CAC (Customer Acquisition Cost) Explained

Everything you need to know about Customer Acquisition Cost (CAC)

CAC is not just a Cost per Acquisition (CPA)

To begin with, let's look at a common myth together. Cost of acquisition per customer (CAC) and cost per acquisition (CPA) are often confused, when in reality, they are different measures. Understanding the difference is only the beginning of a thorough understanding of CAC.

The CAC specifically measures the cost of acquiring a paying customer. Conversely, CPA (cost per acquisition) measures the cost of acquiring “something” that is not a paying customer - for example: a registration, an activated user, a trial, or an opportunity. The two are linked because the CPA is generally used to measure the cost of the factors that make up the CAC.

So let's now look at what the CAC is.

The CAC (Customer Acquisition Cost)

Customer acquisition cost is the KPI used by businesses to find out the cost associated with acquiring a paying customer. Business leaders rely on this measure to determine their profitability and assess the effectiveness of their marketing and sales efforts.

The CAC is a value that managers and companies need to know in order to be able to develop their customers, their turnover but especially their associated margins. Businesses often look for ways to reduce acquisition costs in order to improve profitability.

If your business is highly dependent on your number of prospects, this measure becomes even more vital: you need to know and control it for your business.

It's important that you have an effective method for tracking your lead costs and customer acquisition costs. Getting a lead is one cost, converting them into a paying customer is another. What are your actions to measure the effectiveness of your efforts on the Cost of Acquiring New Customers? On average, only 14% of companies pilot the CAC.

If you want to learn how to control and lower your CAC, you first need to know how to calculate it accurately.

What are the steps for calculating the CAC?

Step 1: Determine the observation period

The first step in calculating your CAC is to determine the period of time you want to track. Every business is different and for smaller businesses, it makes more sense to keep an eye on their CAC for a shorter period of time, like every two weeks or every month.

Large businesses can choose to monitor their CAC on a quarterly basis. It all depends on the size of your business and your average time spent through the various stages of the funnel (especially if what you are selling is complex or expensive).

Step 2: Break down all your Sales and Marketing investments

This step is a bit more complicated as it requires you to first break down all of your relevant business and marketing costs. To do this effectively, you need to have good accounting procedures, have a good view of the time spent per individual in these actions, and really know what you consider to be costs for your business.

It's important to be honest and transparent at this stage because it will help you better understand your business to better optimize it.

Step 3: Add up your marketing and sales costs

We want to know the monthly cost of investments made to Convert new paying customers. In this step, we will therefore use the sum of the marketing investments of the month corresponding to the “1st touch” to the commercial investments that we have just rationalized in the previous step.

Step 4: Divide your total costs by the number of new customers

Once you've decided on the study frequency and determined your total sales and marketing costs, it's time to divide them by the total number of new customers you acquired in the last month of your evaluation period. (and not over the entire evaluation period)

As stated earlier, once you have that number, it's important to keep a close eye on it and start focusing on ways to improve it.

Composition of Marketing and Commercial Investments used in calculating the CAC

Some businesses choose not to include certain items in their customer acquisition costs for a wide variety of reasons. Some simply don't want to accept the real cost of acquiring customers, which tends to be much higher than they think. It's good to be extremely honest about your acquisition costs in order to reduce them and improve the profitability of your business. The most common acquisition costs are explained by commercial and marketing costs.

Commercial investments

Business costs are the direct costs associated with your business producing goods or providing services. It should be noted that these costs will tend to vary between different types of businesses. Here are some common business expenses:

• Production costs
• Salaries of Persons in charge of Commerce
• Maintenance costs
• Tools used for sales
• Any rent (a breakdown of the square meters used), services or equipment spent for sales teams

Sales costs tend to vary from period to period, and as a business, it's important to know how much they weigh on the overall cost of acquiring customers.

If you are a service company and you have salespeople who do a good job closing, they have an impact on your overall customer acquisition cost in one way or another. If you're a business that sells physical products, you can find ways to reduce your production costs in order to improve your bottom line.

Marketing investments

The cost of marketing covers all necessary costs associated with marketing and advertising products and services, as well as the cost of acquiring leads. Most businesses generally have a periodic marketing budget that they follow and adapt as sales increase or decrease.

