You understand the importance of bringing new customers to your business, but do you know the actual cost of acquiring a customer?
There are three calculations you must make when determining your customer acquisition cost, or CAC.
1. Your Actual CACIn its simplest form, your CAC is the total of your sales and marketing costs divided by the number of customers you acquire during a determined period.
Sales costs + Marketing costs / Number of new customers
For example, if you’re spending $200,000 on sales and $100,000 on marketing to gain 50 new clients, your CAC is $6,000. For a more accurate picture of the impact acquiring new customers has on your business, you should compare this number to the value that recurring revenue brings to your company.
2. Your Customer Lifetime Value (CLTV)This calculation, equal in importance to your CAC, gauges how much recurring revenue you can expect from new customers over the duration of their partnership with you. You always want your CLTV to outweigh your CAC (usually, 3:1.) If it does not, there is something wrong with your sales model, pricing model, customer retention or marketing efforts.
The calculation is simple multiplication.
Average sale x Number of repeat sales x Average lifespan of a client
For a better understanding of this concept, let’s put it in practical terms. If you sell IT services, and the value of the average signed contract is $10,000 per month, and you retain clients for an average of five years, the calculation is as follows:
$10,000 x 12 Months x 5 Years = $600,000
How does your CLTV connect to your CAC? When you’re able to determine the lifetime value that a customer will bring to your business, you can weigh that value against the cost of acquiring them. Does the customer’s potential CLTV justify his/her acquisition cost? If not, you may need to rethink your pricing model, retention strategy or whether that customer is the right fit for your business.
3. Churn Rate
The third calculation you should make to gauge the impact of your CAC is your churn rate. In the process of doing business, you’ll always lose some However, retaining as many customers as possible is usually in your best interest. There are two churn metrics that you should follow. This first is your customer churn rate, an important metric because it shows you how well (or poorly) you are doing at retention.
Calculating your customer churn rate for a period of time (say, one month) is a matter of simple division.
Number of customers lost that month / Original number of customers for the month
For example, if you start one month with 50 customers and lose five, your customer churn rate is 10%. Keep in mind that, while you may have overall customer churn, you may still have negative dollar churn (which is good) if your upsells exceed your losses. You should perform a renewal analysis to determine if lost customers are worth focusing on in the future. You can usually learn more from a lost customer than a retained one, so consider your lost customer profiles, along with your operational issues, when developing your prospect targeting strategy.
In addition to customer churn rate, you should calculate your revenue churn rate. Because recurring revenue is such a key factor for business stability, monitoring your revenue churn is an important calculation for measuring client retention success. The calculation is essentially the same.
Amount of recurring revenue lost that month / Original amount of revenue for the month
For example, if your company starts with $500,000 in recurring revenue at the beginning of the month but loses $50,000 of it, your revenue churn rate for the month is 10%.
Customer Acquisition Cost: The Magic Number
Tracking these three metrics—your CAC, CLTV and churn rate—provides you with insight into a few aspects of your business, including the success of your sales team and your pricing model. It also allows you to gain a deeper understanding of your finances, helping you to forecast and budget for future spending.
So, is there a “magic number” for your CAC? Yes and no. Startups must spend money to make money. In the beginning stages of your business, your CAC might be high. You’re investing in your sales team and marketing efforts, and those investments may take time to pay off.
On the other hand, the “magic number” for your company is simply a higher CLTV and a lower CAC. For many companies, the 3:1 ratio for your CLTV to your CAC is ideal. There are a number of ways to decrease your CAC and increase profits—including shortening your sales cycle, increasing lead generation, and changing your payment periods to gain your CAC back as quickly as possible.
Do you need help calculating your CAC? Contact us today.