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Calculating and Reducing Customer Acquisition Cost

The only way to tell if your marketing efforts are not being wasted is by getting friendly with the math. Specifically — with statistics.

All the graphs, infographics, and tables are necessary marketing tools. Only by gathering data can you pinpoint what goes wrong and what goes well — and how to improve it.

Among all the calculations you can find customer acquisition cost, often shortened to CAC. In this blog post, we’ll get rid of the mystery surrounding the term and explain how this measurement works in practice.

Customer Acquisition Cost (CAC)

Customer acquisition cost is the total amount of money required to gain new customers. It’s the most important metric that tells you whether your marketing campaigns truly bring significant profit. It’s also a very strong argument in convincing your investors or business partners that you’re worth the partnership.

You can calculate customer acquisition cost by adding all your marketing expenses and dividing them by the number of customers acquired in a chosen time period.

When we say all marketing expenses, we mean it. You have to take into account: 

  1. Advertising. From billboards, murals, newspapers, radio, television, and the mightiest of them all — the internet — all offer different ways of reaching your target audience. 
  2. Costs of your sales and marketing team. That is the costs of hiring, onboarding, and further training your employees. And of course, sufficiently satisfying salaries, if you want to keep the turnover low.
  3. Technical costs. If your employees have to be equipped with specific hardware and software to do their work, these come under the technical category. You also have to account for the cost of maintenance and inventory upkeep.
  4. Production costs. Especially if you want to jump in on the newest hype in the form of video production, you’ve got to spend some hefty sums on high–quality equipment. 
Customer Acquisition Cost = All Marketing Expenses / Number of Customers Acquired

Considering all the numbers needed, it’s a lot. Thankfully, you don’t always have to calculate the full customer acquisition cost. You can use the simplified version of CAC once a week or per month and use the all–inclusive one quarterly or annually.

To complicate matters a bit more, the interpretation of the results might differ from business to business, depending on certain factors. For example, worse results should be expected by:

  • Businesses just starting their SEO journey. Here the results of sales and marketing efforts will need time to bear fruits, so the return on investment might be low up until a certain point.
  • Businesses that break into new markets. Here the results will also be delayed, since the brand will have to build awareness first.
  • Businesses that significantly alter their revenue schema. This will directly affect the customers and the CAC might fluctuate a lot. 

We’ve saved the most important factor directly influencing the average customer acquisition cost for last — it’s customer lifetime value.

Customer Lifetime Value (CLV)

Customer lifetime value (also called LTV) is the prognosis of the total amount of money spent by a single customer on products or services from one company. It can be either calculated considering the whole business relationship — also called as “customer’s lifetime” — or by choosing a specific time period — most often up to 5 years. To calculate it, you need some more data compared to customer acquisition costs.

To calculate CLV, you need to multiply the average order purchase value by the average number of purchases, and then multiply the total by the average customer lifespan.

Customer Lifetime Value = (Average Order Value x Average Purchase Frequency) / Average Customer Lifespan

More Complex Variations

Customer Lifetime Value with Average Gross Margin

To gain a more thorough and accurate insight into your marketing expenses, you can make more complex calculations with more variables, such as average gross margin.

CLV = (Average Number of Transactions x Average Order Value x Average Gross Margin x Average Customer Lifespan) / Number of Clients

Customer Lifetime Value with Customer Churn

You can also take into consideration the customer churn — the loss of customers over time.

CLV = Average Order Value x Average Purchase Frequency x Average Gross Margin x (1/Customer Churn)

Customer Lifetime Value with Negative Customer Churn

Unfortunately, there’s one drawback to this calculation — it doesn’t work when the customer churn is negative. If that’s the case, you can use another formula.

CLV = ([Average Revenue Per Account x Gross Margin %] / Customer Churn Rate %) + [(Monthly Growth in Average Revenue Per Account x [1 - Customer Churn Rate %]) / Customer Churn Rate % Squared]

Customer Lifetime Value with Retention and Discount Rates

And if your yearly sales tend to fluctuate, you can also add retention and discount rates to your calculations.

CLV = Gross Margin per Customer Lifespan x (Retention Rate / 1 + Discount Rate - Retention Rate)

Wondering which formula to pick?

