In an ideal world, your product or service would sell itself. Customers would sing your praises from their rooftops, and you wouldn’t need to budget for marketing.
The reality of the situation is that you do need to spend at least some money on customer acquisition if you want to bring in new customers for your small business. Even as a kid with a lemonade stand, the construction paper and markers you used to make a sign would have been considered part of your customer acquisition cost, or CAC.
Gartner defines customer acquisition cost as the average sales and marketing expenses necessary to achieve a first sale with customers (full content available to Gartner clients). The customer acquisition cost formula itself is a simple division equation: You take the amount spent on marketing and sales, and divide it by the number of new customers gained. To provide a basic example, say you spend $100 on Google ads in your first month and gain 10 customers from those ads. Your customer acquisition cost would be $10.
The slightly more challenging parts of calculating your CAC include:
Adding up all of your marketing and sales expenses.
Keeping this total number low so that your marketing efforts result in your best possible return on investment (ROI).
Maintaining a well-balanced customer lifetime value to CAC ratio.
But don’t worry: Below, we’ll cover tips for all of that as well. And as an additional resource, we created a downloadable calculator tool to help you add up those marketing and sales expenses and calculate your customer acquisition cost.
As we mentioned earlier, customer acquisition cost is easy to calculate. All it takes are these three steps:
If your small business has been around for a bit, it will help you out a lot to narrow the scope of your data to the past month, quarter, or year.
This way, you can gain insights about how your customer acquisition cost has increased or decreased over time depending on the methods you used or on purchasing trends. For example, your customer acquisition cost might dip in November or December because you’re more likely to acquire new customers who are shopping for the holidays around that time.
If your business is still in its early stages, it can be difficult to calculate your CAC because you might not have all the data you need just yet. But stick with us: You can use the information in this guide to get a rough estimate of your CAC thus far, or just to be prepared for when your business grows.
This part can be tricky, because there are some expenses you should include in this total that you may not have thought about. Here’s a list of possible expenses you might incur:
Ad spend, which is the amount you spend on advertisements, if you choose to go the paid route. (Organic marketing done through search engine optimization is your other option.) Note: Paid advertising is useful because it guarantees that customers will see your ads, but you still want to make sure that the ads resonate with your target audience. Check out our blog post for tips from real small-business leaders on creating content that catches your audience’s attention.
Equipment, or any physical item involved in the creation of your content. If you host a podcast, for example, you’ll need to invest in a microphone and perhaps a mixer.
Software, or any technology your team might use to produce content and/or automate a marketing campaign.
Marketing spend, which could be categorized with your ad spend, but more broadly refers to other marketing efforts such as a radio or television commercial, or an ad in a printed publication such as a magazine, newspaper, or community newsletter.
Payroll, if you are paying sales, marketing, or customer service representatives who assist with customer acquisition.
Miscellaneous expenses might include paying influencers to promote your brand, or even the coffees you purchase for a brainstorming session with your marketing team. Our point is that you’ll want to be as comprehensive as possible to get the best sense of what you’re actually spending on customer acquisition, as well as what you could cut back on to reduce your CAC.
As your business grows, you can look forward to a more established customer base, which will help keep your CAC low since repeat customers are more cost-effective than new ones. But here are a few actions you can take to stretch your customer acquisition budget even further:
Incentivize existing customers to refer their friends. Referral programs help bring in new customers with the only cost being the incentive you offer your existing customers, whether that’s a gift or a discount.
Adopt marketing automation software. If payroll has you sweating, but you don’t want to lay off employees or enact pay cuts, these tools enhance workflow by automating tasks such as email marketing, social media posting, mobile messaging, and ad management. There are even budget-friendly free versions that you can try out first.
Hone your SEO skills. As we mentioned earlier, search engine optimization is the lower-cost alternative to paid marketing. It refers to the use of techniques to drive organic traffic to your website, and while it can be time-consuming, it results in almost 12 times more clicks than paid marketing, as well as higher conversion rates. Check out this blog post for some SEO tips to get you started.
How many new customers did you gain within the time period you’re evaluating for? Remember to only count customers who have made their first purchase within this time frame. A potential customer who has expressed interest but not yet made a purchase should not be counted until they do so.
Divide the total cost of marketing and sales by this number, and voila! You have your customer acquisition cost. This is the amount you paid to acquire each new customer within the time frame you calculated for.
To recap everything we just covered, check out the video we created below:
Knowing your customer acquisition cost will benefit your business in a few different ways:
You can find out how much you’re spending on each individual customer acquisition method (paid advertising versus social media marketing, for example, or even narrower, Facebook versus Instagram). To do this, recalculate your CAC, but narrow your marketing and sales expenses by each marketing channel, and divide by the number of customers acquired from just that channel.
You can revisit your marketing strategies with a focus on the channels that provide the highest ROI.
You can calculate your business’s customer lifetime value to CAC ratio.
As a metric, customer lifetime value is a bit more complicated to calculate than CAC, but we’ll discuss what goes into it for whenever you’re ready to graduate to this next step.
Customer lifetime value, abbreviated as either CLV or LTV, is the average revenue brought in by a customer relationship over a lifetime. How is this relevant to your customer acquisition cost?
Put simply, a repeat customer is more cost-effective than a new customer. So while it’s true that your CAC will get lower with each new customer acquired within the time frame you’re evaluating for, it doesn’t help your business much in the long run if those customers make just one purchase and disappear into the night.
A repeat customer who makes multiple purchases from your business over their customer lifespan, or the total number of years that they purchase from you, will have a higher customer LTV than a one-time customer.
You can find out your business’s average customer LTV by determining the following variables, which we’ve defined for you below with the help of Hubspot:
|Variable||How to calculate|
|Average purchase value||Divide your company’s total revenue within the time frame you want to calculate for by the number of purchases over the course of that same time frame.|
|Average purchase frequency||Divide the number of purchases over the course of the time frame by the number of customers who made purchases during that same time frame.|
|Customer value||Multiply the average purchase value by the average purchase frequency.|
|Average customer lifespan||Find the average number of years a customer makes purchases from your company.|
You will calculate your LTV by multiplying customer value by average customer lifespan. This will give you an estimate of how much revenue you can expect from your average customer over the course of their relationship with your business.
Your LTV to CAC ratio, then, provides your business with a clearer picture of how much value your customers provide your business versus how much you spent to acquire them. It’s important to keep this ratio around 3:1, a number considered to be ideal because it means your business is making three times the amount you paid to acquire customers.
To break this down even further, a 1:1 ratio means that the cost to acquire new customers is the same as those customers’ LTV. This would actually result in a loss for your business, since CAC only takes marketing and sales expenses into account and not what you’re spending on parts, labor, shipping, handling, and other expenses. If the LTV is lower than your CAC, that means your business is spending more to acquire customers than it stands to make from those same customers.
While a ratio that is higher than 3:1 seems like a good thing, it might mean there’s more you could be doing to bring in customers. If your LTV to CAC ratio is closer to 4:1 or 5:1, consider trying out a new customer acquisition strategy that increases your marketing spend.
Now that you know how to calculate customer acquisition cost, you’re probably thinking of other ways you can supercharge your customer acquisition efforts. We suggest looking into tech tools such as marketing automation, referral marketing, or social media marketing software, all of which are designed to help you appeal to potential customers while enhancing your team’s workload.
We also have a collection of resources at GetApp on customer acquisition and customer retention so that you feel confident and well-equipped as you grow your business:
Note: The applications mentioned in this article are examples and are not intended as endorsements or recommendations.
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