Calculating your customer acquisition costs allows you to better understand whether your marketing efforts are profitable.
Every business needs customers, and there are dozens of ways to find them and try to persuade them to buy from you. That's essentially what marketing is—identifying your best prospects and then providing information about your company, its products and services, and a rationale for making a purchase that speaks to your target market. When it works, a percentage of the people you've made contact with end up buying from you.
Find out what customer acquisition costs are, how to calculate them, and why they are part of ensuring your business' success.
What Are Customer Acquisition Costs?
Everything you've done to get a particular sale is part of your cost of acquiring or winning that customer. That includes all the money you've spent that didn't end up in a sale, too. That could include print and online advertising, Facebook posts, direct mail, customer appointments, creating and hosting your website, your 800 number, brochures, and freebies you give away at trade shows. The list could be long.
Jeff Neal, project manager for commercial roofing contractor Capital Coating, says, "We can spend a lot of time trying to turn a prospect into a customer, many prospects will ask that we visit their commercial, industrial location, ask for a quote, and then never return our call. These site visits and estimates take a lot of time and energy, so when we figure our monthly sales, we also figure our cost per lead and close rate."
To be sure his company is relying on accurate data, Capital Coating requires its sales team to enter daily reports on their prospecting, appointments, proposal values, and closed contract numbers "so that we can better understand how much time and money we're spending to acquire a new contract/customer," Neal says. All of that data is factored in as part of the cost of customer acquisition.
To determine exactly how much your customer acquisition efforts are costing you, there is a simple formula you can use.
How to Calculate Customer Acquisition Cost
Start by picking a particular time frame, such as a month, a quarter, or a year. Then add up all of your marketing and sales costs for that time period. You may need to divide any annual costs by 12 if you're looking at a particular month, or four if you're calculating per quarter, though the longer the time frame, the more accurate your number.
Then take your total cost for the period you're analyzing and divide it by the number of sales you had in that same period.
For example, if you spent $5,000 last quarter on marketing and landed 50 customers, your customer acquisition cost (CAC) would be $100. Or if you spent $1,000 and got 1,000 customers, your CAC would be $1.
The two ways to reduce that number are:
- Spend less on marketing while still earning as many customers
- Spend the same amount on marketing but increase your conversion rate, or the percentage of people who buy from you
The Importance of Customer Lifetime Value
Although CAC is a critical business metric to calculate and track, it's virtually meaningless unless you also know what each customer is worth. That is, "what will your average customer spend between their first and last purchase from you?" asks Morgan Taylor, CMO for LetMeBank. What does a typical customer spend with you during their lifetime?
That's important in order to assess whether you're spending too little or too much to acquire customers.
"Without knowing how much you're spending to get each customer, there is no way to calculate or tell if your marketing efforts are making money in either the short or long-term," says Stacy Caprio, CEO, Her.ceo.
If you're a real estate agent who sells an average of three homes to clients during their lifetime, with each sale or purchase in line with the national average of $200,000, and generates a 3% commission on each, or $6,000, the lifetime value (LTV) of a customer is $18,000. Spending $100 or $200 to acquire a customer who will spend $18,000 with you long-term may make a lot of sense, given the potential payback.
On the other hand, if you run a seasonal ice cream shop with an average customer lifetime value of $200, spending $100 or $200 to acquire a customer does not make sense. You're more likely to lose money at that cost than to be profitable.
You can quickly see that if you're spending too much to acquire customers, you'll go out of business fast. You'll lose money on every sale if you're spending $50 to attract a new customer, and they make a one-time purchase of $25. You've just lost $25.
That said, don't expect to earn back your customer acquisition cost with one purchase. It may take several. And aiming to spend less on customer acquisition may not be the solution—you may need to invest more upfront to win a customer, not less.
"Knowing your CAC number," according to Caprio, "allows you to make more intelligent marketing decisions."