Every business/brand pays a cost to acquire new customers. This Customer Acquisition Cost (CAC) includes all costs that you spend on efforts to acquire the customer, such as a sales team, marketing promotions, marketing channels utilized to reach customers, taking customers through the customer journey, and everything leading up to a conversion. To determine how much you are spending to acquire a new customer, you can use a simple formula as shown below:
Customer Acquisition Cost (CAC) = Amount Spent (AS) ÷ # of Customers Acquired (CA)
It is important to know how much you are spending to acquire each customer because this information will help you to maximize your ROI, increase your profit margin once you reduce the CAC, measure the value of each customer, help with determining the profitability of your business/brand from an investors point-of-view, increase effectiveness and efficiency in marketing spend, see what channels are more effective, and help you to determine where to focus your dollars i.e. you would increase investment in channels that have higher rates of acquisitions at lower CAC.
Once you have acquired customers, you need to determine the Customer Lifetime Value (CLV) of each customer. The CLV helps you to determine the total revenue that your business could expect each customer to spend throughout the lifetime of them dealing with your business/brand. Establishing the CLV helps you to determine the value that each customer contributes, the probability of profits, business growth potential, and efficient marketing budget allocation towards retention. Higher CLV leads to brand loyalty, advocacy, and therefore customers’ willingness to pay premium prices if necessary.
CLV is calculated using the formula shown below:
Customer Lifetime Value (CLV) = Revenue Spent per customer each month (RS) ÷ Customer Lifetime Average (CL)
Once you have determined the CLV, you would then compare that to the CAC and the resulting ratio helps you to determine if you are spending the right amount to acquire customers. The ideal ratio is 3:1 (CLV: CAC) as the CLV should be 3 times what you spend to acquire the customer. If the ratio is too low that means you are spending too much, and if it too high it means you may not be spending enough and could therefore be missing new customers.
Calculating your CAC, CLV, and looking at your CLV: CAC ratio can help you to make better decisions on marketing investments, and improving these numbers leads to a better ROI.
Check out last week’s post