How to Calculate Your Customer Acquisition Cost (CAC), Reduce Your Spending, and Increase Your Profits
When building an online business in the hopes of producing sustainable income, you need to understand what your customer acquisition cost (CAC) is.
CAC is a metric used by companies on a global scale to attain an idea of how much marketing spending they ultimately end up using to acquire one new customer. This data can offer a treasure chest of untapped potential in your SaaS or e-commerce business once you figure out how to lower this number in marketing spending to achieve your customer acquisition goals.
Understanding how to reduce your CAC will lead to reduced marketing spending and increased profits. Another metric that runs alongside CAC that many business owners and investors are highly interested in is your customer lifetime value (LTV)—the total value of each customer within your sales funnel over their existence within your market (more on LTV numbers later). Before we dive in to how you can lower your CAC for an individual business model, we should first cover why this number is so important.
Why is Customer Acquisition Cost (CAC) Important?
CAC is important for many reasons—for both companies and investors alike, it shows a general picture of what the marketing effort costs will be to acquire a new paying customer. Knowing this total cost is not only beneficial for those looking to purchase a business, grow it, and flip it for a profit but also for those interested in spending money on paid advertising. Your marketing strategy for your business will also be heavily dependent on this number as well as how quickly a new customer will run through your sales cycle.
This metric is highly significant within the paid media community, as it gives you a general understanding of how much you should be spending in pay-per-click (PPC) and social media advertising. Beyond paid advertising, CAC also gives you an idea of your profitability from marketing spending to gain a large number of customers at the same time. Having this data as a guide for future marketing, ads, and social campaigns will help you avoid going over your marketing budget and keep the business profitable.
How to Calculate Customer Acquisition Cost
The way you would calculate your cost to gain each new customer can be simplified using the formula below:
It is important to be very diligent when calculating your marketing spending as every last dollar that goes into acquiring new customers should be documented. Some marketing endeavors might not fit neatly into this calculation, such as your on-page content and any recent SEO improvements you made to the business. Because a push for SEO ranking will require heavy upfront costs (content production, backlinking efforts, etc.), you might not see any immediate returns in the form of new customers. We will cover how SEO is a fantastic way to reduce your business CAC later on in this article.
Other marketing spending that will offset your true numbers in this general CAC formula may include new marketing channels you’re testing. Because you won’t have any idea of what this new channel is capable of producing in terms of paying customers, you will want to refrain from adding these expenses to your general company-wide CAC.
Two Types of CAC Calculations – Blended and By Channel
Blended CAC is when all of your marketing expenses are compiled into one number to calculate your company-wide customer acquisition cost. Here, you will most likely have all of your content production costs, paid advertising spending, and any other fees associated with gaining new customers across the entire business.
Customer Acquisition Cost (CAC) by Channel
A channel can be any platform or community you use to lead paying customers to your offer. This could include Instagram, Facebook, Google, Pinterest, or any place that you can market your business in the hopes of leading a paying customer to your product.
Keeping track of your marketing spending by individual channels will give you much needed data to determine whether the cost of spending more money on that channel will be profitable or not. Each marketing channel will use the same general formula we have already mentioned. Tracking your CAC by individual channels, you can determine which of these traffic sources is the most costly for gaining new customers and which traffic channels provide the same results for less upfront costs.
Know Your Customer Lifetime Value (LTV)
As mentioned earlier in this post, your LTV number is just as important as the cost per customer acquisition. If one or more channel’s CAC is too expensive, your LTV numbers will be incredibly low as well. In this case, you may want to consider transitioning to a different marketing channel.
CAC should never completely wipe out your LTV numbers. After all, CAC is the payment you’re making to ideally grow your profits. In some cases, a CAC that is higher than LTV can make sense as a short-term marketing push, but this is not something that will be a sustainable strategy in the long run.
The Golden Ratio of LTV/CAC
The LTV/CAC golden ratio is where your LTV/CAC ratio is 3:1—for every $1 you spend on acquiring a new customer, you make $3 over the course of their lifetime in your sales funnel. This ratio is considered a standard you should aim for, and the higher the LTV you can generate while maintaining a lower CAC, the more profitable your business will be in the end.
If you are managing a SaaS business, the moment you sign a customer up, you’ve typically already lost money because you have to wait for a lagging LTV to catch up with the CAC investment you’ve made. An example of this would be if you spent $50 to acquire a customer on a membership that cost $25/month. In this case, you wouldn’t recoup your initial investment until the second month, which is fine if your average customer uses your product for 12 months, yielding an LTV of $300.
Two Main Ways to Lower your CAC
The best way you can get ahead of any downward trend in business profits based on your CAC is by lowering your costs and improving the business performance. This might sound like a no-brainer to most, but many entrepreneurs forget very simple optimizations they could make to their businesses to see profits increase almost instantly.
