In the past there has been a mentality of growth at all costs. Well guess what… that turned out to not work so well. As the software industry flies into strong headwinds understanding and optimising the Customer Acquisition Cost (CAC) is paramount for sustainable growth and profitability.
In this article, we will delve into the intricacies of CAC, exploring how to calculate it, why it's a key metric to track, the relationship it has with Lifetime Value (LTV), and strategies to improve it. Additionally, we'll touch upon the concept of CAC Payback Period (CPP) and provide an example to help illustrate the topic.
How to Calculate CAC
At its core, CAC is a measurement of how much it costs your business to acquire a new customer. The formula for calculating CAC is fairly straightforward, though, as always, the devil is in the detail.
CAC = (Marketing +Sales Expenses) / Number of new customers acquired
Breaking down this formula a little further. You'll want to include all costs associated with acquiring customers, including marketing campaigns, advertising spend, and sales team expenses, plus the costs to provide the service and support.
The resulting figure provides a clear picture of the investment required to bring in each new customer.
What understanding CAC allows you to do
Understanding CAC serves as a compass for decision-making and allows marketeers to assess the return on investment for various marketing channels and campaigns. Moreover, a deep understanding of CAC facilitates a nuanced approach to customer acquisition, enabling businesses to strike a balance between the cost of acquiring a customer and the potential lifetime value they bring.
Armed with this knowledge, marketing teams can refine their strategies, identify areas for improvement, and ultimately guide their businesses toward sustainable growth and profitability.
The impact of Lifetime Value (LTV) on CAC
While CAC focuses on the cost side of the equation, considering Lifetime Value (LTV) is equally critical. LTV represents the total revenue a customer is expected to generate over their entire relationship with your business. The interplay between LTV and CAC is essential; a higher LTV can justify a higher CAC.
Understanding LTV enables marketers to make informed decisions about customer acquisition. For instance, if the LTV is high, investing more in acquiring each customer may be justified, as the long-term value justifies the upfront cost.
Marketing needs to aim for not just a positive LTV/CAC ratio but something that can show good commercial opportunity for the business, say min of 3/1.
Understanding CPP (CAC Payback Period)
Another important aspect of CAC is the CAC Payback Period (CPP), which assesses how quickly a business can recover the investment made in acquiring a customer. The formula for CPP is:
CPP = CAC / Monthly Gross Margin per Customer
This metric is crucial for financial planning and sustainability. A shorter CPP indicates a faster return on investment, which is often a key consideration for businesses, especially in competitive markets or in those back by investors looking for returns.
Ways to improve CAC
Optimising CAC can take several forms, from looking at performance marketing to sales efficiencies. Some are more obvious and short term where others take a longer, more holistic approach.
Ultimately anything that can help reduce a cost to acquire will mean a better CAC and result in higher profit.
How this works in practice
Let’s look at a fictional scenario where our company “CRM Software” spends £40,000 on marketing and a further £20,000 in sale costs. At the end of the quarter, they’re pleased to see that 100 new customers have signed up to use the product.
Additionally, the company expects to spend an extra £60,000 on technical costs during the same period.
The CAC calculation would be:
CAC = (£40,000 + £20,000 + £60,000) / 100 = £1,200
So, looking at the CAC for this campaign you might be thinking this isn’t a scalable position and costs need to come down. Well, here’s where CPP and LTV come in.
The CRM is aimed at SMB’s and the average annual contract value (ACV) is £800 and, typically, a business stays with them for 4.5 years.
The CPP and LTV would be:
CPP = £1,200 / £800 = 1.5
LTV = £800 * 4.5 = £3,600
All of which means that CRM Software spends £1,200 to acquire a new customer. It takes them 1.5 years to cover that cost, and they make a total of £3,600 per sign up. That’s an LTV/CAC of 3.0.
All in all, a pretty good return for their efforts.
Mastering CAC is a game-changer. Once armed with a clear understanding of how to calculate, optimise, and leverage, CAC insights can drive impactful strategies, ensuring the efficient acquisition of valuable customers. As you navigate the intricate world of CAC, remember that it's not just about reducing costs but optimising the balance between cost and value for sustainable growth.
Are you ready to take your CAC optimisation to the next level? Explore our additional resources for further insights and tools to refine your customer acquisition strategies or get in touch today for a quick chat.