Understanding Customer Acquisition Cost: An Introduction Guide to the LTV/CAC Ratio
Understanding CAC is the first step toward aligning marketing with the company’s goals and giving marketers a seat at the table. Here are some guidelines to help you learn more about customer acquisition cost, or CAC, and, more importantly, why you should study CAC and the different stages in this field.
What is the customer acquisition cost (CAC)?
Customer acquisition cost (CAC) is the total cost of marketing and sales to acquire a customer. It is one of the defining factors in whether your company has a viable business model that can yield profits by keeping acquisition costs low as you scale.
The challenge in CAC is maintaining a balance between the total sales and marketing costs required to get all new customers and the revenue generated by each customer over their lifetime value, or LTV.
For SaaS companies, customer acquisition costs are regularly compared with their lifetime value (LTV) and are therefore important. In addition, here are some ways to keep an eye on CAC as follows:
- It helps optimize the LTV/CAC ratio. For example, if you can aim for a 3:1 ratio, this means that for every dollar spent, you can earn 3 dollars, which is already good for your business’s profitable strategy.
- It helps to determine and optimize the payback period. If you are just starting a business, the CAC will hint at how long the interval period can take, which is necessarily important for some companies to practice the freemium method.
- To determine the profit of the business that is being received, CAC shows the flow of the business health. When you want to know your profit, just add up the CAC from the previous months and just subtract the projected revenue.
It is vital to understand the difference between CAC and cost per action (CPA). CAC helps to measure the cost of attracting a customer, while CPAs help to reflect the cost of a specific action.
On this topic, here is the following overview of the average CAC in different stages.
Average Customer Acquisition Costs
In CAC, the only problem is that some companies calculate their respective compound costs and at the same time include the total number of customers acquired without taking the remitted funds they invested or acquired in marketing strategies into account. CAC, on the other hand, comes in two different stages: The organic CAC is defined as the total number of new customers acquired across all channels, while the inorganic CAC includes only new customers acquired through paid marketing and advertising.
Remember, concentrating on the company’s average CAC is essential. There are many metrics that we can consider that are connected to CAC, such as the LTV/CAC ratio. In this guide, will find out the difference between the customer acquisition cost and the lifetime value.
Moreover, some companies, tend to reduce the factors that affect customer acquisition. However, there are possibilities that can lead to inconsistencies or discrepancies when calculating CAC. Here are the following factors to be considered to determine what spending goes to CAC as it differs across the business industry.
1. Creativity and advertising costs
These come from investments in banners, websites, digital marketing ads, and others. In this regard, when using this stage of business, the amount being spent on content creation is what is basically considered creative costs.
2. Employee expenditures
When defining expenditures, this means that this refers to salaries and wages, bonuses, and other expenditures you offer from your customer-facing teams, which generally come from sales marketing, customer sales, and customer service teams. Investing in efficient and productive personnel is usually a good thing to maintain the flow of the business. Implementing salary cut-off periods or layoff periods is only a temporary fix to lessen the CAC.
3. Technical or software expenses
In terms of technical costs, this includes all software containing sales teams and advertisements for the business product. In the case of technical costs, this is what we call it whenever you need tools for easily tracking the progress of marketing campaigns. In customer acquisition costs, this is significant to apply since it helps the company have better-quality conversations, acquire new total customers, and improve client retention.
4. Maintenance cost
When upgrading the CX, in terms of this sector, it tends to spend more on software optimization and maintenance since this is very important when spending on changes or upgrades. This cost would probably include facility expenses and utility expense fees for large-scale enterprises.
5. Merchandise and overall production costs
Merchandising is defined as the act of promoting and selling products once a potential customer is in your business. Typically, the production cost is called the cost of physical manufacturing content.
So, these are the expenses that contribute to the overall CAC. For instance, since we already know which expenses are being contributed to CAC, below is the approach formula.
With this given formula, it can be easily done to calculate the customer acquisition cost for a company. In order to rapidly get an estimate of a company’s acquisition cost, the easiest way is to use the online customer acquisition cost calculator.
