What is Customer Acquisition Cost? Definitions, Comparisons, & More
What is Customer Acquisition Cost?
Customer acquisition cost is a valuable business metric that all professionals should understand. Customer acquisition cost, commonly abbreviated as CAC, is the total cost of new customers attained. Calculating CAC incorporates everything from sales team salaries to search engine optimization technology investments.
Each business is different so no universal CAC formula works for every organization. However, there is a commonly agreed upon customer acquisition cost formula. This CAC formula is the total cost of money spent on sales and marketing divided by new customers acquired.
Customer acquisition costs supply businesses with a lot of valuable information. Knowing the cost per customer of various marketing efforts guides decision making. Customer acquisition costs reflect conversion rate and marketing spend effectiveness. There are dire consequences to ignoring customer acquisition costs. When customer acquisition cost is higher than revenue for a long time period a business may need to close.
What is Customer Lifetime Value?
Customer lifetime value, commonly abbreviated as LTV, and customer acquisition costs are not the same metrics. Unfortunately, many business professionals do not understand the difference between lifetime value and customer acquisition costs. Customer lifetime value is the total sales expected over the entire time period a customer engages with a business. When businesses calculate customer lifetime value a 1, 3, or 5 year time period can be used.
Customer lifetime value is calculated differently for different business model types. For transactional businesses, customer lifetime value depends on repurchasing rates. For subscription businesses, customer lifetime value depends on renewal rates.
What are CAC LTV Ratios?
Customer lifetime value and customer acquisition cost both supply valuable information to businesses. Used together, customer lifetime value and customer acquisition costs are even more effective. The LTV CAC ratio consists of customer lifetime value divided by customer acquisition cost. The LTV CAC ratio determines if the total sales of a new customer are worth the money spent acquiring them.
Combining customer lifetime value and customer acquisition cost also provide a more long term picture. For example, let's say customer acquisition costs for a specific marketing campaign may have initially been high. However, upon calculating LTV through analyzing total sales over a time period specified, money spent may be more justifiable. As such, customer lifetime value can increase allowable customer acquisition costs.
Allowable customer acquisition costs are higher total costs that are worth it according to customer lifetime value. For example, acquisition costs for much larger clients would be incorporated in an allowable customer acquisition cost budget. Although larger clients would have a much higher cost per customer acquired, their total sales prove the marketing spent justification.
However, it is crucial that the allowable customer acquisition cost is predefined. The sales team and marketing team must make sure to discuss allowable CAC with the finance team. There is also one more metric that can be incorporated to provide an even more comprehensive picture. Payback periods are the rate at which a business receives money from its customers. Payback periods are important to consider because they allow businesses to scale and grow. Not only do payback periods encourage growth but they also streamline it.
Key Takeaways for What is Customer Acquisition Cost?
- Customer acquisition costs, lifetime value, and payback periods are all important business metrics.
- Combining the 3 metrics supplies a comprehensive long term marketing activities view.