We all know acquiring new customers is a necessary cost, but if your customer acquisition cost (CAC) is too high, your profit margin will get smaller, and smaller, and smaller... well, you get the idea.
Calculating your CAC helps you understand how much you need to earn from each customer to have a profitable business. There are different ways to calculate your CAC, but before we do so, let's first define it.
Customer acquisition cost (CAC) is the cost to your business of earning a new customer. CAC includes all costs that contribute to getting your product into a customer’s hands. Costs such as sales costs, marketing costs, product costs, etc.
Knowing your CAC ensures that you're not spending more money to acquire customers than they're spending on your company. Although there are exceptions, that's usually not viable long-term.
Put simply: Your CAC is the cost of marketing divided by the number of new customers acquired.
Marketing Spend ($500) / # New Customers (50) = CAC ($10 per customer)
Now that you know your CAC, you can determine if your marketing approach is profitable.
Average Order Value ($50) x Gross Margin (50%) - CAC ($10) = Profit ($15)
There could be an exception if you have a higher customer lifetime value. The CAC might not be profitable initially, but that customer will keep coming back over a lifetime, and you only pay to acquire that customer once.
This method of calculating CAC assumes that the only expense for acquiring new customers is marketing. Although it may be enough for some businesses, we can be more precise.
To be more realistic, you need to take into account other costs involved. A more precise calculation looks like this:
(Total Marketing Spend + COGS) / New Customers = True CAC
What does COGS mean?
COGS stands for the cost of goods sold, which are all the costs directly related to the production of your goods (this does not include indirect costs, such as marketing or sales).
Now that you have a more true CAC, you can use it to determine the profitability of your acquisition model.
(Average Order Value x Gross Margin) - CAC = Profit
Did that calculation leave you with CAC sticker shock?