What Is Customer Acquisition Cost And How To Improve It - Issue 43
A close look at Customer Acquisition Cost, how to calculate it, and ways to improve CAC and user growth.
Let’s say you are a data analyst supporting growth marketing initiatives. The Head of Marketing asks you to report which marketing campaign has made the biggest impact over the last few months. The most successful campaign should have the highest ROI and lead to the increased LTV. To get there, your first step is to understand Customer Acquisition Cost known as CAC.
For today’s issue, I wanted to do a thorough breakdown of CAC to highlight why it is important to measure correctly, and what are the ways to improve it.
You are more likely to work with CAC if you are involved in any Growth initiatives at your company. Measuring and analyzing user acquisition is the most common project supporting Growth Marketing teams. Usually, the smaller the company is, the more heavily marketing is embedded into a product. For the early-stage startups (especially SaaS), it’s common to spend more on marketing campaigns than the revenue budget coming in from customers. With the right product and business scale, marketing spend will level off with incoming revenue and will boost more organic growth. That’s why it is important for analysts to understand CAC, LTV and recommend the right steps of improving user acquisition.
💡 If you are new to CAC and other growth metrics, first of all, I’d suggest familiarizing yourself with the Growth Metrics One-Pager - a short guide to steps and must-know company KPIs.
What is CAC?
Customer Acquisition Cost is money you spend on ads and marketing to acquire a new customer. It is heavily embedded into the LTV metric. Your LTV must be higher than CAC. Otherwise, you won’t stay profitable.
CAC
= Total Cost of Sales and Marketing / Number of New Users (Paid)
You also have to calculate Months To Recover CAC to understand how quickly a customer starts generating ROI:
Months To Recover CAC = CAC / MRR x Gross Revenue (cost of sales/ads)
Important things to keep in mind:
The CAC definition above is simplified and meant to be used by analysts to measure specific marketing campaign impact. In fact, the company spends more money to acquire and maintain users besides the marketing budget. The formula above doesn’t include other expenses like salaries, platform costs, snacks at the kitchen, and other expenses. If you are a financial analyst, then you have to sum up all the expenses.
Working with CAC, you have to calculate it for every marketing channel separately to understand which channel is more effective (blog page, Google Ads, social media campaign, etc).
Like I said above, it’s common for the early-stage startups’ CAC to be higher than MRR over the first year. However, it’s vital to understand how much money you can spend on CAC to maintain cash flow.
A few times I received a question about what the average CAC usually is, or what are the industry benchmarks? I do not recommend relying on or pivoting your campaigns based on specific benchmarks for two reasons. First, CAC can be very different across industries. And second, it heavily depends on your LTV, which can be largely affected by churn. Adopting other benchmarks can be dangerous because you might go with a high ad spend, but your ability to retain or convert users can be weak and that will lead to high churn and thus, low LTV.
If you still want to be familiar with different benchmarks to understand the CAC range, read Customer Acquisition Costs by Industry: What's a Good CAC?
How to improve CAC
There are direct and indirect ways to affect CAC at your company. Direct - you actively invest into marking and data handling, indirect - when you optimize the product, creating a user flow that leads to improved churn and revenue expansion.
Let’s break these down.
💰 Focus on Expansion Revenue
This is revenue generated from existing customers via upsells, Adds-Ons, Upgrades, and Cross-sells. Sometimes it’s called Expansion MRR.
Expansion MRR - existing customers who upgraded.
% MRR Expansion = Expansion MRR / Previous Month MRR
Earning from your current customers is more cost-effective than acquiring net-new customers. Increasing ER can give you a negative churn (I’ve never seen it actually happen, but one can dream). It happens when revenue from upgrades/upsells is higher than lost revenue in a given month. As a rule of thumb, if you want to be profitable, at least 30% of revenue should come from ER.
📈 Invest in a click-stream data
In a nutshell, click-stream is a recorded path throughout every step of the user journey. It can be a challenge to link together every action a user takes, from seeing an ad to the final purchase or upgrade. As an analyst, I often advocate for investing in a click-stream. Simply put, if you want to improve targeting, you have to learn it first, analyze it, and see its pattern. There are many ways how you can set up ad campaigns. The better insight into ad performance, audience, clicks, device, and content you have, the better you can improve it. You want to target high-quality users who are likely to purchase and less likely to churn. And the more data on user acquisition and behavior you obtain, the more precise your forecast and targeting will be. Investing in Google Analytics setup and/or proper integration with other tracking tools is costly, timing, and painful, but eventually gives you better ROI.
📗 Focus on content marketing
Blogs can passively drive constant traffic to your website. It is cheaper to publish evergreen content that doesn’t require maintaining and still get attention to your product than actively run ads. Smartly set up and optimized publications can generate as many conversions as the ads, but CAC will be reduced. For an analyst, measuring inbound leads and traffic coming from blogs or landing pages is also usually straightforward and doesn’t require any data optimization or special handling.
If you want to learn more about content marketing, read Content Marketing: A Modern Guide.
👥 Learn your users
Duh. What I mean is that growth marketing is one of the most affected domains that benefit from Personas and user segmentation analysis. You tailor your campaigns differently for each user profile. You position your product in a way that helps your Personas meet their needs. A combination of quantitative and qualitative data can help you understand your users and significantly improve your CAC.
To understand better user segmentation, its methods, and impact, read:
There are many articles out there about CAC and LTV.
How to Detect Problems in Your Marketing Communications Channels: What is Customer Acquisition Cost is a new piece I contributed to recently that has many good pointers.
Improving CAC doesn’t happen overnight. Decreased CAC will lead to increased LTV, and this goal is one that you should be able to convey to your leadership while setting up objectives for the next growth initiatives. Anything you can do to improve LTV will have a big impact, as it speaks for revenue and user retention (churn) in one clear metric.
That’s it for now. Until next Wednesday!