Some businesses even conduct periodic marketing audits in order to know their marketing performance and correct it if necessary.

Some of the most common marketing costs include:

• Publishing costs
• Advertising expenses
• Production costs
• Software and technology costs
• Website costs
• Graphic design costs
• Any rent (a breakdown of the square meters used), services, or equipment spent for marketing teams

In order to accurately measure your marketing costs, it's important to break them down into their own category and rank them according to the total expenses incurred. This allows you to know which component of your marketing is the most expensive and which is the most effective in helping you generate leads.

Why is the CAC Classic Formula wrong?

95% of businesses are wrong

If you Google “how to calculate the cost of acquiring a customer”, you'll get the basic formula below:

On the surface, this is correct, but it lacks a lot of detail and precision around each variable in the equation for everything to be really correct. Even the best basic calculation can be very misleading.

But what if I told you the following things:

• On average, it takes 60 days for most prospects to become paying customers.
• Not all customers are “new”, but some of them return after a longer or shorter period of time.
• If it's a free product, you have associated costs to support users before they become paying users (customers).

These three additional pieces of information should change the way we think about the basic formula above. Instead of taking the equation at face value, we must first take a step back on its real application with the specificity of our company.

Correlation between CAC and Funnel

To better generalize this formula and ensure that your calculated Customer Acquisition Cost is in line with reality, you should take into account the speed of the steps taken by your customers in your funnel.

In short: what is the average speed of the preliminary steps taken by your customers to convert. Especially in the context of complex or expensive products or services, these various conversion phases can take much longer because:

• The expenses incurred are greater
• The customer takes more time to understand all the benefits of your offer
• The customer takes time to benchmark the market
• The decision-making circle is not committed to one and the same person within the company.

As we see above, you should not confuse CAC and CPA: CPA is the cost of acquiring the preliminary stages of revenue generation — the stage at which we are going to calculate our CAC.

What is the correct formula to calculate CAC?

The key issue of the delay between marketing and sales expenses incurred and customer acquisition doesn't matter if you are in one of two scenarios:

• The time between the first marketing touchpoint and the moment a person becomes a customer is very short. This is true for many B2C businesses that have very short decision funnels.
• Your marketing and sales expenses are so constant that they stabilize over time. But even then, it's better to be more specific.

You need to understand how these expenses are correlated when a customer converts.

The easiest way to do this is to calculate your average length of marketing/sales cycles. In other words, what is the average time between the first touchpoint and the conversion into a customer?

We are going to illustrate our explanation using 2 examples. You can access at any time the Spreadsheet by clicking here.

CAC formula for “fast” conversion cycles (< 30 days) or with stable costs

You can use the formula we saw earlier:

CAC= [Sum Marketing Costs (Month N) + Business Costs (Month N)]/Number Nvx Paying Customers (Month N)

Let's apply the above formula using an example:

Now let's calculate:

CAC= (12 896+ 40764)/(481) =112 €

As you can see, in this example, we assume that all of the investments made as part of these conversions were made over a single month.

Unfortunately for many businesses, the framework of this formula does not always match reality. Let's see another useful alternative right away if your sales cycles are longer than the one in this example.

CAC formula for “long” conversion cycles (> 30 days) or with unstable costs

Here is a formula that takes care of the temporality of marketing and sales actions in the context of companies where the conversion period into paying customers is greater than 30 days:

CAC= [Invest Marketing (Month 1) + Average Commercial Investment (Month 2,.. N)]/Number Nvx Paying Customers (Month N)

(I indicated this formula in months to simplify writing but it is entirely possible to use it with a finer granularity in terms of number of days)

Let's apply the above formula by considering an evaluation period of 3 months:

CAC= (1 34+4 (31 929+40 764) /2) /481=99€

So as you can see, the acquisition cost doesn't really match that of our previous example. In this way, it remains important to take a step back from your complete sales cycle to adapt the formula to your own parameters.

(Optional) Mathematical decomposition

For those who would be interested in going even further, here is the mathematical modeling of the valuation of the CAC that I carried out and that I propose to you below.