Online Customer Acquisition Cost Calculator
To get an idea of your CAC, the way to do this is to enter the sales and marketing expenses for a period and the number of new customers acquired in that period.
Enter the total amount spent on your marketing campaign and sales product ($).
Enter the total number of customers acquired in each period:
Calculate the CAC
Your Customer Acquisition Cost is: $
The next stage will be the CAC benchmarks across industries in order to know whether the business is in red or good to go.
Industry-wise Average Customer Acquisition Cost
When compared with other industries, the cost of acquisition is much higher for the hospitality industry, which explains the slowdown in sales. In addition, the biggest challenge in any sales business is that customer acquisition costs are an inextricable part of it.
Some business industries strive hard to maintain the CAC as low as possible as it is. However, for the business industry, the average for each business industry varies due to several contexts and perplexities. Here’s the following average industry to be considered regarding CAC worldwide:
| Designated Industry | Average Customer Acquisition Cost |
|---|---|
| Saas Company | $205 |
| Fintech Company | $80 |
| Insurance Company | $900 |
| E-commerce | $127-$533 |
| Edtech (K-12) Curriculum | $137-$821 |
| Education | $862 |
Take note that each acquisition cost varies according to the segment’s consumer by targeting (B2B OR B2C) operating the region. The following are the benchmarks for reference to be considered:
1. Education
Initially, according to studies, most educational customer acquisition costs are higher than in other sectors. The education industry has an average customer acquisition cost of $862, most likely owing to the education sector’s highly selective nature.
Moreover, educational advertising has yet to expand online fully. However, in other sectors, like ed-tech, companies may have a much lower CAC. The CAC for an ed-tech company in the K–12 sector can range from $4137 to $821 per student.
On the other hand, traditional education, preferably higher education, is among the costliest because its sources for expenditures are likely higher when it comes to higher education, which is still largely offline. In the education sector, word of mouth, rankings, demonstrations, and more are major influences in this designated industry.
2. E-commerce
According to a Shopify survey, the following rates, depending on the product, tend to have low CAC rates in various e-commerce brands and companies: For instance, most e-commerce brands do not operate offline. It drastically reduces the number of staff, rent for the space, and other such expenses.
The table below shows the mean CAC by category for e-commerce businesses with fewer than four employees, as shown:
| E-commerce category | Average Customer Acquisition Cost |
|---|---|
| Arts and Entertainment | $21 |
| Cosmetics and Health | $127 |
| Business and Enterprise | $533 |
| Home and Garden | $129 |
| Apparel, footwear, and Accessories | $129 |
| Electronics and electrical equipment | $377 |
| Food, beverages, and tobacco items | $462 |
3. Insurance Industry
In acquisition marketing has created an imbalance between established organizations and disruptors. The lifeblood of any agency is the insurance client acquisition costs, which are notably vital.
Insurance companies, in general, have the highest customer acquisition costs of any business industry. It costs approximately $900 per individual to acquire a new member insurance customer.
Most insurers spend ages trying to onboard a new client. In order to avoid further issues and challenges, everything should have a lot of knowledge about the lack of proper technology and long-winded processes. Insurance agencies should have a big investment in customer onboarding automation in order to ensure the security of their clients and possibly avoid incurring losses.
4. Fintech or Credit cards holder
In this sector, Fintech, or credit cards, has among the lowest CAC rates across all industries worldwide. The customer acquisition cost in fintech will likely depend on the sources through which companies acquire customers. However, the average CAC for credit cards in the USA is likely to be $80.
5. SaaS Companies
Software as a service, or SaaS, companies are a type of software licensing and delivery model in which software is licensed on a subscription basis and is centrally hosted. SaaS is also known as “on-demand software” and “web-based or web-hosted software.”
