Acquiring customers is crucial for every business. Without customer, there is no possible business. I don’t know of any business that can operate without customer.
The Customer Acquisition Cost (CAC) should always be one of your primary concern. What if some of your activities aren’t effective at all? You might be wasting money somewhere.
The lower is your CAC, the better. If you spend more on customer acquisition than you can make money out of them, you’ll be out of business pretty soon.
The CAC is one of the levers that can empower you to optimize your business model. What if you could acquire customers at a lower cost? You’d make more money!
Read on to discover how to calculate your CAC and how you can reduce it to improve your profitability.
What is the Customer Acquisition Cost (CAC)?
The amount of money you spend to acquire a customer.
The CAC should be one of your main metric because it’ll allow you to understand your business economics: If I invest $1, I’ll get back $2. You’ll therefore be able to better manage the growth of your business.
The CAC can be segmented with other metrics, such as the channel or plan. By doing so, you’ll be able to understand better your acquisition and how to be more effective.
You can also think about the CAC in terms of customer segment. You know that you won’t acquire a small SMB at the same cost you acquire a Fortune 500 company (they also don’t have the same profitability).
Calculate your CAC
Many companies only include direct cost into their calculation, doing so results in an inaccurate CAC. Other costs are also involved, don’t forget Support, Sales, Custom development…
Accurately calculating the CAC is a thorough and time-consuming process. You need to measure all the costs involved in acquiring customers.
If you drive traffic through Inbound Marketing, you should include all the costs involved with the design and implementation of the strategy. Think about: writing, distributing and measuring your results. These are all activities that should be included in your calculation.
Below is a non-exhaustive list of cost pressure in the CAC. Remember that every business will have different cost structure and marketing activities.
- Sales & Funnel
- Custom development
Pro tip: your team is probably participating in a lot of these customer acquisition strategies, to understand how much that cost you, you could log their time through a software like Toggl and include the incurred costs in your calculation.
Calculating the costs involved in Customer Acquisition is the difficult part. You then just need to divide the cost by the number of customers newly acquired to obtain your CAC.
Impact of the CAC on your Business Model
Besides influencing your margin, the CAC also directly influences the payback period (when you start to make money out of a single user). The lower is your CAC, the fastest you can make money.
The CAC will therefore directly impact your profitability and how fast you’ll be able to grow your business. With $1M, how many users will you be able to acquire (CAC)? How fast will you get back your money (Payback Period)?
Since the CAC is a direct calculation of all the costs involved within Customer Acquisition, your CACC will highly depends on your Sales Process. The more complex your sales process, the highest your CAC.
As a rule of thumb, your LTV (Lifetime Value) should always be at least 3x your CAC. It will allow you to comfortably generate enough money to grow your business.
To illustrate all the points above, Christoph Janz wrote an amazing article about the 8 ways to build a $100M business.
Generally, the bigger your customers are, the higher your CAC will be. As Christoph puts it, there are many ways to build a business. The crucial question becomes “Which one do you want to build?”.
Disclaimer: if you only have a few customers, optimizing your CAC is the wrong thing to focus on. You can’t calculate it accurately. You should focus on building a product people truly value.
Ways to reduce your CAC
1. Distribution Channels
Channels all have different cost associated to them. Social is going to have different cost than running an Email marketing campaign.
Channels behave very differently. Some are going to work while others are going to behave terribly. When a channel isn’t achieving sufficient result, you have several opportunities:
- Reduce or cut your investment
- Optimize it
Your strategy is as good as the channels you use. Pay particular attention to each of your channel in order to make the most out of them.
Please note that some channels will assist conversion (e.g. Retargeting), so make sure you understand how your channels are working together before taking a decision. To do so, you need to look at the Multi-Channel Funnels report in Google Analytics.
2. Ideal Customer Profile
Today, you’re probably wasting some of your budget on acquiring traffic that isn’t buying. These guys won’t convert today and probably won’t tomorrow. If you can discover whom you’re targeting but won’t buy, you’re a king.
As Marketers, we need to build a true understanding of our target market and ideal customer profile. The better you understand them, the more money you’ll be able to make.
Try to answer all these questions:
- Who are they?
- Where do they stick around?
- What do they feel passionate about?
- What are their goals & challenges?
- What are their pains & needs?
The best way to do this is to connect personally with your customer. You’ll often be able to write a few personas that will encompass their main characteristics.
The better you understand them, the better your strategy will be. You can then tweak your distribution channels and your message to target the right kind of people.
