On Sunday the Toronto Raptors (my favourite NBA team) lost game four of the Eastern Conference Semi Finals to the Cleveland Cavaliers, ending our playoff run and crushing our dreams of an NBA championship. As my friends and I discussed the Raptors’ shortcomings, we realized that to be able to compete with Lebron James we’d need to pick up a couple more highly skilled players in key positions on our team. In other words, we’d have to make some smart acquisitions.
As we debated potential additions to the Raptors’ roster we kept coming back to the price tags associated with these potential players. What would we have to give up in order to sign one of these all-stars? Strictly speaking, what was the cost of each acquisition and more importantly should the team be willing to pay it?
The idea of acquisition costs stayed with me and led me to think about their importance and their broader applications in commerce. Customer acquisition costs, how to calculate them, and the levers that drive them should be deeply understood by any brand looking to grow their business. In the service of that goal, here’s everything you need to know about customer acquisition cost (or CAC, for short).
How To Calculate Customer Acquisition Cost
Calculating your brand’s customer acquisition cost allows you to assess their acquisition spending at the most granular level on a per customer basis. This is done by dividing the total amount spent on customer acquisition by the total number of customers acquired, as shown in the equation below.
This is customer acquisition cost in its simplest form. A brand that uses the above formula will be able to easily calculate their lifetime CAC, which is a historic measure of the average cost to acquire a customer since the creation of the brand.
A good question that arises from this formula is what constitutes “acquisition spending”? The answer varies from business to business depending on what acquisition initiatives the company engages in.
A good place to start is with sales and marketing expenditures, as these are usually linked to customer acquisition. Some other items that might fall under acquisition spend would be referral campaigns, free trials, and sales commissions -all of which I’ll discuss later on in this post.
Lifetime CAC can provide a brand with a lot of valuable insights on their day-to-day operations. For instance, if lifetime CAC is increasing from period to period, then one of two things might be the cause:
Either the brand is investing more on acquisition without seeing a proportional increase in customer adoption or the brand is maintaining a constant level of acquisition spending but customers aren’t signing on at the rates they used to. Either way, an increasing lifetime customer acquisition cost signals the need for a closer look at a brand’s acquisition strategy.
A decreasing lifetime CAC is less concerning but just as curious. If a brand’s lifetime CAC is dropping they’ll want to know why. If they’re slashing the acquisition spend, customer adoption rates might not have dropped yet but could in the future.
Lifetime CAC helps us understand acquisition costs at the most basic level but more often than not, brands want to dive a little deeper into their acquisition data using more sophisticated calculations.
Calculating CAC Per Period
Lifetime customer acquisition cost is a great tool for general trend analysis but sometimes you’ll want to get a little more current. In these instances, it’s best to calculate CAC on a per period basis using the formula below.
This per period CAC formula relies on knowing the number of customers acquired during a particular period. If that number isn’t readily available, you can always use the supplementary equation below to quickly calculate it.
Using the per period formula, you can now calculate customer acquisition costs based on whatever time intervals are most relevant to your business. This could be weeks, months, quarters, or even years!
The per period CAC formula helps a brand collect acquisition information in a way that can be easily summarized and included in time-based reports. It also assists in assessing a business’s acquisition strategy period to period.
Calculating CAC Per Campaign
We’ve gone over how to calculate both lifetime and per period CAC, however this wouldn’t be a complete guide to customer acquisition costs without one last calculation tip. Brands sometimes find it helpful to calculate the individual acquisition costs of different customer-facing campaigns, and we’ve got the information to help you do the same.
The per campaign formula uses the same essential calculation as the previous two but uses the actual acquisition campaign to segment the costs and the resulting customers. For a per campaign CAC calculation, it is of paramount importance that you’re able to attribute customer acquisition back to the correct campaign. This formula won’t work if you don’t know what initiatives helped convert each customer.
In this way a business can assess the effectiveness of a referral campaign, paid SEM advertising, free product trials, sales commissions, and many more initiatives by directly comparing their CAC’s. A few of the most popular examples are explained below.
The CAC of a referral campaign is one of the easiest to calculate as the cost is often baked right into the mechanics of the referral. If a brand offers existing customers $5 for every new customer they refer, then the CAC would be $5 per customer. If the referral gives the existing user $5 and the new user a $5 credit as well, the CAC then rises to $10 per customer. This is because it costs $10 total to gain a new customer via referral.
Free trials are another popular customer acquisition tactic. Brands often allow a prospective customer to use their product free of charge for a limited amount of time in order to incentivize their conversion.
Brands can choose to calculate the CAC of a free trial in two different ways: the revenue approach or the cost approach. The revenue approach takes the value that the customer would have been paying as the numerator in our formula, essentially using the lost revenue as the “cost” of acquisition.
Conversely, the cost approach takes the cost of providing the free trial and uses that as the cost section of the formula. Whether it’s the cost of producing the product, shipping costs, or even support costs free trials aren’t free for everyone.
Cost Per Click/Cost Per Impression
Two of the fastest growing initiatives for contemporary brands are social media marketing and search engine marketing (SEM). The jury is still out on which is the more effective of the two, but whichever one your brand uses it’s important to make sure you can track your campaign’s results.
Most social media and SEM platforms operate on a cost per click (CPC) or a cost per impression basis. This might lead you to believe that the acquisition cost is baked right into the program like with referrals however, the calculation is actually more nuanced than that.
You see, not everyone that sees or clicks on your advertisement will actually end up converting into a customer. With a cost per click/impression model, though, these individuals still contribute to your costs! In this case, the conversion rate is actually just as important as the cost per click/impression.
The above formula shows that in order to calculate your CAC for these initiatives you’ll want to take your cost per click/impression and multiply that by one over your conversion rate.
I know that sounds like a mouthful, so let’s walk through an example. Let’s say I created an ad for my business on Google that has a CPC of 10 cents, but my conversion rate from click to customer is one in four (or 25%). This means that if 100 people click my ad, I’d get charged $10 while only 25 of those 100 people would convert to paying customers. We now have all of the information we need to use our regular CAC formula.
As you can see, we end up with a CAC of 40 cents per customer even though the CPC is 10 cents.
We could also use the CPC and the conversion rate in a quicker calculation to end up at the same CAC value without walking through the entire process.
Sales Commissions and Bonuses
The last of our special cases is sales commissions. Organizations frequently motivate their sales staff by giving them commissions over and above their regular salary for excellent sales performance.
Sales efforts are directly associated with customer acquisition, and therefore commissions need to factor into the calculation of customer acquisition cost. When adding up total acquisition spend, don’t forget to include both sales salaries and commissions in that total.
While it may seem logical to attribute bonuses to the individual sale they’re attached to, this actually arbitrarily skews your CAC. The cost of a sales bonus should be evenly applied to all of the sales within the relevant period so they should also be added to the acquisition spend along with salaries and commissions.
With so many different marketing initiatives and more creative methods popping up every day, it’s important to be able to compare performance from campaign to campaign. Each one may have different mechanics, but customer acquisition cost is the common denominator.
Customer Acquisition Doesn’t Have to Be a Mission
Calculating your customer acquisition cost is the first step to understanding it, and understanding CAC is a key part of eventually controlling it. Whether it’s lifetime, per period, or for an individual campaign, brands stand to gain a lot from a working knowledge of how much it costs to bring on a new customer. As Peter Drucker once said, “you can’t manage what you don’t measure”.