You’re passionate about building a business that could best be described as a “raging success.”That’s a pretty universal passion among business owners, and yet, some businesses thrive, while others struggle. Why? The answer can be a multi-faceted computation, but always includes a healthy bottom line. One of the most valuable ingredients in the equation, is another acronym for your collection: Your CAC.
CAC stands for: Customer Acquisition Cost. Do you know how much a new customer costs you? Don’t be too hard on yourself if you don’t. The fact is many business owners don’t, and it’s one of the most helpful concepts you can apply to your business. Life is about learning, right? Let’s proceed.
Here’s why you need to know your CAC: As a business owner, you do your best to keep track of your expenses. And in order to be profitable, your costs need to be lower than your gross income. That same basic concept applies to CAC, of course. The less you spend on customer acquisition, the more money you put in your pocket. But it’s not about spending more, or less, arbitrarily. It’s about spending wisely by understanding your CAC (and a couple more acronyms, which we’ll get to next.) Here comes the fun part:
How do you figure out your CAC? The formula for measuring customer acquisition cost is:
(Your marketing costs) / (number of new customers) = CAC
This easy calculation will serve you best if you revisit it once, or twice, yearly. Set a calendar alert and celebrate CAC Day!
Here’s how it looks in action:
- Say you spent $20,000 on marketing last year and got 200 new customers.
- $20,000 / (divided by) 200 = $100
- Each new customer costs you $100. That’s your CAC.
Once you have that data, you need to figure out how effectively that number is serving your bottom line, which depends on a couple of factors.
Firstly, in order for you to profit from your CAC, each acquired customer needs to spend more than it cost to acquire them. If your customers only spend a total of $30 with you one time, and you’re spending $50 to acquire them, you’re actually losing money. However, if they become repeat customers, or the cost of your goods or services is more significant, then your CAC margins will grow!
Here comes the next acronym. In order to accurately determine your CAC, you need to know the LTV, the Lifetime Value of your customers. Put this task on your calendar, too.
The LTV equation:
(Average annual customer spend) x (years a customer stays with you) = LTV
- Average amount customer spend per year: $100
- Average number of years customers stay with you: 5
- $100 x 5 = $500
- $500 is the average lifetime value of your customers
Important Side Note (ISN): Make sure you get the amount of the average customer spend right (Or, ATACS. Just kidding. We couldn’t resist.) Take your total revenue and divide it by the number of customers you have, making sure to add a bit of padding for those treasured customers who spend more than average. It’s important to take all of your customers into account, as your future marketing has the same statistical probability as your past efforts have. You can enjoy and anticipate those treasured big spenders showing up in the same ratio always. In order to become increasingly profitable, your CAC needs to be lower than your customers’ LTV.
When you’ve calculated your CAC accurately, your business stands to make a significant ROI. But, don’t be fooled by “less is more”, in a general sense. If your CAC isn’t sustainable, of course you need to lower it, but if your instinct is to decrease your marketing budget, let’s say to half of what it was, you also get half the number of new customers. You’re spending less, but your CAC is actually the same. For example:
- $20,000 (spend) / 200 (new customers) = $100 (CAC)
- $10,000 (spend) / 100 (new customers) = $100 (CAC)
The way to grow your business intelligently is to maintain (or continuously increase) your marketing budget, while making slight adjustments based on data found from simple analytics. Track your leads to determine which marketing channels are working most effectively, and apply more of your CAC budget to those channels. That’s allocating your marketing money wisely because you’re spending the same, while bringing in more customers. Using the example above, that reallocation of marketing funds could turn this:
$20,000 (spend) / 200 (new customers) = $100 (CAC)
$20,000 (spend) / 500 (new customers) = $40 (CAC)
There you have it. A few hours of calculations will be time well spent. Let your CAC, and LTV give your ROI a little TLC! Class dismissed!