SaaS CAC is basically the midpoint of industry-wide typical client acquisition expenses. However, within this sector, SaaS is ideally spread across several different industries. Another set of data is shown below:
| SaaS Company | B2C | Small B2B | Mid-market B2B | Enterprise |
|---|---|---|---|---|
| Automotive | $141 | $378 | $2655 | $6419 |
| Education | $264 | $806 | $2814 | $6659 |
| Financial Services | $202 | $1450 | $4903 | $14772 |
| Healthcare | $320 | $921 | $4326 | $11021 |
| Hospitality | $355 | $907 | $3724 | $9448 |
| Insurance | $519 | $1280 | $4446 | $11228 |
| Retail | $76 | $303 | $2980 | $9018 |
The data above gives a rough idea of the CAC rates across industries, and now in this section, we will try to review the customer acquisition cost per channel.
Source or Channel-wise Average Customer Acquisition Cost
As discussed, the CAC varies according to the region that is being operated in from the target of the consumer segment (B2B and B2C).
Below is the table showing the channel-wise average customer acquisition cost as being shared.
| Channel | Average CAC (B2) | Average CAC (B2B) |
|---|---|---|
| SEO | $647 – $1,786 | $298 – $1,201 |
| Email Marketing | $510 | $287 |
| Social media marketing | $658 | $212 |
| Social media marketing | $658 | $212 |
| Content marketing | $1254 | $890 |
| PPC | $802 | $290 |
| TV Ads | $2028 | $306 |
1. SEO
Search engine optimization (SEO) is the practice of optimizing a site so it ranks highly when being searched. This estimate ranges from $4000 to $10000 for SEO setup changes.When working for an online marketing agency, you may expect to be paid around $1000 each month. To figure out how much it costs to acquire a total number of new customers with SEO, add up all the expenses.
One of the factors that may be part of this is the total manpower and other financial investments. by using analytics software to track the number of conversions after dividing the number of SEO-based conversions.
2. Email marketing
This is very important and one of the expenses that should be present because email marketing expenditures are comparable to the price of running SEO or PPC campaigns. Essentially, they could be expected to pay anywhere between $3,500 and $100,000.
3. Social media marketing
Many people are active on social media, so it’s obvious to use this channel in the customer acquisition strategy. This kind of business strategy typically refers to marketing campaigns in many forms, like online video products, display ads, search engine marketing, content digital marketing, Facebook ads, and other social media platforms. This way, it helps the customer learn more about the products and be able to increase the customer’s sales. With this sample, the US citizen June 2020 emarketer survey below reveals interesting views on the purchases made via social media platforms.
As discussed above, the given data shows that the social media customer acquisition cost ranges between $212 and $658, according to the customer segment. Basically, brands employ in-house social media marketing teams, which enable them to interact with shoppers or customers. The social media platforms also outsource creatives and posts to digital marketing teams, whose fees vary according to the engagement deliverables and durations.
4. Content marketing
Initially, content marketing is a type of marketing strategy that involves the creation and sharing of online materials (such as blogs, videos, and social media posts) that do not explicitly promote a brand but are intended to stimulate interest in its products or services. Social media marketing is an integral part of content marketing. In content marketing, this might cost anywhere between $5000 and $12,000. The CAC will start to decrease unless more clients convert from it.
5. PPC
PPC stands for pay-per-click, a digital advertising model where the advertiser pays a fee each time one of their ads is clicked. Essentially, you’re paying for targeted visits to your website (or landing page or app). They may look luxurious, but they are rewarding if you aim for quick growth in your business. Constant optimization is the only way to reduce the customer acquisition cost in PPC ads, and so on and so forth.
6. TV Ads
TV ads are one of the most popular channels when it comes to customer acquisition costs. Nevertheless, with other digital platforms in play, it might be difficult to attribute this source of customer acquisition costs to them and calculate them through incremental sales, which is one method of measuring customer acquisition in TV ads.
Guide to reduce Customer Acquisition Cost
1. Concentration on retargeting customers
Retargeting is a helpful way to extend the business strategy in front of new clients. Customers regularly disregard the unfinished operations on other websites and apps. They refuse to purchase certain products for a variety of reasons. Some might not be necessary for them or just get distracted.