Acquiring strangers is more expensive than getting acquaintances to get back to your website. When users left your website without giving you any way to contact them, retargeting is here to help.
By advertising to these people on the Google Display Network or on Facebook Ads, you’ll be able to bring these guys back to your website.
In my experience, we were able to bring back unconverted visitors and to convert them to a free trial for less than $1. Your software and onboarding can then take the leap and convert them as paying customer.
The main advantage is that you’ll be able to convert these users more easily than people you don’t know at all.
4. Website optimization / CRO
Optimizing your website can help you to convert more users by tweaking some parts of your website and funnel.
One good example is to include questions you get asked a lot in FAQ. By answering these questions on your website, visitors won’t have to contact you and you’ll shorten the sales cycle.
Plenty of websites out there (KISSmetrics included) are talking about CRO (Conversion Rate Optimization), so I recommend you to read them and to build a testing plan.
The more you optimize your website, the more visitors you’ll be able to convert directly.
5. Timing & Sales Cycle
The time necessary to convert Leads to Customers is primary. The longer it gets, the greater it costs. If you need 6 months to convert a Lead, the CAC will be greater than if you take a few days.
Here are a few techniques you can use to reduce the length of your sales cycle:
- Communicate often & quickly with your leads
- Qualify them early and know where they are in the purchase cycle
- Shorten your free trials & avoid renewing
- Focus on the hottest leads
Working on your sales cycle can greatly reduce your CAC. You want customers to convert quickly.
SaaS Marketing can be wonderful when your software can sell itself. You don’t need to speak to your customers: they can just sign up and start paying.
However, many startups struggle because they fail to onboard new users. They see a lot of signups, but low conversion rates once leads get to the free trial.
Working on your onboarding can therefore helps you to show the true value of your service and to improve the number of people at the bottom of the funnel.
Working on your onboarding is necessary if you want to take advantage of the self-service model. The better is your onboarding, the lower your CAC will be.
7. Referral Program
Imagine that a customer that you acquire for $10 bring in 4 new customers. You acquired 5 customers for $10, which means that your CAC is $2.
Referral program can be very powerful to reduce your CAC when they’re well executed. They apply to most businesses, however, need to find an innovative way to implement it in your industry.
One good example is Airbnb who offers incentives to their user. They give you discounts if you can find someone to get on board with them.
Referral can be extremely powerful. However, make sure that your industry is used to it. What if your users don’t like to talk about your service? They won’t invite anyone.
Overall, working on your k-factor can have an incredible impact on your CAC. Referral program are only one way to do so. Make sure you experiment and find the perfect tactic for your business.
8. Customer Success
Customer Success can help you to convert more customers to evangelists. These customers will then talk with other people about your product.
These people will soon form your own “organic” sales force. They’ll sell your software for you.
Bill Macaitis (Slack, Zendesk) and Tomasz Tunguz wrote a great read on how to turn customers into evangelist with Customer Success “How Customer Success Meaningfully Reduces Cost Of Customer Acquisition”.
Let’s go further
To sum it up nicely, calculating your CAC involves thinking about all the costs involved in acquiring customers.
Reducing your CAC involves thinking about innovative ways to reduce the costs involved in your CAC.
Reducing your CAC shouldn’t be a one-time thing. You should iterate on it and reduce it as you move forward. Lean Analytics sum up this process in this presentation:
Always focusing on reducing your CAC isn’t a good thing. You should know when to focus on reducing it and when to experience new things.
When optimizing part of your business model, take extra care that you’re not damaging others part of the model. If you decrease both your CAC and your LTV, you’re harming your business.
Optimize your CAC but make sure that you include other metrics (LTV, Churn) in your analysis. You don’t want to improve one part of your business while you hurt another one.
Master the CAC to Grow
Optimizing your business model, including your CAC is primary to your success. SaaS offers great advantages when it comes to data analysis and metrics optimization.
Take advantage of this wonderful business model in order to improve your overall profitability and hence generate greater revenue.
Always keep an eye on your metrics in order to analyze the health of your business and maintain sustainability & profitability.
Reducing your CAC is one of the main functions of SaaS Businesses. You could also try to optimize your LTV or reduce your Churn, it’s up to you. What you choose to focus on will determine your success.
It’s your turn now. How did you reduce your CAC? Have you tried some of the techniques above? What results did you get?
I’m Pierre Lechelle and I’ve been working in the tech ecosystem building businesses for about 10 years. I’m now focused on helping MadKudu to reach $100M in ARR. Connect with me on LinkedIn.