What is Customer Acquisition Cost (CAC)?

Customer Acquisition Cost (CAC) is the total cost involved in acquiring a new customer. It represents the average cost your company incurs to acquire one new customer.

CAC includes all marketing, sales, and service expenses related to acquiring new customers. This includes costs like:

• Marketing campaigns and advertising to generate leads

• Sales team salaries and commissions

• Promotions and discounts offered to attract new customers

• Free trials or demo products given to prospects

• Sales collateral, travel, and events expenses

CAC is an especially important metric for software as a service (SaaS), subscription, and other recurring revenue businesses. Since these business models rely on continually acquiring new customers to drive growth, understanding your CAC is critical.

By calculating CAC, SaaS and subscription companies can determine the payback period to recover the costs of acquiring new customers through their ongoing revenue streams. CAC helps set benchmarks for marketing and sales expenses to ensure acquiring new customers is profitable.

Tracking CAC over time allows businesses to optimize their customer acquisition strategies. Reducing CAC improves profit margins and provides competitive advantages.

Why CAC Matters to Your Business

Tracking your customer acquisition cost (CAC) provides critical insights that can directly impact your business growth and profitability. Here are some of the key reasons why understanding and optimizing your CAC is so important:

Helps Determine Optimal Spending on Acquisition - Knowing your CAC enables you to determine the appropriate amount to spend on acquiring new customers. If your CAC is too high, you may be overspending on marketing and sales. By tracking CAC you can find the optimal level of spending to achieve your customer growth goals.

Enables Calculation of LTV and LTV:CAC - CAC is needed to calculate your customer lifetime value (LTV) and LTV:CAC ratio. These metrics help assess the long-term value of your customers versus the cost to acquire them. A high LTV:CAC ratio means your business model is profitable.

Allows Benchmarking Against Competitors - By calculating your CAC, you can compare it to industry benchmarks and competitors to evaluate how your customer acquisition costs stack up. This helps you understand if your CAC is in line for your market or if there is room for improvement.

Knowing and optimizing your CAC gives you key insights on your business and spending. That's why undertaking the CAC calculation on a regular basis is so important to maximize your profitability.

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For the next section, can you write the h2 and section for How to Calculate Your CAC. Focus on:

• Add up all marketing and sales expenses for acquiring new customers over a period

• Divide the total cost by the number of new customers acquired

• Time period can be monthly, quarterly, annually

• Include all costs like advertisements, sales team, promotions, etc.

Again, please format in markdown.

How to Calculate Your Customer Acquisition Cost

To calculate your customer acquisition cost, you'll need to follow these steps:

1. Identify the time period you want to measure.

Most companies calculate CAC on a monthly or quarterly basis. Choose a consistent time frame that makes sense for your business operations. Monthly is a good option for subscription businesses with recurring revenue.

2. Add up all your sales and marketing expenses for that period.

Include all costs associated with acquiring new customers, such as:

• Marketing campaigns like PPC, social media ads, content marketing

• Sales team salaries and commissions

• Sales software and tools

• Discounts or promo offers for new signups

• Lead generation costs

• Sales conferences and events

3. Identify the number of new customers acquired in that period.

For subscription businesses, use new MRR or new ARR from new customers. Ecommerce sites can use number of first-time buyers.

4. Divide total acquisition costs by number of customers.

CAC = Total Customer Acquisition Costs / Number of New Customers

This gives you your average cost to acquire a new customer over that time frame.

5. Compare CAC over time and optimize.

Calculate your CAC monthly or quarterly to spot trends and see the impact of changes to sales and marketing. Look for ways to improve conversion rates or lower costs to reduce CAC.

The Formula for Calculating CAC

The formula for calculating customer acquisition cost (CAC) is:

CAC = (Total Acquisition Costs) / (Number of New Customers)

Where:

• Total Acquisition Costs = All expenses related to acquiring new customers over a period of time. This includes marketing expenses like ads, promotions, content creation etc. It also includes sales team salaries and commissions attributable to acquiring new accounts.

• Number of New Customers = The number of new customers acquired in the time period you are calculating CAC for. This could be monthly, quarterly or annually.

For software as a service (SaaS) businesses, it is more accurate to calculate CAC based on new monthly recurring revenue (MRR) rather than number of customers. The formula becomes:

CAC = (Total Acquisition Costs) / (New MRR)

Where:

• New MRR = The new monthly recurring revenue generated from customers acquired in the time period. Using MRR accounts for differences in plan pricing and ensures customers with higher contract values are weighted appropriately.

