Customer Acquisition Cost is the sum of all the costs a company must spend to acquire one new customer. It includes all the sales costs, such as the salaries and travel expenses of salespeople, and all marketing costs, such as the costs of running a digital ad campaign. CAC is an important metric for business leaders and investors because it is a key measure of the profitability and growth potential of a business – a company’s ability to acquire large amounts of customers at a low cost is a strong signal that there is market demand for their product or service.
CAC is calculated using the following formula:
Customer Acquisition Cost = Total Cost of Sales and Marketing / Number of New Customers Acquired
The first thing to note is that CAC is calculated over a period of time, and you must ensure that the Total Cost of Sales and Marketing, and Number of New Customers Acquired both are totals from the exact same time period. For example, if you’re going to measure your business’s CAC for the past 6 months, you should be dividing the total sales and marketing costs incurred during those 6 months (let’s say $1,000) by the number of new customers you acquired over those same 6 months (let’s say 100 customers), then the CAC would be $10 using the following formula:
CAC = $1000 / 100 new customers
CAC can be as useful metric for making decisions around sales and marketing spend, which in turn plays a big role in profitability. For example, let’s say Company A has two marketing channels, digital ads and TV ads, and at the end the year Company A is trying to figure out whether they should make any changes to their marketing budget for next year. CAC is a helpful metric in this decision because if Company A sees that their CAC for digital ads is far lower than the CAC of their TV ads, it’s a good sign that they ought to allocate more budget to their digital ad campaigns because it’s a much cheaper marketing channel for acquiring customers.
CAC is often referenced alongside Customer Lifetime Value (LTV). LTV is defined as the total value of a customer to a business over the full course of their relationship. LTV can be calculated in multiple ways that you can learn more about in the LTV entry of the Sturppy Financial Glossary, but here is the simplest formula:
Customer Lifetime Value = Customer Value * Customer Lifespan
Customer Value can be thought of as the value of one customer purchase. For example, if a SaaS company charges $10 per month for a subscription and the average customer stays subscribed for an average of 12 months, the LTV would be $120. CAC and LTV are closely related because together they represent the profitability of a single new customer. If a company can acquire customers at a cost (CAC) that is less than the amount of value they’ll get from the customer over time (LTV), that customer is a profitable one.
This relationship is most commonly expressed through the Customer Lifetime Value to Customer Acquisition Ratio (LTV:CAC). A ratio of 1:1 or lower means that a business is losing money with every new customer acquisition, as they are paying more for their customers than they receive from the customer. A ratio of 3:1 is generally considered to be the minimum level at which a business can survive over the long term. However, it’s important to remember that even if a business has a positive LTV:CAC ratio, there may be other costs not reflected in CAC, such as the cost of customer support, that can still make the business unprofitable.
CAC is a core focus in some industries and less in others. CAC is generally considered a vital metric in subscription businesses with recurring revenue, such as most SaaS companies and subscription box businesses like Dollar Shave Club. The reason for this is that it’s much easier to measure the LTV of a subscription customer because you know exactly when they stop being a customer – when they cancel their subscription. In contrast, a grocery store will have more difficulty calculating LTV because it’s harder to calculate the average customer lifespan – a customer may not return to a grocery store for 3 months due a temporary change in taste, but the grocery store might wrongly consider that customer relationship finished when calculating LTV. CAC as a metric is much more valuable when accompanied with LTV because the LTV:CAC ratio is an excellent measure of profitability and business efficiency. That said, many new analytics and data enrichment products have been released in recent years to help businesses of all types measure their LTV.
CAC also differs in adoption across various industries based on their preferred marketing channels. Digital ads are optimal when calculating CAC you have so much more data around the costs of the ad and the customer buying process. For a local grocery store that relies on billboards, it’s much harder to measure whether it was the billboard that drew in the customer. Therefore, a companies that market heavily through digital channels will likely have more use for CAC as a metric than those that do not.
Below we’ve aggregated benchmarks for CAC across a variety of industries that are known to use it. It’s important to keep in mind that a high CAC does not necessarily mean a bad business. A business with a high CAC but much higher LTV is still an attractive business.
Our favorite free CAC resources:
Our favorite paid CAC courses and resources: