See how this key metric reveals the effectiveness of your sales and marketing initiatives and affects pricing.

Do you know how much it costs to gain new customers? Understanding this key metric helps business owners in two key ways. First, it helps evaluate how well sales and marketing initiatives are working—or not. Second, it plays a role in pricing. Let’s take a closer look at this key performance indicator.

How is Cost of Acquiring Customers (CAC) calculated?

There’s a simple formula for calculating the CAC:

CAC = (cost of sales + cost of marketing) ÷ number of new customers

Let’s run some numbers through the formula with a hypothetical business that spends $100,000 on sales, $50,000 on marketing, and gains 500 new customers:

($100,000 + $50,000) ÷ 500 = $300

In this case, the CAC = $300. That means the business invests $300 to gain each new customer.

Using CAC to measure client value

In order to sustain or scale a business, CAC needs to be lower than the amount of profit customers bring in. In the example above, if the average profit brought in by new customers is $250, the business is losing money; at $300 they break even. When profit per customer tops $300 the business can grow.

When looking at CAC, it’s also important to consider customer Lifetime Value (LTV). This metric goes beyond a single transaction and looks at revenue from a customer over the entire time you have a relationship with them.

Looking at the CAC to LTV ratio

A key indicator of business performance is the CAC to LTV ratio using this formula:

LTV:CAC Ratio = LTV ÷ CAC

Let’s say our hypothetical business with a CAC of $300 also has a customer LTV of $900. They calculate:

$900 ÷ $300 = 3

Their LTV:CTC ratio is 3:1, or in other words, the business makes three times the amount they spend to acquire a customer. A ratio of 3:1 is generally considered healthy. Lower ratios (for example, 1:1 or 2:1) suggest that CAC is too high in relation to the LTV. Higher ratios (like 4:1) could mean more customers could be gained if more is spent on sales and marketing. You can find resource for industry-specific ratio benchmarks here.

Using CAC to shape strategy

Tracking CAC provides clues to how well sales and marketing initiatives are working. If CAC goes down over time, it’s a sign that your efforts are working. A rising CAC calls for an examination of sales and marketing efforts, the channels used, customer behavior and other factors affecting cost.

CAC also affects pricing strategy. A higher CAC may demand premium pricing to stay profitable while lower CAC may allow for lower pricing.

You’re not alone in running your business

Calculating the cost of acquiring customers is just one of the many things business owners need to do but you don’t have to go it alone. The Business Services team at Consumers is here to help you navigate all things related to your business finances. If you don’t already do your business banking with us, check out these business member testimonials to see what you’re missing.

 

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