Ecommerce businesses can employ a myriad of digital marketing techniques to reach out to prospects — search engine optimisation, pay-per-click advertising, and content marketing to name a few. The question is: how do companies determine which of these marketing practices fits them best?
The answer is customer acquisition cost (CAC). This key performance indicator (KPI) enables ecommerce marketers to gauge the cost of attracting a new customer.
In this guide, we’ll delve into the customer acquisition cost metric, show you how to measure it, and teach you how to improve how much it takes to get new customers.
Why Customer Acquisition Cost Matters
Customer acquisition cost shows you what it takes to convince prospects to purchase your products or services. If you want your brand to grow and profit, it’s important for you to understand the significance of the CAC metric.
Determining a company’s profitability
The CAC metric matters to early investors as it informs them of the company’s potential to be profitable. They want to provide the necessary resources. At the same time, they want to be certain that their investment will be worth it.
Maximising the company’s return on investments
Marketing specialists’ primary concern is the company’s growth. They also need the CAC metric as it enables them to determine how to maximise the company’s return on investment (ROI).
Measuring Customer Acquisition cost
To determine your customer acquisition cost, you need to divide the total cost of sales and marketing incurred over a given period by the number of new customers that you acquired.
Customer acquisition cost = Total sales and marketing costs ÷ Number of new customers
Your total sales and marketing cost may cover a wide range of expenses. Take note of the expenses listed below when you’re calculating the CAC metric:
- Cost to produce content
- Ad spend
- Technical cost
- Publishing cost
- Employee salaries
- Management time
Let’s say you spent a total of £10,000 on promotions and acquired 500 customers for that particular quarter. That makes your company’s CAC £20.
The first thing you need to do when you’re measuring the CAC metric is to identify a set period of time to evaluate. You can select a specific month, quarter, or year to limit the scope of your data. Then, calculate the total cost of your promotions of that given period, as well as the number of customers you acquired. Using the CAC formula, you can determine how much it costs to acquire a customer.
Now that you know how to calculate your CAC, you’re probably wondering: “What should I do with it?”
Take your CAC and compare it with other critical business metrics. This way, you can gain insights about your sales, marketing, and customer service campaigns.
Measuring Customer Lifetime Value
Moving forward, it’s important to understand that these expenses aren’t always bad for business. You can consider them as investments. Some might help your brand flourish, while others don’t. So, how can you determine a worthy investment?
Through customer lifetime value (LTV). This metric pertains to a predicted revenue that one customer produces throughout the course of their relationship with your business. Most companies either use a one-year, three-year, or five-year LTV calculation. Calculating this metric allows companies to determine if the customers that the company has acquired will drive more revenue than cost.
Take note of the following variables when you’re calculating for the LTV metric:
- Average purchase value: To get this value, divide your total revenue over a specific period of time by the number of purchases gained during the same time period.
- Average purchase frequency: Divide the total number of purchases over a given period of time by the total number of unique buyers to calculate the average purchase frequency.
- Average customer lifespan: To determine your average customer lifespan, divide one by your churn rate.
- Customer value: When calculating customer value, multiply the company’s average purchase value by its average purchase frequency.
To calculate the LTV metric, start by multiplying the company’s customer value by its average customer lifespan. This shows you an estimate of the revenue an average customer will generate over the span of their future relationship with your company.
Measuring your LTV and CAC will help you determine the amount of time it’ll take to recoup investments used to acquire a new customer. On average, it can take about a year to recover your CAC. Also, you should strive to achieve a 3:1 LTV to CAC ratio, which means your customer value should be three times the cost of acquiring a customer. Let’s say the ratio is 1:1. That means you’re spending way too much to acquire consumers. If it’s 5:1, you aren’t investing enough on your prospects.
Understanding the LTV:CAC ratio allows you to uncover additional financial opportunities for your campaigns. It also helps you make well-informed decisions about your operations.
Enhancing Customer Lifetime Value
There’s a multitude of ways to boost revenue. But in terms of improving customer lifetime value, there are only two essential factors to consider:
As long as customers are happy and satisfied with your products or services, you can encourage them to spend more on your company. In a study, HubSpot Research found that companies who invest in customer success drive more revenue due to high customer satisfaction rates.
Another metric that marketers should invest in is customer retention. Acquiring new customers isn’t an easy endeavour nor is it a cheap one. As a matter of fact, the cost of acquiring new consumers is more expensive than retaining them. Not to mention, retaining customers leads to an increase in revenue at a lesser cost.
Improving Customer Acquisition Costs
There are several ways to keep the LTV:CAC ratio at 3:1. Here, you will find a few techniques that will help:
Improve customer value
You can improve customer value by offering your audience something that they themselves value. This may come in the form of feature enhancements, product fixes, or complementary offerings. Pay attention to their interests, and you’ll find exactly what they want. Collect feedback from your customers so you can deliver what they’ve asked for and entice them to buy more.
Enhance on-site conversion metrics
Google Analytics provides powerful opportunities to improve the overall performance of your website. Setting up goals in Analytics, as well as performing A/B tests, can help you improve your landing page, optimise the mobile experience, reduce cart abandonment, and so on.
Build a customer referral program
Implementing an effective referral program will reduce your customer acquisition cost over time. Of course, whenever an existing customer refers your brand to a valuable prospect, that prospect’s CAC won’t cost a thing if they do convert.
Companies ought to be strategic about their sales and marketing investments if they want to remain profitable. The customer acquisition cost is the best way to determine cost-effective methods. This metric tells companies if they are missing out on potential opportunities to earn revenue or if they are spending way too much.
Also, for any type of business, it’s imperative to get the right balance between the cost of acquiring new customers and their lifetime value. Companies must strive to optimise their techniques on a regular basis to maintain this ratio and keep their competitive edge.