But at what cost?
This is the answer that you sooner or later will have to answer.
And only the way to answer that is through customer acquisition cost.
Customer Acquisition Cost (CAC) is a metric used to evaluate the cost associated with acquiring a new customer.
CAC represents how much a company spends on marketing, sales, and other related activities to attract and convert a potential customer into an actual paying customer.
It’s a crucial growth metric for businesses because it helps them assess the efficiency and effectiveness of their marketing and sales efforts. Which is the opposite of a vanity metric.
To calculate CAC, you can use this simple formula: Customer Acquisition Cost (CAC) = (Total cost incurred on marketing & advertising / Total number of customers converted)
💡 Example: if you spend $100 on the marketing and advertising campaigns, and around 20 people buy the product by viewing that advertisement, your CAC would be $5.
Accordingly, CAC = $100 / 20 = $5
CAC is such an important metric because it’s one of the best ways to assess many aspects of a business such as its efficiency, sustainability, and profitability.
CAC can be a vital metric for most kinds of businesses. However, like churn rate, it matters most for businesses in competitive markets with recurring revenue models, such as:
Subscription services. From streaming and food delivery to fitness and fashion, CAC is imperative for businesses with these subscription services they rely on a recurring revenue model.
SaaS (Software as a Service). The SaaS industry is a highly competitive landscape and most SaaS businesses work with a subscription model.
Mobile apps. Mobile apps’s business model typically relies on in-app purchases, subscriptions, or advertising.
B2B (Business-to-Business) services. B2B companies, such as agencies or software providers, often need to measure CAC as they spend a lot on advertising and sales and there is an ongoing relationship with B2B clients, in contrast to B2C customers.
By now, you’ve probably realized that the lower the CAC the better. A lower CAC means that you’re getting customers more efficiently. At the same time, you need to ensure the value you get from these customers is worth the cost.
That said, CAC differs from industry to industry. For example, the average CAC in the retail industry is $10, while in real estate is 20 times that.
Accordingly, to find what is a good CAC for your business, you will need to compare it with the industry average.
So, for example, if you are in the Banking/ Insurance industry and you have a CAC of $400, then that’s a good sign that you need to start optimizing your customer acquisition stage in your funnel.
But CAC alone is not always enough. While CAC is crucial for understanding the direct cost of customer acquisition, you will also need a deeper and more strategic perspective. To gain that insight you will have to measure CAC in relation to what is called CLV—Customer Lifetime Value.
The CLV to CAC ratio is a metric that compares the value of a customer to the cost of acquiring them.
Finding the CLV:CAC ratio means realizing not only the efficiency of your acquisition efforts but also your long-term sustainability and profitability.
But first, let’s have a more in-depth look at CLV.
Customer Lifetime Value, or CLV, measures the total revenue a company expects from a single customer over a span of time. This metric provides businesses with valuable insights into the overall worth of their customer base.
CLV goes beyond the immediate transactional value, focusing on the extended contribution each customer makes to the company’s bottom line.
The formula of CLV is as follows: CLV = Customer Value x Average Customer Lifespan
💡 Example: Suppose the average purchase value is $50. The purchase frequency is 2 transactions per month. And the customer lifespan is estimated at 2 years.
Accordingly, CLV = $50 x 2 x 2 = $200
In this example, the estimated CLV for each customer is $200 over the course of their relationship with the business.
Now that you know more about CLV and CAC, the formula to calculate the ratio is pretty straightforward. And it looks like this: CLV ratio = Customer Lifetime Value / Customer Acquisition Cost
💡 Example: if the total customer lifetime value is $1000, and the customer acquisition cost is $200, then
CLV to CAC Ratio = $1000/$200 = 5:1
As with CAC, CLV:CAC ratio can vary depending on factors such as industry and business model.
Nonetheless, as a general rule of thumb, a CLV:CAC ratio greater than 3:1 is what you should be aiming for.
A ratio above 1:1 is an indication that the business is not only covering acquisition costs but also making a substantial profit over the customer’s lifetime.
A ratio around 1:1 is a break-even scenario where the business is recovering the cost of customer acquisition but may have limited room for profitability.
A ratio below 1:1 shows that the cost of acquiring customers exceeds the value they bring over their lifetime that the business is facing challenges.
To improve CLV to CAC ratio, you will either need to increase your CLV or decrease your CAC. Or even better—do both.
Some of the best tactics for decreasing your CAC and increasing your CLV are:
For most kinds of businesses, there aren’t many metrics that can predict marketing effectiveness, revenue, and profitability as successfully as CAC.
The CLV to CAC ratio, in particular, can be the north start metric that makes the most sense for your kind of business, at the stage you happen to be right now.
Are you looking to improve your CAC, CLV, or any other kind of business metric?
Contact us and let’s find out if we can work together.
I write for GrowthRocks, one of the top growth hacking agencies. For some mysterious reason, I write on the internet yet I’m not a vegan, I don’t do yoga and I don’t drink smoothies.
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