Ways to Improve Your CAC for Fun and Profit
There are several different ways you can improve your CAC to bring you closer to the 3:1 LTV:CAC ratio we discussed earlier. A few improvements you could test include testing your pricing strategy and performing conversion rate optimization.
Test Your Pricing Strategy
Online business owners will often get stuck in the mentality that their pricing structure is one of those ‘set it and forget it’ aspects to their assets, but in reality, this is not always the case. Depending on the type of product or service your business provides, you may be able to change your pricing and see some great results. Of course, you should always test this theory before you make anything permanent, but it might uncover a new price point and will draw more paying customers into your sales funnel.
Perform Conversion Rate Optimization (CRO)
When you A/B split test different calls to action (CTAs) on your website, landing page, or offer, you test what is best leading that traffic to convert into paying customers. CRO could be changing your web design, the placement of paid ads on your page, or other similar variables to see what drives a different psychological shift in making someone click, download, or sign up for your offer. This is something that was once overlooked in the past, when every online business owner thought using the same CTAs as their competition would yield the same results.
Decrease Time For Prospect Engagement
The faster your sales or marketing team engages with an interested prospect, the sooner that person is most likely to convert. This theory can be seen as widespread across many platforms with the invention of chatbots that essentially act as a ‘real person’ ready to help your customer from the moment they land on your page.
Online business owners have started using this technology because they understand the value in creating a pleasant first-time user experience with help always available should they need it. You can also use similar tactics within your business model by creating fun and engaging conversations with your customers sooner. This may even decrease the time it takes them to trust you, which is a huge deciding factor for many people in punching in their credit card number for something new they just discovered.
Optimizing Paid Marketing Funnels
One way you can focus on improving your paid marketing funnels is by split testing your campaigns even after you find a winner in your initial tests. Over time, paid advertising campaigns will need to be reevaluated to see if the ad itself is still relevant. Because ad campaigns can grow stale based on the basic human nature of not wanting to see the same thing over and over again, this same principle applies to creating new advertising initiatives as often as possible.
Refresh your creative ad every 2–4 weeks to prevent advertising blindness. What we mean by this is that you should never set your paid advertising campaigns and leave them running after the initial launch. There is always something you can be testing, whether that be at the offer, copy, or audience level.
Remove Under Performing Channels
Removing under-performing channels should be a no brainer as well, but you might never really know which channels these are unless you completed the CAC breakdown by channel. Take this with a grain of salt, and be mindful to not just delete a channel based off this number. If the channel is still new, give it some time to show you what is possible, but don’t sit around dumping money into it if the CAC never decreases.
This exercise is for the more mature channels; consider getting rid of these if they can’t be optimized into lowering the CAC, unless, of course, the current CAC is still within the LTV/CAC ratio.
Search engine optimization (SEO), when done right, can become the #1 way to decrease your blended CAC once traffic has begun to start converting on a consistent basis. Outside of the content cost itself, the CAC is basically free in the SEO channels, except in the most competitive of markets (once you rank number one, you’re there until someone else does all that work or more). SEO can almost be looked at like a “cheat code” for CAC because once you figure it out, you can usually skip a lot of the game that others are still trying to figure out.
A Lower Blended CAC Lets You Scale Fast
If you can lower your overall blended CAC significantly, there will be two things you can do with the increased profit you are now generating. One option is to pocket all the extra profits you are now generating and to use that to scale your business. This might include scaling your operations so that you have outsourced VAs handling nuance tasks that don’t necessarily require your help or trying a new design agency that a fellow entrepreneur mentioned improved their brand’s look.
Option #2 might be when your SEO campaign worked so well that it started producing new traffic at a large rate, and you take all that extra money and put it into paid media channels, spurring an even larger stream of traffic to your business. In this scenario, you are basically stealing CAC from one channel and using it to scale up another dramatically. You wouldn’t have to use this approach when pouring extra income into paid media alone. These additional profits could also be used to hire a business developer or perform experimental marketing that you may not have done otherwise until your CAC was lowered first.
Lower CAC, Higher Profit – a Lucrative Exit
You should always aim to find the right balance in your LTV/CAC ratio. Once you figure out the secret sauce to lowering your company-wide CAC, you can scale in some of the areas we’ve covered in this article. Because lowering your CAC increases your profits, the valuation of your online business will also go up at the same time.
Increasing your monthly net profits can offer huge potential when the time comes for you to exit from your business. As more and more entrepreneurs increase the value of their assets using some of the techniques covered in this article, what is stopping you from doing the same?
If you would like to see how much your business is worth before making any of the improvements covered here to reduce your CAC, head over to the valuation tool. Here, you can gauge how much your business is worth compared to similar businesses in your assets range. If you would like to sell your business now, one of our business advisors can ensure you get the most from your exit, even if that means making some improvements to your assets beforehand.