Definition

Customer Acquisition Cost (CAC) measures the total cost incurred by a business to acquire a new customer. This includes all marketing and sales expenses, such as advertising, salaries, commissions, and other direct costs associated with acquiring customers. Some companies go as far as including all operational expenses. CAC allows you to put generated revenue into the context of profitability.

Importance of CAC

Without understanding your CAC, you cannot know whether you're executing a profitable commercial strategy. Here’s why CAC is so important:

• Sanity check: Are we going to earn more cash from this customer than we'll spend on acquiring them?

• Profitability Analysis: By comparing CAC to Customer Lifetime Value (CLV), businesses can determine whether the revenue generated from customers in the long term actually exceeds the initial cost of acquiring them.

• Resource Allocation: CAC provides clarity into which acquisition channels are most cost-effective, enabling better allocation of time and cash.

• Scalability: Decreasing your CAC while increasing CLV means you'll be able to sustainably scale your business.

How to Calculate Customer Acquisition Cost

The formula for calculating CAC can be as straightforward as:

CAC = Total Sales and Marketing Expenses / Number of New Customers Acquired

However, opinions differ on which expenses you should include beyond marketing and sales investments.

Example Calculation:

1. If a company spends $100,000 on marketing and sales in one quarter and acquires 1,000 new customers during that period:

   • CAC = $100,000 / 1,000 = $100

   • This means the company spent $100 on average to acquire a new customer.

2. For a SaaS company that spends $50,000 on marketing and sales in a month and acquires 500 customers:

   • CAC = $50,000 / 500 = $100

   • The CAC remains $100 per customer.

This is an oversimplification as most sales and marketing investments will not result into instantaneous client acquisition.

Components of CAC

CAC includes both fixed and variable costs associated with customer acquisition, for example:

• Marketing Expenses: Ad spend, SEO investments, affiliate marketing, salaries, etc.

• Sales Team Salaries: Salaries and commissions paid to sales staff.

• Software Tools: subscription cost of CRM systems, email automation tools, analytics platforms, etc.

• Creative Costs: video production costs, visuals, or other promotional materials.

• Event Costs: Trade shows, conferences, or webinars.

What Is a Good CAC?

A good CAC varies by dramatically by industry, customer type, and maturity. That said, a healthy ratio between CLV and CAC to aim for is around 3:1 or 4:1 –meaning the revenue generated from a customer should be 3-4x higher than the cost of acquiring them.

Challenges in Managing CAC

Maintaining an optimal CAC can be difficult and it will likely fluctuate over time due to several factors:

1. Increasing Competition: Competitive markets will drive up CAC and may even erode any prospects of profitability.

2. Inefficient Channels: Spending in underperforming acquisition channels will inflate your CAC.

3. High Churn Rates: Losing customers shortly after acquisition may not increase your CAC directly, but will reduce the return on investment and lower your budget.

4. Wrong Audience: Poor targeting or lack of personalization can lead to wasted investments on irrelevant leads.

CAC vs Related Metrics

CAC is closely related to other metrics like Customer Lifetime Value (CLV) and Return on Ad Spend (ROAS):

• CLV measures the total revenue a customer generates over their lifetime; comparing CLV to CAC determines your profitability.

• ROAS evaluates the revenue generated directly from advertising spend alone.

Conclusion: Why Is CAC Important?

Customer Acquisition Cost is one of the most impactful metrics to track for any for-profit organization. By tracking your CAC alongside CLV, you'll get a direct assessment of your ability to profitably acquire customers. It should be one of the biggest drivers of resource allocation for your commercial teams. Your ability to influence and master the CAC will directly impact your ability to raise external funding.