One of the fatal mistakes startups do is either neglecting to focus or miscalculating customer acquisition cost (CAC). This metric is at the core of any viable businesses. If you are spending more money on acquiring customers than you are generating from them, you’re setting yourself up for defeat. And yet many businesses measure or calculate CAC incorrectly, leading to fundamental errors in their sales and marketing strategies. CAC is not the same as the cost per acquisition (CPA), yet the two are essential to track when you need to forecast your budget. Andrew Chen, a general partner at legendary firm, Andreessen Horowitz, explained the breakdown best on his blog.
At a basic level, CAC is defined as the average sales and marketing outlay per customer acquired. It is typically calculated as follows:
CAC = Total cost of sales and marketing / # of customers acquired.
It’s important to calculate CAC accurately. Many companies fail to include all the costs entailed in user acquisition in the calculation. It’s essential to include both marketing and sales costs, including employee salaries, subscription costs associated with sales and marketing tools, referral fees, etc. Anything that’s included in your P&L statement that is directed at customer acquisition should be included in your CAC calculation.
In addition to understating the costs associated with acquiring customers, many companies fail to distinguish between users acquired via paid channels and those acquired organically. Companies should monitor both their “blended” CAC (which includes users acquired organically) and their paid CAC (which only includes users acquired via paid channels). Only by segregating your non-organically-acquired customers from your paid-acquired customers will you be able to understand how effective your paid campaigns are.
CAC should not be assessed in a black box. The metric is only valuable when viewed in the context of customer lifetime value (LTV), or the projected revenue you expect a customer to generate over their lifetime. Your objective should be to decrease CAC without jeopardizing the LTV of a customer. David Skok, VC at Matrix Partners, recommends that a company’s average LTV per customer be at least three times its CAC.
Here are a couple of effective ways a marketer can minimize CAC:
Invest in search engine optimization (SEO)
If you want free traffic, you need to be ranked well in search. The first thing to remember is that SEO is a long game. You can make some easy changes and see some quick results, but the real value will come with a lot of sweat equity poured into your strategy.
The first step is to start tracking everything to understand your baseline. With search engines becoming for customized, so has a marketer’s ability to track progress. I think even lean budgets should invest in a tool like Moz to ensure your efforts are getting the results you need. Moz also produces great content to help you understand where you should prioritize your time.
Evaluate your sales and marketing tech stack
One of the easiest ways to decrease CAC is often hidden within our own internal tech stacks. Sales and marketing can accumulate a laundry list of tech that promises to give their team an edge over the competition. The problem is that these costs can add up quick. It is best practice to routinely gage the activity levels on the software you are paying for to ensure your team is getting value. It is important to add up all these tools and services and include them in your CAC analysis. This will keep your team honest about what is actually needed and remind team members to regularly use the tools that they purchase.
Experiment with Account-Based Marketing (ABM)
Account-Based Marketing is one of the hottest trends in B2B and for good reason. Today we have a tremendous amount of data on our ideal customers and know with a new level of granularity how to reach them. Therefore older methods of “spraying and praying”, are not the best use of a marketer’s time and budget.
The hardest part of ABM is taking the initial leap. The reasoning is that you are putting a lot of money into fewer bets in order to land a prospect. Customized direct mail is incredibly powerful, but it is physiologically challenging to get over the fact that you may spend $50 a person. The reality is that when done well and in conjunction with strategic native ads, the acquisition costs are much lower than traditional methods.
Support with native advertising
Banner ads are a thing of the past. Increasingly, companies are turning to native social ads (offered by Google, Facebook, and others) to reach customers, especially when they play a part in a bigger ABM strategy.
In contrast to banner ads, native ads match the form and function of the non-paid content that surrounds them. Because native ads are so cohesive with their surrounding content, they come across as less “in your face” and are received more favorably than banner ads. Native ads are viewed 53 percent more frequently and result in an 18 percent increase in purchase intent compared to display ads.
Today’s native platforms also let you target with custom audiences that ensure that you only pay for impressions of your ideal customer profile (ICP).
Implementing an official or unofficial referral program can be a low-cost and effective way to not only decrease your CAC, but also to increase your average LTV per customer. Referrals have 16% higher retention rates compared to non-referrals.
CAC is an essential metric in terms of understanding the health of your business. It’s critical that companies properly calculate their CAC, meticulously track it, and take all steps to reduce it (while at the same time optimizing LTV). Understanding and managing your CAC will help you make more informed business decisions and fuel long-term growth.
The opinions expressed here by Inc.com columnists are their own, not those of Inc.com.