What is the cost of customer acquisition? Formula and lifetime value cost

Whether you’re a new niche startup or an established business in your industry, a powerful metric to understand and track is the cost of customer acquisition. What does that mean? In short, it’s a compilation of data points that helps you understand the cost associated with acquiring customers. To help you better grasp customer cost acquisition, let’s explore what goes into customer acquisition, formulas, and how you can streamline your overall costs. 

What is the cost of customer acquisition?

Customer acquisition costs (CAC) is the cost your business incurs by acquiring a new customer through acquisition channels such as:

• Marketing: marketing team and content creation 
• Advertising: cost to run ads and other advertising materials 
• Sales efforts: sales team and their needs 

For many businesses, especially small businesses, the CAC goes unreported, which can potentially lead to the inappropriate use of the marketing budget in the long run. By calculating and understanding CAC, small business owners have the potential to make their marketing efforts go further. 

What is the importance of CAC?

The importance of customer acquisition costs varies depending on your role. For example, business owners and investors may have a different outlook on what’s most important. 

For a business, here are a few instances where the CAC is important:

• Helps brands to allocate their budget: Since most small businesses cannot be everywhere at once, it’s important to know where to put marketing dollars for the highest return.
• Allows for better decision-making: CAC bolsters the decision-making process by providing a clear visual of what tactics are most cost-efficient for the company.
• Tells businesses the cost to scale: Understanding your CAC will also lead to a better understanding of your cost to acquire new customers while you scale. 

For investors, CAC not only provides all the metrics from above but also includes insight into a business's ability to scale and grow. If a business produces a low CAC, investors have reason to believe that the business is capable of scaling.

Customer acquisition cost formula 

The customer acquisition cost formula evaluates a defined period of time through the cost of marketing/sales and the number of customers gained. The formula is as follows:

• Cost of customer acquisition = total cost of marketing and sales ÷ total number of customers acquired

It’s important you narrow down your date range as much as possible when calculating the CAC. This way, you can see the full scope of your data and use it to measure against other key metrics, like advertising spend and customer service interactions. 

Customer acquisition cost vs. customer lifetime value 

Another metric that is often associated with customer acquisition cost is the customer lifetime value. The customer lifetime value is a metric that uncovers the approximate worth of a customer to your business over the lifetime of your relationship. 

The formula is as follows:

• Customer lifetime value = (average purchase value x average customer lifespan)

In this formula, average purchase value is the average amount a customer spends on purchases and average customer lifespan is the amount of time a person remains a customer.

Customer acquisition cost vs. cost per acquisition

Customer acquisition cost and cost per acquisition (CPA) can seem very similar, but they are different metrics. CPA measures the cost of a customer completing a certain action like a lead or an opt-in. Usually, CPA is used to gauge how much it costs to get your customer down your sales funnel. CAC measures the cost to acquire a paying customer, whereas CPA measures the cost to acquire a non-paying customer—just a lead or an action. 

The formula is as follows:

• Cost per acquisition = total cost of conversions / total number of conversions

Customer acquisition cost vs. customer retention rate

While it’s important to understand your CAC, it’s also wise to have a firm grasp on how many customers you’re retaining over time—your customer retention rate. You can use this metric to see when, where, and if your customer base is decreasing. This then becomes valuable information when testing marketing tactics and new products.

The formula is as follows:

• Customer retention rate = [(no. of customers at the end of the measured period - no. of new customers during the period) ÷ no. of customers when the measured period began] x 100

Factors affecting your customer acquisition cost

The lower the CAC, the better. If you notice your CAC is increasing, it could be due to several factors. For instance, the look and feel of your marketing materials. If your marketing is forced or off-brand it could be deterring customers from hopping on board. Other factors include average spend on advertising and marketing channels used. 

Marketing strategy effectiveness 

Having marketing materials that are on-brand with your business is important to draw in additional customers and retain the ones you currently have. This includes:

• Correct color schemes
• Fresh designs
• Captivating content  

Average spend on advertising 

If your advertising costs are too high they could be offsetting your CAC. For example, it’s better to analyze the performance of your advertising before throwing more money into it. This way, you mitigate the customer acquisition costs if one marketing campaign outperforms another. 

Channels used

If you’re not marketing where your audience is, you’re wasting money. Make sure your advertising channels are effective with your target audience. With so many channels available, like social media, print advertising, and television, you need to know where to best reach your audience. For example, if your customers are primarily on Instagram, it would benefit you to allocate most of your budget toward that channel rather than spreading yourself too thin. 

Pricing and promotions

If you aren’t creating an effective incentive for new buyers through your pricing and promotions, you may be losing them in the sales funnel. One way to remedy this is by better market and competitor research. For example, if your competitors are offering a 20% off incentive for the exact product you sell, you are probably losing customers to them with your smaller 10% discount on the product. 

Improving customer acquisition cost

When it comes to improving your customer acquisition cost, there are some additional tactics you can implement. Remember: The goal is to keep your CAC as low as possible to show your business is able to sustain growth and scalability. These tactics include:

Giving additional value 

Aim to overdeliver. Give your audience what they want and then some. This instills brand trust and credit among your target audience. For example, try answering your customer's next question or fulfilling their next need through your marketing tactics. Make your business their go-to source. 

Implementing a CRM

You won’t have much success with your customers if you don’t engage with them properly. A customer relationship manager (CRM) can give you a leg up in managing your company’s relationships with potential customers. For example, a CRM can assist you in building customer relationships and catering to their needs more efficiently than without a CRM in place. 

Improving customer conversion rates

On a related note, pay attention to improving your customer conversion rates. Take a deep dive into your sales funnels and see where you’re losing potential customers from lead generation to the actual buy-in. For instance, if you’re noticing a drop-off at checkout, you may have a problem with your system, or shipping costs could be the deterrent. 

Tracking marketing spend accurately

Another great way to improve your customer acquisition cost is through management of your marketing spend and knowing where your business finances are being placed for the optimal return.

This all starts with a powerful accounting system that can help you not only generate a profit and loss statement but can integrate with your spending accounts to uncover where exactly your funds are being placed. To get the most benefit from your figures, integrate a system like QuickBooks Online for maximum results.

The impact of your customer acquisition cost

Customer acquisition cost can impact your business through gaining a solid understanding of how the costs associated with converting customers are impacted by different activities. 

Choose to segment your marketing activities to give you a broader scope of how and where you may be losing or earning money over time. Pin this up against other key metrics and you’ll be able to see why some segments outperform others.