• Total Acquisition Costs = Remains the same, all costs spent to acquire the new MRR.

This formula shows that in order to decrease CAC, you either need to decrease acquisition costs or increase the new MRR from acquired customers. Optimizing both sides of the equation is key to improving CAC efficiency.

What is a Good CAC?

There is no one-size-fits all answer for what is considered a good customer acquisition cost (CAC). The ideal CAC will depend significantly on factors like your industry, business model, and customer lifetime value. However, there are some useful guidelines for assessing if your CAC is within a reasonable range:

• Benchmark Your CAC Against Your Industry Averages

The best way to determine if your CAC is good is to compare it to industry benchmarks. Research typical CAC for comparable companies in your industry. This at least provides a baseline to understand if your customer acquisition costs are aligned with your peers. Excessively high CAC compared to your competitors indicates opportunities to improve.

• Aim For a CAC That's 1/3 of LTV or Less

For many SaaS and subscription businesses, a good rule of thumb is to keep your CAC around 30-50% of your customer lifetime value (LTV). The lifetime value must be at least 3X higher than customer acquisition cost to profit from the customer relationship. If your CAC creeps above one third of LTV, it will be challenging to profit from acquiring new customers.

• Target a CAC Payback Period of Under 18 Months

Companies typically want their CAC to breakeven within 12-18 months. For example, if your average customer lifetime is 3 years and CAC payback happens in 12 months, you will profit from the remaining 24 months. Long payback periods limit profitability. Use payback period along with LTV:CAC ratios to gauge good CAC.

While the specifics vary, keeping CAC below industry averages, around 33% of LTV, and with payback under 18 months are good general guidelines. Track these metrics over time, test new CAC-reducing initiatives, and continue optimizing to reach your CAC goals.

How to Improve Your CAC

There are several strategies you can use to lower your CAC and make customer acquisition more efficient and cost-effective:

Optimize Your Marketing and Sales Efforts

Conduct an audit of your existing marketing and sales processes to identify the channels, campaigns, and tactics working best at driving new customers. Double down on the highest converting and most cost-efficient lead sources. Cut budgets on activities with a high CAC and low conversion rates. Experiment with new marketing channels and measure results. Optimizing your marketing and sales efforts ensures you focus budget and resources on the most profitable growth activities.

Focus on Channels with High Retention and Lifetime Value

Prioritize marketing channels that bring in customers who purchase again and have a high lifetime value. Be willing to pay more to acquire these loyal, valuable customers. Avoid spending on channels that have high churn or low order values. Offer promotions or free trials through your best channels to incentivize high-value customers to sign-up.

Increase Customer Retention Rates

Retaining customers longer reduces the number of new customers you need to acquire. Ramp up your customer success and support teams to boost retention. Check in with customers to ensure they are satisfied. Address complaints quickly. Surprise customers with special perks and promotions. The higher you can boost retention, the lower your cost to acquire each new customer.

Target High-Value Customer Segments

Not all customers have the same lifetime value. Segment your customers and identify the highest value groups based on revenue, order frequency, longevity etc. Then focus your marketing on just acquiring more of those high-value customers. Avoid spending to acquire one-time buyers or customers with high churn rates. Go above and beyond to delight and retain the 20% of customers driving 80% of your revenue.

Refine Your Sales Process

An efficient sales process converts prospects to customers faster and at a lower cost. Train your sales team on best practices. Standardize and automate parts of the sales process. Remove roadblocks slowing down the sales cycle. Use analytics to calculate your lead-to-customer conversion rates, sales cycle length and sales team capacity - then optimize accordingly. Higher conversion rates directly lower your CAC.

Calculating CAC for SaaS Businesses

For software as a service (SaaS) businesses, calculating CAC requires a few modifications to the standard formula to account for their subscription revenue model.

• Use MRR instead of number of customers

  • Rather than looking at the raw number of new customers, SaaS businesses should calculate CAC based on new monthly recurring revenue (MRR). This accounts for the fact that customers may be on different subscription tiers.

  • To calculate, take the total marketing and sales costs for the period and divide by the new MRR added from new customers. Using MRR gives a more accurate CAC.

• Factor in discounts and promotions

  • Signing up new customers often requires discounts, free trials, or other promotional offers. These reduce the effective MRR from each customer and must be incorporated into the CAC calculation.