Easy. 

Choose the one you have the data for. The fewer assumptions you have, the more precise data you’ll get. If you have all the data possible, use the simpler formulas regularly and the more complex ones every now and then, depending on your needs. Also, not all formulas will be relevant to your business, so pick the one that reflects your circumstances best.

Bad at Math? Then Count On These Tools 

We have to admit — the deeper you go, the harder it is to get relevant numbers with no mistakes. Thankfully, technology can help us out.

Online, you can find a myriad of different calculators such as the one you can find on Nickelled, Startup Bonsai, or Traktion for CAC and on CLV Calculator, CleverTap, or Harvard for CLV. With them, you can check how accurate you are with your own calculations and deepen your understanding of the formulas and all the variables involved.

You can also invest in analytics tools such as Klipfolio PowerMetrics or Solvvy.

CAC & CLV in The Real World

No matter which formula you’re going to use, there are some important things to keep in mind. Mainly, that the formula is based on certain assumptions and gives you only a vague prognosis that might only partially reflect the true situation of your business. Calculating CLV is tricky — which is proven by the fact that only 42% of companies are able to measure it, despite the fact that 76% consider CLV an important concept.

So what are the things that aren’t taken into account:

  1. All clients are different and so they differ in their value. During calculations, we base all our assumptions on the average client. And the profile of such a client will probably change along with your business — every time the policy changes, the rates are raised, and new markers are seized. 
  2. Situation on the market isn’t stable. We assume that our present situation will stay the same in five years, if not more. We don’t account for any disruptions, drastic social changes, or new competition. 
  3. The marketing expenses will change because of external factors. The raise of pay for your marketing staff, Facebook raising the price of their ads, or having to invest in new forms of marketing will influence your expenses.

Common Mistakes in Using the Formulas

  1. Calculating with too many unknowns. Although in some cases it’s unavoidable: like in case of new businesses or old ones taking over new markets.
  2. Calculating with revenue instead of profit. If you calculate with revenue, the numbers won’t be as accurate, leading to wrong decisions. 
  3. Being overly optimistic. Don’t believe in the best–case scenario, it hardly ever happens anyway.
  4. Taking into consideration all of your customers. It’s more efficient to divide customers into segments by chosen characteristics (be it location, age, or lifetime) and calculate a lifetime value for each segment, which would be called customer cohort. Because of that precise data, you’ll be able to improve your marketing strategies.
  5. Not recalculating often enough. Since the realities of business are turbulent at best, the data will change over time. That’s why it’s prudent to make recalculations at least once a week.
  6. Not recalculating the variables. Don’t forget to recount customer churn, gross profit margin, or any other data pertaining to your chosen formula. 
  7. Attributing conversion to wrong channels. The customer’s journey tends to be long and convoluted, with many touchpoints involved. Giving credit to the last touchpoint only and assuming that other channels don’t do their job might actually harm your customer acquisition efforts.
  8. Cutting customers lose too fast. Customers change just as well as your business might — so don’t burn your bridges too fast. You never know where high–paying customers might be hiding. A slight change in communication might be enough to change the tides.

The CAC/CLV Ratio

Now that we’ve got friendly with both CAC and CLV, let’s focus on the most meaningful number that’s easier to interpret. That’s the CAC/CLV ratio, also known as the magical number in marketing. Of course, that ratio depends on the accuracy of CAC and CLV calculations, so don’t rush into figuring out the ratio too soon.

Why is this ratio so important?

It informs you whether you’re spending enough money on the marketing — because indeed, you might be spending too little — and whether your business stays in a healthy place. This ratio is especially beloved by the stakeholders and the investors, so maintaining a good rate is most beneficial to everyone involved.

CAC/CLV = Customer Lifetime Value / Customer Acquisition Cost

Generally, the 3:1 or 4:1 ratio is considered to be a worthy goal in every business model. Lower ratios will inform you that your customers don’t bring you any profit, while higher ratios mean that you’re not spending as much as you should on your marketing campaign — that is, that you’re missing out on the opportunity to grow your business. This also increases the risk of your target audience being seduced by your competition.

