Make your customers more profitable: How to analyze and lower your Customer Acquisition Cost
Congratulations, you’ve managed to persuade a customer to purchase your product or service. In fact, you have managed to repeat this action over and over again. But, do you know the true cost to acquiring those customers and have you figured out how to improve that cost?
Your customer acquisition cost (CAC) is a KPI that provides insight for your business operations and should be a focal point for key stakeholders. CAC is the amount of money you need to invest in order to win one new customer. When coupled with the profit you expect to receive from that customer, you can then decide whether or not it makes sense to continue investing to bring in more customers.
I recently had a client ask how they might capture the cost of customer acquisition. To put it simply, tracking it is certainly the first step, but of course the real goal is to lower your CAC. By lowering your CAC, it then makes customers more profitable to you.
How do you calculate your CAC?
Your CAC is found from taking your total sales and marketing expenses over a given amount of time, (normally a month) and dividing that total by the number of new customers in the same length of time.
Total Sales and Marketing Expenses (per month) / # of New Customers (per month) = CAC
From the most simplified version of the CAC formula, you and your accounting team can then determine how to best apply it to your business model. By slicing and dicing the data to look at CAC by marketing channel or CAC per customer segment, you can calculate the ancillary payback period and lifetime value metrics as well.
What’s not included in your CAC?
These customer support costs do affect your customer monthly profit margin, but should NOT be included in your CAC calculations:
- Account management
- Training on new releases
- Customer service
Customer Acquisition Cost (CAC) in action
Say your marketing and sales campaign cost your company a total of $5,000. You acquired 75 new customers through the campaign. Using the CAC formula above, your CAC would be:
$5,000/75 = $66.67 CAC
Now, if you found a way to spend only $2,500 to acquire the same number of new customers, then your CAC would be cut in half.
$2,500/75 = $33.33 CAC
Now, multiply both CAC examples by 1,000 customers, and you would have spent $66,667 in the first scenario and only $33,333 in the second scenario to get the same number of new customers. If you figure out a way to achieve the second scenario, then you could reinvest even more in your marketing spend and could have brought on 2,000 customers at the same cost as the first scenario.
As you can see, finding a way to lower your customer acquisition cost is a pretty big deal. But, what should your CAC be? That depends on your industry and the revenue you get from a single new customer. For example, real estate brokerage tends to have much larger CAC compared to an industry like online retail. When you think about what kind of sales cycle and effort it takes to help a client buy a new home, versus getting an excited first-time dad to buy a kiddie pool online, it is no surprise that the CAC would be quite different for those two industries.
Segmenting Customers for Better CAC Analysis.
Calculating your CAC and LTV by segments can help you identify the best bang for your buck. For example:
- Customer types
- Sales channel
- Customer location
Take your LTV divided by your CAC and you have got your “magic ratio”. Aim for a ratio of three or greater to see optimal growth. Let’s dig in further. Say your average CAC is $150 and your average LTV is $400. Your magic ratio would be 2.67, pretty close to three. Not bad.
LTV/CAC = Ratio
$400/$150 = 2.67
But how do you know which customers you should target? The overall average is a vanity metric and not that helpful. Instead, segment your customers and get the ratio for each segment to understand more about your best customer. Take this example of a SaaS company and the different account tiers they offer:
The blue bar is CAC, the green the LTV and the red is the magic ratio. While some might assume you should focus marketing and sales on personal accounts because it costs less to acquire each customer, the 0.8 ratio for personal subscriptions will grow this company broke! So where should the company invest its precious cash?
As always, the data only tells part of the story. Perhaps investing in Enterprise with a 3.0 ratio could work if the company has the right team and structure in place. But in this case, I would likely recommend focusing on Pro accounts and growing to a healthy level before tackling Enterprise customers.
Related Watch: Are you spending enough to acquire new customers? Use your allowable CAC to find out for sure.
Three ways to lower customer acquisition cost
Lower your customer acquisition cost, increase your profit. Sounds simple right?
1). Improve Your Sales Funnel Proficiency to Reduce CAC Salaries.
This can mean anything from becoming more efficient at building leads, personalizing your messaging through the selling process or fine tuning your pitch. Decreasing your sales cycle automatically lowers your CAC by letting a salesperson focus on more leads at once. This spreads that person’s salary out over more customers eventually acquired. Quick tips to shorten your sales cycle:
- Use automated CRM tools to cultivate leads and create tailored campaigns.
- Be transparent about pricing.
- Know your prospects’ goals and/or customers’ expectations.
2). Create an Efficient Marketing Machine.
Focus your customer acquisition strategy to be the most efficient marketing machine possible. Know your target market and build your strategy accordingly. If you are diffusing your marketing budget and salaries out over a poorly defined target audience, you could be wasting valuable dollars on selling to someone who might not actually be a potential customer.Social media marketing is a powerful tool you can use to cut marketing expenses and lower your CAC. Not only can you focus customer engagement to learn more about their personas and create economical targeted ads, but it can also allow you to have your customers do the selling for you. A good word-of-mouth (WOM) strategy is one of the best (and cheap) acquisition tools you can implement. A couple of ways to strengthen your WOM strategy:
Set up loyalty and referral programs
Incentivize brand ambassadors.
3). Optimize Your Website.
In today’s market, you cannot overlook the importance of your website. Make sure your site is easy to navigate for the audience that you have now carefully targeted using the steps above. While cutting expenses is key to lowering your CAC, make sure to spend the money and invest in optimizing your site for conversions:
- Review form fields for concise, ease of use;
- Implement A/B tests on your landing pages to make sure your call-to-action is working; and
- Ensure that your site is mobile friendly, so you do not lose transactions. Think about how many times you research a company on your smartphone before making a purchase.
Investing in conversion rate optimization can lower your CAC by ensuring that you are getting the most out of your paid advertising campaigns. Increasing optimization can increase your total customers, thereby lowering your CAC.
Remember, lowering your CAC does not happen overnight and it pays to continue to track it. Impress your investors as your customers become more profitable and less costly to your business.
Need more help understanding the effects of CAC on your bottom line? Get in touch to book your free consultation.