The Real Customer Acquisition Cost Formula
Interchangeably using critical metrics such as Customer Acquisition Cost and Cost Per Acquisition while projecting growth can play a bad joke on you. In this article, I show how to calculate the Customer Acquisition Cost and analyze the most widespread mistakes the leading growth teams make while calculating it.
Let’s start with myth-busting. CAC and CAP are often mixed together, however, those metrics are totally different. Let’s start with the Customer Acquisition Cost definition.
CAC measures the actual cost to acquire a customer. On the other hand, CPA measures the cost to acquire everything, but a customer. It can be a lead, a subscription or a product trial. The two metrics are associated because CPA measures the cost of a leat, trial etc. which are the main component of a CAC.
Let’s take Google Drive, Salesforce as a B2B example and Facebook as B2C.
Google drive adopts a freemium model. Its Cost Per Acquisition is to acquire a paying user to their new Google One platform. Cost Per Acquisition, in this case, indicate the cost of a free user registration, free account activation and various signs that a user has successfully transformed from a visitor to a user.
Salesforce is a SaaS CRM. Its Customer Acquisition Cost would consist of a price of a new user acquisition any of their Essentials, Professional, Enterprise or Unlimited plans. Cost Per Acquisition, in this case, indicate the cost of a lead, lead qualification, cost per trial walkthrough.
Facebook, as a majority of the large B2C platforms, unlike their B2B counterparts monetize with the advertisement. In this case, the advertisers are their paying customers. The fun thing is that their customers and users are the same, so facebooks cost per acquisition is the same as a cost per registration and activation.
Customer Acquisition Cost Calculation
The hardest part is to establish who exactly is your customer in this model. This should be your starting point.
If you google “Customer Acquisition Cost Calculation” you will receive this formula:
However, we feel like it is only good as a general direction since it is missing details and variables to make it precise. If you feel like it’s enough for you, here is a link to a basic CAC calculator.
This customer acquisition cost formula has certain limitations since:
- It takes two months on average to transform a lead into a paying customer.
- The equation includes only new users. What about the returning ones?
- If we talk about a freemium model, there are expenses to support free users and not all of them will convert eventually.
We suggest focusing on these 2 key points to make an accurate calculation. It would help you better identify your variables.
What is the time interval between the first marketing or sales touch point that you pay for and the moment a user becomes a paying customer?
That is the first problem with the generic CAC formula since it assumes that you spend zero time and money on unpaying users.
Let’s take Google Drive for example. When you sign-up you are given 15 Gb of forever free storage. You can use it up until the moment you hit the size limit, which might be upgraded. For most users, the free period can extend to more than a year, and for some, it might never end.
If we look at Salesforce, or in fact, any other SaaS with an inside sales model, there is a chance that a user will convert into a lead this month, but will become a paying customer only in 3 months. This happens due to a long sales cycle.
By neglecting these sales cycles you can end up in over or underestimation of a Customer Acquisition Cost and you which might result in bad future operating decisions.
A great example of overestimation is taking a month’s marketing expenses and dividing it by the amount of the same month’s new customers. The problem becomes evident when let’s say you have an experimental Pre-Spring marketing expense spike in February. Let’s insert this amount into our simple calculator. We will get an overrun and consider this month bad and cancel this marketing channel for March.
But what if your sales cycle is 30 days? Then you will get a month CAC delay and instead of canceling the unsuccessful marketing channels you might even extend it.
So does this time frame rule apply to everyone? Almost. There are in fact two exceptions:
- If you are a B2C company with very short sales cycles (i.e. an Instagram shop)
- You have a super-consistent expanse plan. Even there are month-to-month variations, they are slight. and do not make a noticeable difference.
If you take into consideration that your Sales expenses can have different timing (between the first touch point and the actual sale), the formula becomes even more complex. For example for a company like Salesforce with a 2-month sales cycle the sales expense are consistent during the whole period, this formula should be applied
The result compared to the basic is here:
The second point is what kind of expenses do you include in the Sales expense column?
Here’s the list of what You should definitely include:
Both Marketing and Sales departments payrolls should be included including the staff with other functions that contribute to the team.
You should include office and equipment rental expenses in the Sales column
The amount of software used by sales and marketing teams is enormous these days and should be included as well.
Let’s look at some cases.
For some freemium companies as (i.e Spotify), customer acquisition method is their free version of the products that get shared. The expenses for free product support as well as R&D should be included in the equation. Those can be project managers and engineers, in other words not the kind of guys that you traditionally expect to include into Marketing/Sales.
Some companies have nontraditional roles on board such as customer success team. Whether to include those into the Customer Acquisition Cost formula depends on the responsibilities of the team members.
Subscription business is another interesting case. For example, Harry’s gives you a free trial, but you should pay a 3$. You can argue, but I say that someone who made a 3$ shipping payment still isn’t a customer yet. So those costs that are associated with a trial user support should be included in a customer acquisition cost (even though they are outbalanced by the shipping cost).
New vs Returning Customer
CAC calculation requires us to precisely define between new and returning customers.
To avoid having synthetically low CAC’s you should always include the cost of customer retention and a total amount of customers (new and returning).
Another way to achieve this is to create two tables, one for new customers and one for the returning ones.
I hope you understood that there is no one-size-fits-all formula that you can simply paste your numbers in and receive your CAC. It is a complicated process that involves a lot of analysis.
You should focus on:
- The time between of your first touch and an actual sale
- The number of new customers
- The cost of all assets needed to support the sales/marketing teams