Customer Acquisition Cost (CAC) might sound complicated, but it’s really just a way to measure how much money a business spends to get a new customer.
Think of it like fishing—if you spend too much on bait, gas, and gear, and only catch one fish, you’ve spent a lot for very little. In business, if you spend more to attract a customer than you make from them, that’s a problem.
Breaking Down CAC
To figure out your CAC, you add up all the costs you spent on marketing and sales—like ads, emails, and even the salaries of your marketing team. Then, you divide that by the number of new customers you gained in that same time period. For example, if you spent $500 and got 50 new customers, your CAC is $10 per customer.
Knowing this number helps you see if your marketing is working. If you’re spending too much to get new customers, you might need to change your strategy. Maybe you’re putting ads in the wrong places or spending on things that don’t work.
Why Should You Care About CAC?
Let’s say you run a lemonade stand. You spend $30 on lemons, sugar, and cups. If you sell enough lemonade to make $50, that’s great. But if you spent $40 to get each customer (maybe by putting up expensive signs or giving out free samples), you’re actually losing money even though you made sales. That’s what happens when your CAC is too high.
Another important thing to think about is how long your customers stick around. If they buy from you again and again, it might be okay to spend more to get them in the first place. But if they only buy once, you need to keep your CAC low.
How to Improve Your CAC
To get a better CAC, start by looking at where you’re spending money. Are some ads working better than others? Focus on what’s bringing in the most customers for the least money. Another idea is to make it easier for people to become customers—like simplifying your website or offering better deals.
Some businesses also work on keeping their customers around longer, which can make the initial cost of getting them worthwhile. If you can keep them coming back, you don’t need to spend as much finding new ones.
A Fresh Perspective
Most people think of CAC as just a number, but it’s more like a pulse check for your business. If your CAC is too high, it’s like your business is working too hard for too little reward. The real trick is to find that sweet spot where the effort you put in is balanced by what you get back.
Sometimes, this means looking beyond the numbers and understanding what really draws people to your business. Is it the product, the experience, or something else entirely?
CAC and LTV
CAC connects with another important metric—Customer Lifetime Value (LTV). Simply put, LTV is the total amount of money a customer is expected to spend with your business over time. When you compare LTV with CAC, you get a clearer picture of whether your customer acquisition efforts are paying off.
The CAC to LTV Ratio: Why It Matters
The CAC to LTV ratio tells you how much return you get for every dollar spent on acquiring a customer. If your CAC is high and your LTV is low, it’s like buying a fancy fishing rod but only catching small fish. On the other hand, if your LTV is high compared to your CAC, you’re getting great value for the money you spend.
A good CAC to LTV ratio is generally considered to be 3:1. This means that for every dollar spent on acquiring a customer, you’re earning three dollars back over the customer’s lifetime. If your ratio is lower, it might indicate that you’re spending too much or not getting enough long-term value from your customers. A ratio higher than 3:1 could suggest that you’re not spending enough to grow your customer base, missing out on potential revenue.
How Different Businesses Use the CAC to LTV Ratio
The way businesses use the CAC to LTV ratio can vary significantly depending on the type of business.
Direct-to-Consumer (DTC) E-commerce: For DTC e-commerce brands, CAC is often front-loaded. These businesses spend heavily on marketing channels like social media ads to drive immediate sales. Since DTC products often have lower price points, it’s crucial for these businesses to have a high LTV relative to their CAC. A subscription-based DTC brand, like a meal kit service, focuses on increasing LTV by encouraging repeat purchases. If their CAC is too high compared to LTV, they might offer discounts or improve customer retention strategies to balance it out.
B2B SaaS (Software as a Service): In B2B SaaS, the CAC is usually higher because the sales cycles are longer and involve more decision-makers. However, the LTV is also higher because SaaS companies often rely on subscription models with recurring revenue. For example, a SaaS company might spend $2,000 to acquire a new customer, but if that customer stays for five years and pays $1,000 annually, the LTV would be $5,000. This gives the company a CAC to LTV ratio of 1:2.5, which might indicate that they need to either reduce CAC or increase LTV by upselling additional services.
Marketplaces and Platforms: Companies like Uber or Airbnb operate as marketplaces. For them, both sides of the market (e.g., riders and drivers) have different CACs and LTVs. These companies focus on balancing CAC across multiple customer segments while maximizing LTV through network effects, where more users lead to more value for each participant.
Improving the Ratio
Improving the CAC to LTV ratio isn’t just about lowering CAC; it’s also about boosting LTV. Businesses might introduce loyalty programs, enhance customer service, or add value through product upgrades to keep customers longer. Similarly, refining your marketing to attract higher-value customers can improve the ratio without changing the CAC.