Not all costs are bad costs, so the goal of completely reducing them isn’t always profitable. It’s better to find a balance instead to keep your business thriving and your business plan evergreen.

Reducing Customer Acquisition Costs 

Although completely reducing your sales and marketing costs isn’t always the best move, sometimes it’s a necessary one. Here we’ll gather all the tips on how to improve customer acquisition cost and limit your marketing spend.

1. Limit Your Audience

There’s no point in spreading your message to everyone and hoping someone might be convinced to give your brand a shot. Instead, find those who already are looking for solutions that you offer. This requires extensive research and in–depth understanding of your potential customers. 

In B2C companies, it’s done by specifying a target audience, which consists of characteristics such as age, sex, location, social and economic status, and so on. B2B companies, on the other hand, tend to create a buyer persona, a representation of an ideal customer whose main characteristics are related to their job. So it’s important to specify relevant job titles, industries, types of companies, among many others. 

That kind of knowledge is essential to successfully craft a message that will resonate with potential buyers. But of course, things change over time — your target audience might lose interest due to their age, you might alter your brand to better suit the current events, or new trends might disrupt the status quo. That’s why you should keep track of who needs your products or services the most and ensure that your marketing is appropriately altered.

2. Focus on Customer Retention 

The numbers say it all. Increasing customer retention rates just by 5% increases the overall profits by 25% to 95%. Moreover, acquiring new customers costs five times more than keeping the current ones. I hope you can see how much more beneficial it is to switch your focus from attracting new customers to nurturing the existing ones. So instead of spending money on yet another batch of ads, it’s better to improve the customer experience, involve customer relationship management, gather feedback, and offer a convincing reason to stay.

One of the most convincing reasons is the loyalty program, which was indicated as a strong motivation to continue doing business with the chosen brand by 83% of customers. Additionally, 49% of them admitted to buying more after joining the loyalty program. 

Of course, loyalty programs come with some expenses on your side, since you’ve got to offer discounts, beta access, or any other attractive deals that sweeten the program. Still, the return on investment far outweighs the costs.

3. Turn Your Loyal Clients Into Brand Advocates 

With the increasing distrust towards marketing, customers may view your marketing efforts with a grain of salt. This throws a wrench into acquiring customers. 

But they will trust someone else — their friends, family, and other customers. In a survey run by Nielsen, 92% of respondents claimed to trust recommendations from people they know. We can take advantage of that. How, you may ask?

By delivering an excellent customer experience that will leave clients more than happy. And while the positive feelings are fresh, ask for a referral

Unfortunately, while people don’t have anything against referrals per se, they might lack the motivation to do so. Offering discounts, gift cards, or access to unique content might convince them to pass the message. Also, make the referral process as smooth as possible — send a quick form or add special functionalities to your website. 

4. Invest In Retargeting

Between new customers and loyal brand advocates, there are also those who at some point almost made a purchase, but withdrew for some reason and that amounts to almost 70% of people abandoning their carts. That group of potential customers are low–hanging fruits — they already know your brand and are interested enough, so you only have to remind them of your existence. 

And it’s super effective.

Customers who see retargeted ads are 70% more likely to convert on your website. Moreover, conversion rate increases with more ad impressions. So hopefully we can agree that in the right hands, it can be a surprisingly powerful move.

Some retailers don’t like remarketing because it seems too intrusive or even downright creepy. Thankfully, the customers spoke up on how they feel about it: only 11% admitted to having negative feelings towards remarketing, while 59% felt neutral and 30% positive. Also, they admitted that they’re even willing to sacrifice their personal data for better deals

The last argument for remarketing is its price. Compared to paid advertising, it’s way more cost–effective, especially when combined with Google Display Network. So instead of overinvesting in paid advertisement, put the money in remarketing instead.

5. Don’t Neglect Your Funnel

The fastest way to harm your business is by focusing too much on lead generation, and forgetting the rest of the funnel. It’s important to take care of customers on each step of the journey — by creating valuable content that’s going to attract them in the first place, and then giving them a nudge when they seem interested with follow–up messages.  

But your funnel shouldn’t stop there. Actually, it should resemble a flywheel more.

