Customer Acquisition Cost and Why It Matters
Growth at any cost is a recipe for disaster and a dangerous way to run any business
Pyrrhus, king of Hellenistic kingdom of Epirus, was asked by Tarentum in southern Italy for assistance in the fight against Rome. He eventually won the war yet with each of his victories, he suffered devastating losses to his own army which is tantamount to defeat. This lead to the term “Pyrrhic Victory” which symbolizes a success that comes at the expense of great losses.f
In the startup world, customer acquisition is an important measure of success. After all, the more users or customers, the higher the revenue, resulting in a more successful startup right? Well, that isn’t always the case. Unfortunately, many startups seem to have a single-minded approach to customer acquisition that often leads to a Pyrrhic Victory; the more customers they have, the higher their operating cost becomes.
“Growth is good, but growth at any cost is very, very bad”
However, there’s another metric that can help you to avoid this pitfall, and win actual victories with your marketing: Customer Acquisition Cost.
What is the customer acquisition cost (CAC)?
Customer acquisition cost is basically a business’s best estimation of the total cost to acquire a new customer. This goes beyond your advertising cost and includes all potential expenses such as salaries, payment processing fees, marketing software, etc.
Once you have calculated your company’s total spend on sales and marketing, you have to determine how many customers or users were converted based on those investments; only new customers should be taken into account. Finally, you should factor in the time frame; are you calculating the CAC on a daily, weekly, or monthly basis?
Why CAC matters
Imagine you’re running three different ad campaigns and each of them helped acquired ten customers. If you didn’t know better, you might assume that they are all equal and allocate your budget accordingly.
Will treating those three different ad campaigns equally really help maximize your growth?
Nope. In fact, doing so might actually have a negative impact on your business. Customer acquisition metrics might be popular to showcase the growth of your business, but it fails to uncover the underlying costs behind it.
If you want to grow in a scalable and profitable way, then you have to look beyond customer acquisition and get smart with other relevant marketing metrics to help with your growth strategy:
- Lifetime value (LTV)
In simple terms, customer lifetime value is an expression of how much revenue each customer will generate for your company over a specified time period.
- Return on investments (ROI)
This measures the returns you get from spending all those money on acquiring new customers; basically growth minus cost.
- Churn rate
This metric tracks the percentage of your customers that leave and/or never buy from you again.
Avoid wasting resources
CAC can help you to determine which channels are profitable, and which ones are wasting your company’s resources. For example, let’s take a deeper look at those three different ad campaigns.
By introducing basic costs into the mix, you can already have a better understanding of which campaign is more effective in acquiring new customers; allowing you to make smarter decisions. Yet, this is only the basics as advertising is just a part of the total cost of acquiring a customer.
All of these factors should be accounted for in your CAC calculations to ensure that you can accurately determine the actual cost of each new acquisition; it also allows you to strategize on ways to lower your overall CAC.
Focus on what matters
You can combine different metrics to help you better understand the effectiveness of your marketing efforts. For example, by focusing on churn rate and CAC, you can decide whether retention or acquisition should be your main focus.
Businesses can also use LTV to CAC ratio (LTV/CAC) to determine whether the customers you’re acquiring contribute more revenue than they cost. Ideally, it should take roughly one year to recoup the cost of customer acquisition, and your LTV/CAC should be 3.0 — in other words, the value of your customers should be three times the cost of acquiring them.
“Sometimes, the most effective ads might not acquire the most valuable customer”.
When you include lifetime value into your calculations, you will be able to determine the value of customers acquired. Sometimes, the most effective ads might not acquire the most valuable customer; companies need to find the right balance in order to fully optimize their marketing efforts.
Identify weak links
As you itemize the different expenses involved in your total customer acquisition cost, you will be able to pinpoint and question inefficiencies in your sales and marketing process;
- Why do we need two people working on content?
- Are we able to switch to a cheaper EDM software?
- Are we able to do the designs in-house, rather than employ an agency?
- Are we able to automate certain processes?
Once you’ve identified those potential weaknesses, you’ll be able to address them one by one and reduce your overall CAC.
Customer acquisition costs will always be a key component in your marketing strategy. The challenge is how you’re able to effectively and accurately calculate it as data tends to be messy and inconsistent. Nonetheless, as responsible marketers trying to drive growth, CAC is absolutely necessary to avoid Pyrrhic victories, and enjoy sustainable business growth.
Remember, growth at any cost is a recipe for disaster and a dangerous way to run any business; just look at how so many of those “unicorn” startups turned out.