What is Customer Acquisition Cost?
Customer Acquisition Cost is 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.
Customer Acquisition Cost gives a clear picture of how much money needs to be spent to increase the customer base. This cost can then be compared to the total profit that can be generated from a customer to get a realistic idea about the returns on investment that are possible.
How is it Calculated?
Customer Acquisition Cost is calculated by dividing the 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 too high for an e-commerce company, while it could be very low for a real-estate company.
To get a relevant view, the calculation of customer acquisition cost must be done with reference to 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.
Therefore, the same CAC of $20 will be considered as high, if the customer makes no additional purchases or never returns. However, it will be considered to be very 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. The marketing team is always focused on reducing the customer acquisition cost so that their returns are optimized and the company’s profit margin increases.
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, and may prove to not be a viable business model.
A high customer acquisition cost is likely the number one cause of startup failure, especially in regards to internet companies and web-related campaigns.
Startups should be concerned about their CAC, along with their team, product, and market, to create and sustain a viable business model. If there is an optimal customer acquisition cost, the startup has the potential for improved profit margins and a higher probability of survival and growth.
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, which enhances user value and improves their conversion metrics through better site performance.
About: Chris lustrino
A Boston College Eagle for life, on a mission to democratize startup investing for all people at KingsCrowd, with a passion for Fintech, investing, social impact, doing well and doing good, and an avid runner, cyclist and writer.