  • Take the discounted price, accounting for any promotional periods, as the MRR for those new customers when calculating CAC.

• Account-based marketing impact

  • Many SaaS companies use account-based marketing focused on landing big enterprise accounts. The costs are high but so is the potential MRR.

  • When calculating CAC, isolate the costs and MRR specifically attributable to ABM campaigns rather than averaging across all marketing activities. This prevents overstating CAC.

The core CAC formula stays the same, but these adjustments allow SaaS companies to calculate a more relevant CAC number based on the key metrics that drive their subscription businesses. Accurately measuring CAC is critical for SaaS companies to evaluate the profitability of their customer acquisition strategies over time.

Calculating CAC for Ecommerce

Ecommerce businesses need to calculate CAC a bit differently than SaaS or services companies. The key is to focus only on revenue from new customers acquired during the time period, not total revenue. You also need to factor in all customer acquisition costs like ads, discounts, referrals, etc.

Here is the formula to calculate CAC for ecommerce:

CAC = (New Customer Acquisition Costs) / (New Customer Revenue)

The acquisition costs should include:

• Paid advertising expenses (Google, Facebook, Instagram, etc)

• Affiliate and referral fees

• Promotions and discounts given to acquire new customers

• Any other marketing costs associated with getting new customers

And the new customer revenue is the total sales from only new customers within the time period, not total revenue.

For example:

• An ecommerce company spends $100,000 on Facebook ads in a month and generates $200,000 in revenue from 500 new customers.

• They also gave away $5,000 in discounts and paid $10,000 in affiliate fees to acquire new customers.

• Their total new customer acquisition costs were $100k + $5k + $10k = $115,000

• New customer revenue was $200,000.

• So their CAC is $115,000 / $200,000 = $575

Tracking CAC accurately for ecommerce requires isolating new customer costs and sales. But it provides an invaluable metric to understand true customer profitability.

Calculating CAC for Services Businesses

For services businesses that bill customers on a recurring basis, such as monthly or annual contracts, calculating CAC requires factoring in the value of those contracts. Here are some tips for calculating CAC for services businesses:

• Use annual contract value for new customers rather than a simple customer count. For example, if you acquired 100 new customers at $5,000 annual contracts, use $500,000 as your revenue from new customers rather than just 100 customers.

• Factor in any sales commissions, bonuses, or other variable compensation paid to the sales team for those new customer deals. These are costs of acquiring those customers and should be included in your CAC calculation.

• Look at any upfront discounts or promotions given to new customers as part of your sales and marketing costs for acquiring those customers.

• Consider the impact of contract length - a 12 month contract vs 24 month contract may have different CAC implications. Use annual contract value, but consider differences in upfront acquisition costs.

• For multi-year contracts, you may choose to amortize the acquisition costs over the lifetime of the contract rather than taking the full impact in year 1. This can help smooth out CAC from year to year.

The key is to accurately reflect both the revenue value and total costs associated with acquiring new customers over a given time period. While customer count is simpler, using contract value for services businesses provides a much more meaningful CAC metric.

CAC Case Study Examples

CAC can vary widely across industries and business models. Here are a couple real examples to illustrate how to calculate CAC:

SaaS Company

Let's look at a fictional SaaS company called CloudApps that sells a cloud-based project management tool.

• Monthly revenue from new customers averaged $5,000

• Annual marketing budget was $360,000

• Over the past year they acquired 120 net new customers

To calculate their CAC:

CAC = Marketing Expenses / New Customers = $360,000 / 120 = $3,000

For SaaS companies, it's best to look at new monthly recurring revenue rather than number of customers. So their CAC based on new MRR is:

CAC = Marketing Expenses / New MRR = $360,000 / $60,000 = $6

This means CloudApps spent $6 in marketing for every $1 of new monthly revenue last year. Their CAC payback period is 6 months ($6 CAC / $1 MRR).

Ecommerce Company

Let's look at an example ecommerce company called Outfitters Inc. that sells outdoor apparel and gear.

• Their total online marketing expense was $250,000 last year

• This helped generate $1.5 million in revenue

• A total of 1,200 new first-time customers made purchases

Their customer acquisition cost is calculated as:

CAC = Marketing Expense / New Customers = $250,000 / 1,200 = $208

So Outfitters spent $208 on average to acquire each new customer. This seems reasonable for an ecommerce business if the lifetime value of these customers is high enough.

Tracking CAC by channel can also help Outfitters optimize their marketing mix.