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This guest post is written by Ashley Scorpio, VP of Partnerships at Hawke Media.
Customer acquisition cost (CAC) is the marketing metric that tells you how much it costs to gain a new customer during a specified period of time. Unlike other metrics, such as return on ad spend (ROAS) or profit on ad spend (POAS), CAC takes into account all of your advertising, marketing, and sales costs, telling you exactly how much you have invested in acquiring each of your customers, on average across the board.
Calculating The Cost of Acquiring a Customer
Calculating CAC is relatively easy. Simply pick a period of time, like a year, then add up all your sales and marketing costs for this period. Next, divide this amount by the number of new customers you acquired.
CAC = (sales and marketing spend) / number of new customers
If you spent $10,000 on sales and marketing efforts and have 500 customers to show for those efforts, then the cost of customer acquisition is $20.
Comparing CAC to Revenue
As soon as you have calculated your CAC, human nature dictates that you have already jumped to your sales figures to see if your sales per customer exceeds your CAC. Hopefully it does. However, if you’re new to digital advertising, or if you have just started your business, your CAC is likely higher than your revenue per customer. In many cases, it could be a lot higher.
Interestingly, there is no established acronym for revenue per customer. Subscription services use a similar term, revenue per user, or RPU. But for revenue per customer, you won’t often find marketers talking about RPC — and for good reason. It’s seldom a number you should focus on.
The number you should pay attention to encompasses a longer time period that goes beyond your initial sales — rather looking at total revenue over the lifetime of your relationship with that customer is aptly called customer lifetime value, or LTV.
Customer lifetime value (LTV) represents the amount of revenue each customer will bring to your company throughout the life of their relationship with your business. In all situations, your CAC needs to be lower than your LTV.
As an example, imagine you sell artisan soap. You invest in Facebook ads, go to farmers’ markets, and promote a buy-one-get-one-free offer to get people to try out your product. Your CAC is $25 after the first quarter and your initial sales make only $10 in revenue and less than one dollar in profit. You’re losing money. But if you fast-forward two years, as customers run out of your amazing soap and keep ordering more, your LTV soars to $500 in revenue.
Just as your LTV increases over time, your CAC should also decline. When loyal customers convince their friends to try your product via word of mouth, those new customers don’t have an associated acquisition cost unless you have a refer a friend program. As you perfect your advertising campaigns, the cost of running ads declines, your click rates go up, and your conversion rates do too.
So even if you’re losing money in your first few weeks or months in business, with increasing sales and declining costs, your sales revenue should begin to exceed your marketing and sales costs. With the extra revenue, you can afford to put more money into marketing, creating a snowball effect that soars upward instead of downhill.
As another example, suppose you focus primarily on email marketing campaigns to small business owners. You get prospects to sign up for a free offer and then you begin marketing to them with weekly emails. It takes time to build up their trust in your business and brand. Their first purchases will likely be small, and these conversions may take several weeks to happen. But if they like your product, if they like your brand, when you present them with another opportunity, they are more inclined to buy from you, and more inclined to spend more money if your offer seems worthwhile.
Considering CAC Ratio When Planning Social Media Advertising
Many people describe digital advertising as a numbers game. Unfortunately, the numbers all have dollar signs attached to them. You might test some ads by running them with low daily budget limits, and if they perform well, you ramp them up. If they don’t, you turn them off and launch a new ad set or campaign.
Suppose you make designer handbags and your research indicates that your target audience is on Pinterest, Facebook, and Instagram, and you decide to start with Instagram. You’ll then ask yourself such questions as the following:
- Should you use videos or still images?
- How long should your videos be?
- What is your value proposition? Price, quality, exclusivity, free shipping?
- What is your call to action?
- Who is your target audience?
- How wide or how narrow should your target audience segments be for your initial tests?
- What days or times should you run your ads?
There are many more questions, of course, like ad layouts, ad formats, font and color selections, title wording, descriptions… The choices go on and on. The right combination of answers to these questions could give you some great conversions, but most of the combinations will cost you money to test instead of making you money.
Testing Ads: One Example
So you run a few video ads for three days and they result in zero purchases. Next, you try a carousel ad. You get more clicks but, once again, no purchases. You run a story ad with a single image and get two purchases on the first day. So you start ramping up that ad and get more conversions. After a month, you calculate that your CAC is $40. You earn $42 profit on each sale. Life could be worse.
The problem with this scenario is that you’re running blind. In this particular example, the first two sales didn’t result from the story ads but from people seeing the videos first and then the story ads a few days later. There was nothing spectacular about the story ads — it was actually the one-two punch with a bit of brand recognition that landed the first few sales.
Imagine for a moment you’re in an alternate universe where you were luckier on your first day and made a sale from your first video. You continued running the video, did some A/B testing and made modifications to it while optimizing the campaign. After a month, your CAC was just $30, instead of $40.
Trial and Error vs. Experience
Successfully running ad campaigns requires experience and iteration. After you run a few thousand ads and spend thousands on campaigns, you will have a much better idea of what your target CAC should be. You’ll know how much your social media ads should cost and how much you should be bidding on search keywords in order to justify those campaigns compared to your LTV.
Unfortunately, getting to that level of experience has a price tag when you’re doing it yourself. Learning through trial and error when every campaign costs money to run is an expensive education. If you could acquire that same level of experience for a fraction of the price, that would likely be a good business investment, wouldn’t it?
Why Outsourcing Experience Reduces CAC
Partnering with an experienced marketing consultant may seem like another cost, but it’s actually an investment that reduces your costs overall.
The marketing consultants at Hawke Media have been working with clients across all industries and markets since 2013. They’ve run millions of ads on every platform and, thanks to progress in artificial intelligence, can now test ads offline to predict how they will perform with your audience. If you’re ready to take the guesswork out of your marketing strategy, just ask for a free consultation.
About The Author
Ashley Scorpio is the Vice President of Partnerships at Hawke Media, a full-service digital marketing agency and Your Outsourced CMO.® With over a decade of experience in both traditional and digital marketing, Ashley is a performance marketing leader that specializes in paid social media advertising, focusing on eCommerce brands and B2B SaaS companies.
Over the years, Ashley has worked with a variety of brands, organizations, startups, personalities, and public figures to meet their digital growth goals through full-funnel performance marketing campaigns across multiple channels - in-house, at agencies, and through her own consultancy. Ashley is a nationally recognized woman in eCommerce by eCommerce Magazine and a 30 under 30 by Everipedia.
Prior to joining Hawke Media, Ashley managed community and digital for the former Prime Minister of Canada and the largest political party in the country. Over the course of her career, she has managed millions of dollars in digital ad spends that helped launch and scale household digitally native eCommerce brands and publicly traded SaaS companies. Ashley also held positions as the Head of Partnerships at Wpromote and Chief Marketing Officer at a venture-backed startup.