The flywheel model puts more emphasis on the repeated customers. The customer’s journey shouldn’t stop with conversion — it should be just the beginning. If they bought from you once, they should be easier to convince to buy again. Of course, as long as they were satisfied with the overall experience.

How that experience should look like? Well, besides excellent customer service, it should be as smooth and painless as possible. Quick forms, multiple payment gateways, and user–friendly websites are a must. The more obstacles you’ll place in the client’s way, the more reluctant they’ll be to go through the process. 

Last advice — keep adjusting your funnel with the help of gathered information for maximum effect. Keep analyzing what works and what doesn’t, and observe the current marketing trends.

6. Automize Everything

No, we don’t want to convince you to let go of your current team members and substitute them with AI. But your team can only do so much, and the tasks keep mounting up, along with necessary meetings. You should do your best to make their jobs easier by finding ways of optimizing and streamlining all the processes, and automation is here to help you with that. 

So instead of manually calculating all the numbers, use software instead, like HubSpot Marketing Hub or Klaviyo. For cold mailing campaigns, you could try Woodpecker or SmartReach.  For coming up with catchy headlines and riveting social media posts, use Jarvis

Automation helps you save a tremendous amount of time, which in turn will most definitely result in saved money, sooner or later. Human touches, although often necessary, are expensive. And by letting your team focus on things that truly matter, you can increase their effectiveness and productivity.

But don’t try to automize everything just for the sake of it. Make sure that the reasons for automation are sound and that it really will make a difference in the long–run. Or else you’ll be — ironically — wasting time.

7. Create Valuable Content

By creating great content that people can truly benefit from, you gain more visibility as people share your articles, videos, or any other form of content. Additionally, it can help you fashion your own, unique brand voice, build authority, and a reputation as an expert. It’s a great opportunity to make your company memorable and strengthen your message.

Moreover, high–quality content is the key to increasing your online presence, since it influences SEO ranking. So the higher you want your page to rank in SERP (Search Engine Results Page), the better content you need to produce. 

If you’re still not convinced, think about it this way — creating good content ensures that the client themselves will reach out to you, reducing the customer acquisition cost.

8. Bring in A/B Testing

A/B testing, also known as split testing, is an experiment that can show which version of content — be it a landing page, an email, or even a feature — is better received by users. So if you want to improve user engagement, user satisfaction, or conversion, discover which forms are superior. And the best part is that the versions don’t have to differ too much. Sometimes a simple color button change can bring significant benefits. But of course — you need to gather a significant amount of data to indicate the winners. So don’t rush it!

Let’s bring in some real–life examples. 

In one such case, Brookdale Living wanted to increase their conversion rate by diversifying one of their pages. They’ve introduced two new versions of the page: one with a static image and another with a video. Against current trends, the page with static image performed better, bringing in additional revenue of $106,000.

As another example, Electronic Arts wanted to check whether adding a 20% discount to the preorder of SimCity 5 would result in more clicks in the promotional banner. Apparently, the discount–free version turned out to be more appealing, since it generated 40% more clicks.

Sometimes though, the devil lies in the details — as Firefox can surely confirm. They focused on reducing the page speed, which is the time needed for a page to load. By making the page load faster by 2.2 seconds, they managed to increase download conversions by 15.4%.

what matters is the technical side of things — for example, page speed, which measures how much time a page needs to load. In some cases, if the page’s content is heavy, it can take up to even 6 seconds. 

Key Takeaways

  • Customer Acquisition Cost is a marketing metric that evaluates whether your marketing efforts are good enough; 
  • The results should be analyzed hand–in–hand with Customer Lifetime Value via CAC/CLV ratio;
  • There are many mistakes that can lead to wrong conclusions. Make sure all your data is up–to–date and keep recalculating relevant numbers;
  • You can use various software and tools to measure those metrics;
  • You can use several tactics to reduce Customer Acquisition Costs, such as focusing on customer retention, polishing your marketing funnel, or introducing automation.
Paulina Gajewska

Paulina Gajewska

Word Designer and Article Developer, devoted to breaking down complex ideas to make Information Technology look simple.

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