How Much Do you Pay to Play?
Reporting on your Customer Acquisition Cost
Marketing for SMB’s is tough; it requires a mix of several advertising and marketing tools in order to reach B2B audiences. It’s equally challenging to quantify the exact contribution that marketing makes to sales and to the business as a whole. That’s why when a business calculates its quarterly or annual revenues, it’s crucial that the cost of acquisition metric is measured and accounted for. $500K in revenues can reflect a landmark closing quarter but if the cost of acquisition, including the cost of marketing expenses and overhead, is higher than the net worth that it took to gain that revenue, then something might be wrong.
What Is CAC and Why Is It Important?
Customer Acquisition Cost (CAC) provides a broad understanding on how much money and effort is being spent on attracting new or returning customers. The basic rationale is that a business shouldn’t spend more than the value the customer is expected to provide. A high CAC could result from inefficient marketing whereas a low CAC could be better leveraged to improve overall company performance. Of course, sometimes a high CAC isn’t necessarily a bad thing but only if it’s part of a bigger strategy.
CAC can be also measured per individual campaign or activity so these can be compared for effectiveness. With CAC you can set pre-defined goals, in order to fully track and assess performance rates.
For the business and for marketers, CAC is possibly one of the most important KPIs. Previously, marketers were focused on their own specific KPIs such as CPA and CPL. But these indicators were disconnected from the bigger corporate picture. Today, higher-level business KPIs (ROI, Revenue, Gross profit, etc.) can be analyzed together with classic marketing KPIs. This not only requires marketing performance to become much more transparent, but it creates a mutual connection between marketing activities and the overall business performance.
How Do You Calculate CAC?
To calculate CAC divide the total costs associated with acquisition by the total number of new customers, within a specific time period. Acquisition costs would include all sales and marketing costs – programs and advertising spend, team salaries, commissions and bonuses, plus overhead. The time period could be monthly, quarterly, or annually.
The formula is:
CAC = Sales + Marketing costs
Ratio of Customer Lifetime Value to Customer Acquisition Cost
CAC can also be used to determine a number of essential related metrics. Since the quality of the customers is obviously also important, the most vital related KPI is probably the one that shows how much value you’re making from your customer in relation to how much it cost to acquire them. This is known as LTV:CAC – Ratio of Customer Lifetime Value to Customer Acquisition Cost.
Now compare it to their CAC. A well-balanced business model requires that the CAC be significantly less than the LTV
Optimizing LTV:CAC Ratio
- 1:1 or lower – You’re losing money from every acquisition.
- 3:1 – The ideal level. You have a solid business model and a thriving business.
- 4:1 – While this is good news, you’re probably underinvesting in marketing and advertising and could be growing much faster.
The Not So Secret Sauce
It’s no mystery that winning and retaining customers for the company is the name of the game. But if your marketing or business expenditures are outpacing your overall profit goals, something’s wrong. CAC gives organizations the ability to gage their output vs. its input on the most definitive level. Measuring, analyzing and reporting on the correct indicators is critical for enabling good business decisions that improve the bottom line. Find out how to best leverage your analytics and report to upper management by downloading Datorama’s new How to Guide – What your CEO expects from your Marketing Report.