Customer Acquisition Cost Defined
Customer Acquisition Cost: The total cost associated with persuading a customer to buy a company’s products or services. It includes all costs involved with customer research, marketing, and advertising: anything done to acquire a new customer. It is a critical business metric when evaluating the viability of a business model.
A clearer picture showing how much money to spend to increase customer base can be seen with customer acquisition costs considered. This cost can be compared to total profits generated and provide a realistic idea about returns on investment that are possible.
Calculating Customer Acquisition Cost
To calculate Customer Acquisition Cost, divide total costs of acquiring customers, or marketing expenses, by the number of customers acquired in that period. For example, if a company spends $2,000 per quarter on marketing, advertising and acquiring customers, and ends up attracting 100 new customers in that quarter, the customer acquisition cost is 2000/100= $20.
The figure of $20 is not relevant in itself. First, the significance of the CAC varies from industry to industry. For instance, a CAC of $20 may be high for an e-commerce company, but low for a real-estate company.
To get a relevant view, the calculation of customer acquisition can reference customer lifetime value (CLV). CLV is the measure of the monetization of the relationship with the customers, i.e., how much net profit the company makes from a customer over its future relationship.
The same CAC of $20 will be considered as high if the customer makes no additional purchases. However, it will be considered low if the customer generates purchases of $2,000 during the entire business relationship.
The companies use highly targeted campaigns to track the transition of customers from potential clients to long-lasting ones. They also deploy several ways of calculating CAC in the most insightful, yet straightforward ways.
Who is it Relevant for?
Customer acquisition cost is very relevant for both the companies and their investors.
When investors look at a startup, there is not much operating history or financials that they can base their investment decision on. They almost always look at the future potential of the idea and the company. Therefore, investors place considerable importance on how much the business needs to spend to acquire a customer versus how much money the business can earn from the customer.
CAC is equally important for the company itself, especially the marketing department. Marketing teams main goal is to reduce customer aquisitions cost to optimize and increase the companies profit margin.
Significance of CAC for Startups
With startups, the customer acquisition cost is critical. If the cost of acquiring a customer is higher than the net profits they will generate, a startup will need to raise significant capital to scale. Ultimately, this may prove to not be a viable business model.
A high acquisition cost is likely the number one cause of startup failure. This is especially true in regards to internet companies and web-related campaigns.
Startups should be concerned about their CAC to create and sustain a viable business model. Startup have the potential for improved profit margins and higher probability of survival with optimal customer acquisition cost.
Customer acquisition cost is also a critical deciding factor of the potential of a startup at the time of a liquidation event, like an IPO or acquisition, or while raising funds from investors.
The Bottom Line
Customer Acquisition Cost is one of the most significant factors for judging and analyzing a startup’s future potential. A startup must optimize its CAC to survive and grow.
Companies can minimize their customer acquisition costs through better customer relationship management. This enhances user value and improves their conversion metrics through better site performance.