If you are not interested in this or if it seems too complex you can skip this step 😀

Common mistakes in calculating the CAC

The important question you need to answer to get an accurate CAC calculation is this: what expenses do you include in calculating the numerator (marketing/sales)? Before looking at some examples of different answers to this question, here are the three most common mistakes businesses make:

1) Do not include salaries

You should include salaries for everyone working in marketing and sales. This includes not only individual contributors who are 100% dedicated to marketing/sales, but also those (often managers) who devote a portion of their time to these activities.

A CAC whose salaries are included is often referred to as a “100% charged CAC.”

2) Do not include overhead

As with the mistake of not including salaries, you should include overhead expenses (rent, equipment, etc.) that are allocated to employees who work on marketing and sales.

3) Do not include money spent on tools

Marketing and sales tools (especially SaaS) have exploded. Most teams use more than a dozen tools to make their entire system work. The price of all of these tools/licences. must be included in your investments to calculate your CAC.

4) Neglect the fees of those who contribute directly to your product

In most businesses, products, engineering, and support are not included in the CAC (they are generally part of R&D). But if the free product is your primary method of acquiring customers, shouldn't the expenses that support that free product be included in the expense portion of your CAC calculation? Opinions differ on this issue, but we are voting yes.

If you had engineers, project managers, and others on the marketing or sales team for marketing/op, you would include these salaries and expenses in calculating the CAC. The engineers, project managers, or others who work in these roles may not be part of the “marketing” or “sales” teams, but they are still necessary expenses to support the acquisition of new customers.

5) Never distinguish between new customers and those you have already converted in the past

A customer is a customer, right? Not necessarily. When it comes to calculating the CAC, we need to distinguish between new and existing customers. In most organizations, marketing and sales efforts are focused on new customers, and marketing and sales efforts are focused on retaining or returning customers.

The mistake is to include marketing and sales expenses in the numerator only for new customers, but to include all customers (including returning customers) in the denominator. This will make your CAC look artificially low. You can fix this problem in two ways:

• Include all marketing and sales expenses (including those aimed at retaining customers) and all customers.
• Separate expenses for new customers from expenses for reactivating old customers and separate new customers from reactivated customers in the denominator.

Let's see now what a good Customer Acquisition Cost is.

What is a good CAC (Customer Acquisition Cost)?

It is more than obvious that the CAC will vary greatly depending on the different sectors and types of businesses. It will also vary depending on the type of marketing and sales strategies that businesses use. It is therefore important to have a good idea of the average CAC in different sectors of activity to understand whether we are picking up or not:

• Travel - $7
• Retail - $10
• Consumer Goods - $22
• Manufacturing - $83
• Transportation - $98
• Marketing - $141
• Financial - $175
• Technological (Hardware) - $182
• Real estate - $213
• Telecommunications - $315
• Technological (Software) - $395

Source: Hubspot

As you can see, some of these costs are quite shocking. This only reinforces the reason why keeping track of your CAC costs is so important. Acquiring new paying customers is simply expensive and knowing which marketing sources convert your paying customers is extremely important for running a profitable business.

Customer Acquisition Cost per Channel

Most professionals will want to know their CAC by marketing channel. This helps them understand the most profitable way to acquire customers - and where they should put more effort into in the future.

It exists two main methods to achieve this: the use of averages or last-touch attribution.

Use of averages

To use averages, simply break down spending by channel, assume that each channel brings the same number of customers, and divide them.

Unfortunately, this hypothesis can prove to be flawed because channels do not always have the same force of attraction and conversion.

If a channel is particularly effective, or if you only activated LinkedIn campaigns for one day, your CAC for that channel will be biased.

Last-touch attribution model

Instead, most professionals will use the “last touch” attribution model. In this case, the channel through which the customer was last “touched” before the purchase is credited for the conversion.

For example, if a customer saw an ad on Facebook, uploaded electronic content to your site, and then purchased through a Google marketing campaign, we would say that the customer was acquired through the latter channel.

Once again, this method can prove to be biased and flawed because it does not take into account the power of the authority of the channels that really convinced him to buy beforehand.

Conclusion

Hopefully, it's more clear from the examples we've covered today that calculating the true CAC involves much more than just a one-size-fits-all equation.

On the contrary, an honest assessment of the cost of acquiring customers takes into account the length of your sales cycle, the number of customers who are actually new customers (as opposed to repeat customers), and the total costs and resources needed to support marketing efforts that lead to new customer acquisition.