How To Calculate Customer Acquisition Cost (CAC): Effective & Easy Way
Before you burn your dollars on advertisements it is important that you know how to calculate the customer acquisition cost (CAC). Don’t spend money on advertisement blindly. Today it is very easy to set up an AD in no time and it is overwhelming.
Many businesses are desperate to set up the ads to generate leads from Facebook and to use other advertising platforms. But very few businesses know how to calculate customer acquisition cost in the right way.
And due to lack of the right numbers, businesses cannot make accurate and strategic decision to grow that particular vertical or whole business in general.[cta id=”1340″ vid=”0″]
Customer Acquisition Cost Definition
Customer Acquisition cost is the cost you pay to bring a new customer into your business.
If you’ve done ads in the past, then use those data to calculate CAC. If you haven’t, then you can estimate for now and correct these numbers at each level of business as you go along.
Importance of calculating Customer Acquisition Cost (CAC)
It is very important to calculate Customer Acquisition Cost (CAC) in your business.
- It helps you find which advertising channel/source is worth and working for your business. So you can focus only on that particular channel/source which gives you a result and positive return on investment (ROI).
- It helps you to establish the price you are paying to acquire a customer in your business.
- It helps you to determine your traffic strategy, whether it is paid or free traffic sources you should focus on.
So whatever hacks you are using to acquire customers, drive traffic and grow email list that is upon your business and product personas.
Knowing how much you are paying to acquire those customers through that channel and making a strategic decision to grow your business and profit margins is the real deal.
Let’s say I am making $1,000,000 (1 million) in revenue and I have $9,99,999 as a business cost. Therefore, I have made $1 in profit. If I, as a businessman tell everyone that I am making 7 figure income then I am an IDIOT.
Let’s say I am making $150,000 in revenue and I have $20,000 as a business cost. Therefore, I have made $130,000 in profit.
If I, as a businessman, tell everyone that I am making 6 figure income, this is correct because I am.
So the conclusion here from the scenarios above is that it does not matter how many customers you acquired, if you are paying wrong customer acquisition cost then it is not worth buying it. To know these figures, you need to determine the Customer acquisition cost.
It doesn’t matter whether you are a small tiny business working from home or a Startup or a Giant corporation. You must know these figures before you JUMP and include PAID traffic sources in your traffic generation strategy.
Calculating customer acquisition cost (CAC) is for whom?
Any business (small or big) whether it is a start-up, entrepreneur, blogger or home based business. In short, everyone who is selling something in exchange for money.
It doesn’t matter where you are coming from, as far as you are selling something it is important that you know how to calculate customer acquisition cost (CAC) and apply these calculations in your business to understand how much money you are paying to bring the customers through the door.
How to calculate Customer Acquisition Cost (CAC)?
In a simple way, the customer acquisition cost (CAC) can be calculated by dividing all the costs (money) spent on acquiring customers by the number of customers acquired. For example, if a business spent $100 and acquired 2 customers, their customer acquisition cost (CAC) is $50
But I’ll take you deep inside to understand the two things below:
- How to calculate customer acquisition cost using ALL details (so you get accurate number).
- To know the realistic approach behind calculating the customer acquisition cost in the real world.
You’ll find the formula below on how to calculate customer acquisition cost. You can use this formula to know exactly how much money you are spending to bring in the customer in your business.
Customer Acquisition Cost FORMULA:
Customer Acquisition Cost (CAC) = Money Spent + Time Cost / Number of Customer Acquired
Money Spent: Advertisement cost
Time Cost: If you are paying someone to do this for you.
Check out the customer acquisition cost calculation below:
You SPENT $100 on advertising and received 100 website CLICKS to your landing page (or high converting squeeze page).
From that 100 clicks at 30 % conversion rate, 30 people signed up to your EMAIL LIST, meaning you acquired 30 leads.
Therefore, the cost per leads is Money spent on advertising/leads acquired = $100/30 = $3.33
At the 5 % conversion rate, 1.5 leads (we’ll make it round figure to 2) turned into customers.
So CAC = money spent/customer acquired = $100/2 = $50
Now let say your product gross profit = $150
RATIO between product profit and the acquisition (CAC) = $150/$50 = 3
It means that EVEN if 1 out of 3 people buys your product, your advertisement is in PROFIT.
You always need to see and make sure that your ratio between profit and acquisition is greater than 1 for your ads to be in profit. If it is less than 1 then your ads are not profitable. If it is equal to 1 then it is break even (no profit, no loss). The higher the number, the better it is.
Choosing traffic generation strategy model
Now you know how to calculate the Customer Acquisition Cost (CAC), so you can easily find out whether the advertisements are working for you or not. Also based on that you can figure out your traffic generation strategy.
Just to give you a glimpse of technique on traffic generation strategy based on customer acquisition cost, so below are the 5 powerful combinations of traffic generation strategy. Pick one based on your Customer Acquisition Cost (CAC) calculation.
- 50 % Paid + 50 % Free
- 75 % Paid + 25 % Free
- 25 % Paid + 75 % Free
- 100 % Free
- 100 % Paid
If the RATIO between your product profit and acquisition (CAC) is HIGHER, then it is advisable to pick the second option (75 % Paid + 25 % Free) as your traffic generation strategy.
If the RATIO is LOW, then it is advisable to pick the third option (25 % Paid + 75 % Free).
For example, Dropbox during their early days acquired customers through Google Adwords (Paid acquisition), but their advertisements were not profitable. Then they implemented the referral hack (free traffic) and they drastically increased their user base. Thus, it is very important to know how much you are paying to bring the customers in your business. And based on those figures make a smart decision.
It is always advisable to use both traffic sources paid and free and not relying on just one source.
Whatever business or niche you are in, it is always wise to calculate the customer acquisition cost. Once you know how much are you paying to bring the customer into your business. You can make a strategic decision to increase your profit margins, invest more funds/money to profitable marketing channel to grow your business or open new verticals. Start small: test if it is worth time or money, iterate until it is profitable and finally track and scale to make it bigger. It is all about creating an ecosystem.
So how much does it cost you to acquire customers in your business? Leave me a comment below and let’s keep the discussion rolling.