A focus on retargeting can possibly have an outcome in a trademark search of up to 1,046% in just 4 weeks, while a slight nudge in the right direction can sometimes persuade a prospect to make a purchase of the product.
2. A/B test and analyzation campaign performance
A/B testing is essentially an experiment where two or more variants of a page are revealed to users at random, and statistical analysis is used to determine which variation performs better for a given conversion goal. Customers who have a better experience and knowledge (UX) of the website are more likely to feel happy and content with it, increasing their satisfaction. Good UX designs lead to a higher rate of sales.
A/B testing products’ titles, patterns, buttons, layouts, and many more are essential to improving and upgrading a website’s landing pages. Some companies use A/B testing to check how possible slight changes to their websites affect click-through rates.
3. Sales and marketing automation
In sales and marketing automation, the term preferably refers to a productive interplay between sales and marketing departments that can be achieved by leveraging sales and marketing automation tools in tandem. Doing so makes for better interdepartmental alignment, more targeted campaigns, higher-quality leads, and other mutual benefits.
For targeted marketing, a corporation can come up with ways to collect future contact information. Through gated content, customers tend to agree to be on email lists in exchange for the value of gaining experience.
These are the simple tips you need to guarantee your customer acquisition cost rate stays low. Aside from these, another way to reduce CAC is through stellar customer service. Furthermore, to help increase retention rates and thus keep CAC low, quality customer service is the solution since we are now in a more customer-centric world.
How to calculate Customer Acquisition Cost?
CAC is calculated by dividing the total cost of marketing and sales by the number of customers acquired over a specific period. In this section, to calculate CAC, you must add up all the total costs associated with acquiring new customers (which means the amount being spent on marketing and sales) and then divide that total amount by the number of customers acquired. For example, if an organization spends $1,000 on marketing in a year and is able to acquire 1,000 new customers, the CAC would be $1 because $1,000 divided by 1,000 total customers equals $1 per customer.
On the contrary, if the company brought in 500 customers, their CAC would be twice as high, or $2, because they spent the same amount of money and brought in half the number of new customers.
This simplified formula is simple and easy to learn, but adding up the total expenditures can take a lot of factors into account, including the cost of multiple marketing channels and staff salaries.
Overview of LTV/CAC ratio
By using this equation, it is helpful to add more business products and target new valuable customer sectors, and trying out different media enables one to see how CAC is in line with the customer lifetime value (LTV), which is very important and efficient.
To define the LTV/CAC ratio measures the relationship between the lifetime value of a customer and the cost incurred in order to acquire new customers. The customer’s lifetime value (LTV) refers to the profit brought in by a customer, whereas the customer acquisition cost (CAC) is the total expense incurred in the process of convincing the customer to purchase the product. The above figure is the formula for the LTV/CAC ratio.
LTV / CAC Formula
The company retains 75% of its customers per year. An eCommerce company spends at the rate of $10,000 on a Goodle Adwords campaign and acquires 1,000 total customers. The average revenue per customer is $50, and the direct cost of filling each order is $30.
To analyze the given sample, we have the calculation:
Customer contribution margin = $50 – $30 = $20
LTV = $20 / (1-0.75) = $80
CAC = $10,000 (rate) / 1,000 (total new customer) = $10
LTV/CAC ratio = $80 / $10 = 8.0 x
This is how LTV and CAC are computed. For SaaS companies, the LTV/CAC ratio is frequently
used to assess early-stage businesses; however, its usage extends to any type of business with repeat purchases (like, for example, the direct-to-consumer type, e-commerce, etc.).
Comparison of CAC and LTV Ratio
CAC and LTV: Stage 1
Try to imagine the sample data given above, that you have only accounted for paid advertising in your CAC calculation. If you’ve spent at the rate of $1,000 on paid advertisement in one month then you will acquire 50 new total customers, then your calculation will be:
($1,000 / 50) = $20 per customer
So you have the average lifetime value of a customer at $1,500.
