Reducing Your Cost of Customer Acquisition: The Basics
Written by Ita Buckley on 14th July 2016
The cost of customer acquisition (CAC) refers to the price that one must pay to obtain a new customer. To calculate CAC:
Divide the total costs associated with acquisition by the total number of new customers, within a specific time period.
Being able to calculate and identify the CAC is one of the most important metrics for any business. Why? Because you need to secure a return on investment to generate profit. CAC costs can be quite high and this is the main reason why many online businesses fail.
All of your investments should be thought of as a machine. You invest money in one side of the machine and you should generate sales (and profit) from the other side. To know how effective your machine is performing for your business, you must be able to calculate how much you need to invest to secure a profitable return.
Once you know your CAC, the important ratio to consider is when the value that your customers bring is compared to how much it costs to acquire them. The lifetime value of a customer to your business, must be higher than the cost of acquiring them. Otherwise the business will fail. No matter how efficient your customer acquisition, if you cannot generate revenue higher than the cost of acquiring them, you are losing money.
By generating the CAC for a business and comparing it to the lifetime value of customers, you will be able to clearly identify and analyse the health of your business model. To calculate the lifetime value of customers, follow the formula below:
(Average Value of a Sale) X (Number of Repeat Transactions) X (Average Retention Time in Months or Years for a Typical Customer)
The ratio between CAC and lifetime value will also be useful when assessing how marketing and sales campaigns are performing. You should always aim to identify marketing channels that provide a high lifetime value compared to the cost of acquisition.
It is important to make a clear distinction between the cost of customer acquisition (CAC) and the cost per action (CPA). In ecommerce, the amount that you pay to acquire a customer, is referred to as cost per action. This cost relates to both new and returning customers. Meanwhile, CAC focuses solely on the cost of attracting and converting new customers.
To reduce the cost of CAC as much as possible, follow our tips below.
- Referrals, referrals, referrals.
The fastest growing companies operate largely on referrals from existing clients. This means that the lifetime value of the new customer drastically outweighs the cost of acquisition.
Potential clients will trust their family/friends much more than any marketing campaigns directly targeted towards them. This means that once a referral is made, you are more likely to close a sale promptly as the potential client already has a reasonable level of trust towards your company. In this scenario you are saving both money and time.
- Grab the attention of your target audience!
Paid advertising is effective and will lead to customer acquisition. However, it is important not to undermine the value that free or low cost actions can have on reducing your CAC. PR stunts are the perfect way to grab attention and showcase the personality of the brand at the same time.
An example of a master in this area is Richard Branson, founder of the Virgin group. With over 400 companies, Branson brings a unique flair to his strategies.
In 1996, the Virgin Group launched their bridal chain. Branson arrived at the launch event, with full make up and dressed in a bridal gown. This grabbed headlines worldwide and everyone knew that the bridal chain was now open.
Again, in 2007, Branson demonstrated a unique way to attract attention to his airline.
He celebrated the first Virgin America flight by bungee jumping off the Palms Hotel Casino in Las Vegas, a 407-foot tall building. This daring move did not require a large investment however, it grabbed attention worldwide and maximised exposure for the airline.
On a continuous basis, new customer acquisition channels become available. Meanwhile, existing ones might be improved. It is important to stay focused on what works for your business and think outside the box from there.
Set aside a small portion of your overall budget for experimentation. Test new channels that are becoming available and see how they work for your business. Collect the data from these rapid tests and use it to steer your future actions in an attempt to reduce your CAC.
If you would like to learn how FCDM can help your business grow with AdWords help and direction, contact a member of our dedicated business development team today and get a free consultation with one of our PPC Specialists.