Customer Acquisition Cost
Hi friends, In this chapter we are going to talk about Customer Acquisition Cost or short: CAC.
What is CAC?
Many start-ups fail because they can’t find a way to acquire customers at costs that are low enough to justify the expense of acquiring a new customer, such as sales and marketing costs.
Costs are not a bad thing, they are an investment – but you need to know if the investment is worth it.
Imagine you bought a house for $100,000. When it takes you 100 years to pay it off, it was probably a bad investment. But if you paid it off in 2 months, you would be crazy not to buy more of these houses, right?
How to calculate it?
That is what this KPI is all about. The Customer Acquisition Costs are the total expenditure for sales and marketing – divided by the number of new customers I have acquired.
Our sales and marketing expenses include salaries (i.e. commissions, bonuses), overheads (think laptops, renting office space or the Porsche for the sales manager), paid advertising such as Instagram ads and Google campaigns, and costs for sales and marketing tools such as your CRM tool (e.g. Salesforce or Hubspot).
Sum all of these expenses together and divide it by the total amount of new customers and you will see how much you paid on average to acquire a new customer.
What is not part of the CAC?
There is no written rule anywhere, but for best practices do not include the following costs in your CAC calculation:
Product, engineering and support are not included and usually part of Research & Development costs
Don’t include the churn in any type of form
Customer Success is a difficult one. Normally I wouldn’t include it, but some people say it has a lot to do with keeping the customers from churning. If your customer success team mainly provides telephone support, I wouldn’t include it. But if they are full-fledged account managers who actively keep your customers happy – then I would argue that they are part of the CAC.
By the way, another common misconception is that Customer Acquisition Cost is the same as Cost per Acquisition. It is not. CPA is a marketing metric that measures how much you need to pay for a prospect to perform a specific action. For example, you pay an average of $20 until someone signs up for a free trial.
CAC (Cost Per Click), the cost of the number of times you need to show an advertisement until someone clicks on it is also not the same as CAC.
But Cost per Click and Cost per Acquisition are definitely early indicators of your Customer Acquisition Costs.
Ok so back to Customer Acquisition Cost. CAC are all sales and marketing costs divided by our total amount of new customers.
In my KPI calculator I have included a template that you can use to calculate the CAC for your company.
You would first enter the monthly salary cost for the sales team and then the salary of the marketing team. I added an overhead multiplier of 1.35 for offices, laptops, insurance, etc.
Below you add all your marketing expenses in the same month. Like your search engine marketing.
Lastly, enter the number of new customers you have acquired in the same month. And as a result the calculator shows you your customer acquisition costs.
I kept this calculation simple, but when you make your own copy of the KPI calculator you can of course add your cost positions until you reach the level of detail you think is right for your company.
CAC with and without Headcount
You may have noticed that I have recorded two different CAC results here. CAC with head count and CAC without head count.
This is because we usually use a simple CAC that only includes marketing advertisement costs such as Google Ads or coupon codes, rather than doing the entire calculation including salary and rent every time.
The simple CAC is used to evaluate which marketing activities performed well and you will want to track that on a weekly or even daily basis.
A complete CAC is usually measured long-term, quarterly or annually to obtain the overall picture.
Delayed Customer Acquisition
Ok, I think Customer Acquisition Cost is pretty clear to us now.
But what if I told you this? We want to measure a monthly CAC for a freemium product like Dropbox. But the average time it takes from the first contact to paying customer is 60 days. So in my first months, after 30 days, the CAC will not include this customer, only the cost we spent to get this customer. Because the person will not convert until one month (+30 days) later.
No need to worry my friends. We´ll get this one solved.
The first example is our regular calculation. We have our marketing expenses, which include advertising expenses. We have our sales expenditure. And the sum of marketing and sales is our total expenditure. Divide this by our new customers and we get our CAC on a monthly basis.
Now in the month of March we can see that we ran a big marketing campaign for our fake Dropbox company here. And based on our CAC calculation this campaign was a big miss. What a pity. Our CAC costs are skyrocketing at $193 for the month of March. But wait, didn’t we say it takes our fake Dropbox company in average 60 days until a free user becomes a paying user?
And yes, see there we have a spike of new customers two months later in May (731).
Ok so we need to take this offset into account. And we will do that by simply dividing the marketing and sales expenses from 60 days ago, by our new customers.
So the CAC for May is based on the Customers from May, but the marketing and sales cost from March and so forth.
The lesson we have learned here is that depending on the profile of your company, there may be some specifics that you need to iron out to make these metrics work for you. There is no “one size fits all” approach, don’t be afraid to make the metrics work for you.
Return of Investment
Knowing your Customer Acquisition Cost and your Average Revenue per User will tell you the number of months it takes you to earn back the sales and marketing dollars you spent to win a new customer.
Take the CAC and divide it by the average user per month, and the resulting number is the number of months the investment will pay for itself.
Depending on how long you can expect your new customers to remain a customer, you usually want a payback period of less than 12 months, which means that with a new customer you will be “profitable” in less than a year, and then you start making money.
CAC are the total costs of my sales and marketing department, including the Porsche of my sales manager, divided by the new customers in the same time period
Do not mix up CAC with Cost per Acquisition or Cost per Click. Even though these marketing KPIs are an early indicator for your CAC
In fact, in the short term we only want to check our simple CAC to evaluate the success of marketing or sales campaigns
And lastly, don’t fear to do slight adjustments to the CAC calculation to make it work for your company
Alright, thank you for reading this chapter. If you are interested in learning more about these KPIs – I have a full online course that is covering over 20 SaaS metrics including all the ones listed in the KPI calculator.