LTV:CAC ratio: Stage 1
According to the above calculation, the LTV/CAC is a stellar 75. As you can see, this is a very low CAC in comparison to the LTV, yielding a very encouraging LTV: CAC ratio as described in the above figure as target #3.
However, this is not the end yet since it’s easy to only consider the paid advertisements because they are the most obvious additional expenses that directly bring in customers.
Upholding successful LTV and CAC channels helps for modern subscription business purposes.
Second mistake: Do not include all of the marketing costs.
The company’s exposure and the brand building still need to serve customers. Including the following expenses, like the services, tools, and software that are essentially used for:
- Website Designing
- Content Management Systems
- Keyword Research
- Data Enrichment Systems
- Lead Scoring
- Content Marketing
Comparison of CAC and LTV
For example, the figure above shows if the spending is $10,000 on these systems within one month to acquire the same total 50 customers. When including the costs of marketing and paid advertisement when calculating, then the CAC can be determined as
($10,000 + $1,000) / 50 = $220 per customer
Therefore, the CAC is visibly ascending when compared to the unchanging LTV.
LTV/CAC at Mistakes Stages
LTV: CAC ratio: Stages 1-2
This increase in CAC compellingly and dramatically lowers the LTV/CAC in comparison.
The LTV/CAC above is shown from 75 to 6.8, which determined that the additional expenses that increased the CAC enormously affected this ratio.
Since the LTV/CAC ratio is lower, it is still above the target of 3. It would probably be tempting to say that this is still set up to be very profitable and effective.
In the end, these marketing programs and advertisements are not running themselves.
Third, salaries for acquisition-related employees are not included.
The sales and marketing teams work hard to bring satisfaction to the customers. It would be neglectful if we ever forgot to include the salaries in the calculations and possibly not be accurate. The following costs are important to include:
> Salary of the sales director
> Base salaries of account executives and overtime compensation
> Salaries of sales development representatives
> Salary of the marketing manager
CAC and LTV: Stages 1-3
To discuss the combined salaries of the sales and marketing teams, this reveals that they have an average of approximately $33,000. This is approximately $5,500 as an average of the individual monthly salaries of one sales director, one marketing manager, two account executives, and two SDR’s. To compute the total CAC, we have:
($33,000 + $10,000 + $1,000) / 50 = $880 is the total cost per customer
The CAC, therefore, is now over half of the lifetime value.
LTV/CAC ratio: Stages 1-3
The LTV/CAC ratio has dropped to an alarming 1.7 with the CAC increase.
The total expense to acquire new customers was miscalculated by the numerator of the CAC equation. The LTV/CAC is now far below the ideal 3:1 ratio due to miscalculation.
Here is the 5-step revenue recognition process for subscription businesses.
Fourth mistake: counting non-paying customers as acquired
Moreover, including these users in the total count of acquired customers will skew the CAC. Considering the following of the acquired users agreeably:
>Signed up for a free trial period.
>You are on a freemium plan based
Despite the fact that 50 customers have used the service in the last month, only 30 are on a paid plan.
Given the above, one should not think of these freemium users as acquired customers when calculating CAC in the LTV/CAC ratio and tracking the cash flow. The new simplified calculation would only show that the CAC is solved as follows:
($33,000 + $10,000 + $1,000) / 30 = $1,467 is the total per customer
With LTV/CAC of 1, the LTV and CAC are almost equal or have the same value.
As mentioned, mistakes show that incorrect CAC calculations can cause changes in the value of LTV/CAC to differ between 75 and 1.
LTV: CAC ratio corrected from 75:1 to 1:1
When calculating the CAC, the devil is in the details. For example, if a miscalculation happens along the way, it could possibly lead to a calculation of CAC as low as 1/75 of the fully loaded CAC.
If you already knew that the fully loaded CAC was $1,467, you could set a goal for the final ideal customer’s LTV to be at least $4,400. However, if the CAC calculation is less than that, then this is most likely an unknowingly low aim. This simply means that it lays the groundwork for very misguided and possibly deleterious future business decisions.