies, etc., and generate a little profit.
The CAC for a jewelry product is very high if the customer only makes one purchase in their lifetime. However, it will decrease if the customer keeps returning for further purchases.
2. Customer Acquisition Costs for a Mobile Application
A mobile games company creates a car racing game for google users. The app is available on Google PlayStore for free. However, the game has an additional in-app purchase of $6 to unlock the multiplayer version.
The company spends $60000 on advertising in the game’s first month of release, acquiring 300,000 downloads. Its google monetization rate is $3 for 1,000 impressions (CPM).
The company displayed two commercials to each customer, creating a total revenue of $54000 in the first month. This revenue generates a negative CAC as the acquisition value is higher. However, the company had 6% of its subscriber opt for the premium version, increasing the revenue to $162000.
The following example suggests that the company’s CAC is very high if the subscribers play the free version. Nevertheless, the revenue will boost with a small percentage of the subscribers purchasing the premium version.
How to Reduce Customer Acquisition Costs?
There are several ways to reduce customer acquisition costs for a business.
Research shows retaining customers spend more on products and services than new ones. Therefore, companies should develop strategies for customer repetition frequency and added order value. The same customers returning to the company will decrease the Customer Acquisition Costs.
Affiliate marketing is a marketing strategy that uses internet influencers to sell products. These influencers advertise the company’s products through their web pages and social media accounts. The advantage for the company is that it only pays the influencer when they sell a product or service. The CAC in this strategy decreases to zero before the sale.
Targeting Potential Customers
When a company creates a product or service, it has a potential customer base to serve. It is essential to target your primary audience because they are most likely to convert into customers. These customers have a higher return rate decreasing the initial Customer Acquisition Costs.
To keep a customer involved in the business, companies create a loyalty program that gives a customer premium access. Loyalty programs offer bespoke facilities to customers. However, customers are only eligible for these programs after purchasing a certain amount of products. Attracting customers with loyalty programs benefits the company by increasing the same customers’ returns and reducing acquisition costs.
Wrapping It Up
The Customer Acquisition Costs (CAC) metric calculates the amount of capital invested in acquiring new customers. It is crucial for startups and developing companies with rapid growth. In addition, this method tracks marketing performance concerning the addition of a company’s annual revenue. Also, CAC helps a company find a customer’s total value. If you want to calculate the total capital it takes to acquire new customers, CAC is the perfect tool for you.