Why CAC (Customer Acquisition Costs) is important & counter-intuitive

Even the roughest estimated CAC is better than no CAC at all. In this article we run through the basics of your first CAC calculation.

Imagine with me if you will, a shop where I could go in and buy a customer for Calqulate.
That shop has customers on their shelves, each customer comes with a fixed price.
Each customer is in the same brown paper box.
I have no idea what sort of customer I will get, but I do know how much they cost me. 

Let's say $10.

There’s another shop across the street that also sells customers. They sell them for half price at $5 a customer. They also use the plain brown packaging, with no indication as to the contents of the customer inside.

In its simplest terms, this is Customer Acquisition Cost. We pay money for a customer, whether that is through marketing activities such as Social Media advertising or Google ads, each “Shop” sells customers at an average price.

But that’s only half the story.

What about you? What does it cost you to go into the shop and purchase that customer? How much of your salary should be allocated to accomplish that task?

Did you buy a bus ticket to get to the shop? Maybe you bought a large bag to carry all the customers you bought?

After you factor the costs of your time and tools into the search for finding customers, your $10 customer from the first shop could be costing you a lot more.

If you don't track these things, then you will never know. And if you don't know, it can come back and bite you in the ass. This guide aims to help you avoid getting bitten in the ass.

Let's look at an example. In your monthly meeting you notice that your customer acquisition costs have dropped, your SEO team lost a staff member and you hired a new SEM intern. You have also noticed that your conversion rate has improved. Everything looks great on the surface, but the following month you start to see an increase in churn. Three months down the line you observe that your lower CAC and higher conversion rates may actually be losing you money in the long run.

In short, If you can't measure it, you can't grow it.

Building a CAC formula. 

Staff Costs

A solid CFO knows all the things they can include in their acquisition cost formula. The more you can think of attributing, and in the right quantity, the sharper and more accurate your CAC will be.

The first part of the formula is to factor in staff costs when acquiring customers.
After all, we have to pay someone to go to the shop and buy those valuable brown packages for us.  

From your accounting or payroll software, you can import your staff costs. 

Assign a percentage of each employee's wages to Customer Acquisition Costs.

For example, if you are the CEO, in the early days of your company, it is not unheard of for 50% of your salary to be attributed to CAC due to the hands on, sales orientated nature of the role at this fledgling stage. 

For anyone in your sales or marketing teams, that percentage is set to 100%. This is where the aforementioned “Right Quantity” become important.

Having a solid CAC formula is really important in the first few years of your company's growth, which is why we don't stop our formula here. 

Marketing and Sales Expenses

A sobering fact is that you will need to burn money to acquire your first few customers. 

And without any previous information, you better hope they're good customers.

All marketing and sales costs, tools and services need to be factored into your customer acquisition costs.

Did you spend $300 on google advertising? Did you go to lunch after a particularly hard day shopping in the LinkedIn mall?

All of these need to be added to your CAC formula on top of your staff costs.

Now we have a realistic idea of how much we spent while going customer shopping.

Take your total costs and divide them by your total customers for the same period.

Costs:

Salaries: $9,300

Expenses: $1,000

Tools: $3,000

Ad Spend: $2,000

Total: $15,300

Total Customers Acquired: 43

CAC = 15,300 / 43 = $355,81

MARKETING AND SALES EXPENDITURE + STAFF COSTS / No. Customers = CAC

Now you should have a solid CAC figure to start playing with. 

You can now start forecasting your CAC, review your historical CAC data and look for trends, or you can track your CAC by country to find out which markets to better focus your growth efforts.

Other things to consider are CAC by customer segment. Let's look at CAC broken down by customer content type. 

There are a few rules of thumb which are worth noting.
The harder the content is to produce (Video, Podcast, white paper, interview), the lower the CAC should be, while conversely the easier the content is to produce (Blog post, Display, SEM), the higher the CAC.

Inbound CAC should also be lower than Outbound CAC, which is why so many companies in today's crowded markets are putting effort into focusing on creating great content, which lasts a lot longer than a display campaign. 

You see, CAC by itself is interesting, and good to know over time. But its real value comes when it is compared to Customer Lifetime Value.

Lifetime Value is when you unwrap the customer box at home and find out if they are worth more than you paid for them. It is your scratchcard moment.

Did you just pay $10 for a customer that is only worth $2?
Maybe you hit the jackpot and bought 5 customer boxes from a guy on a street corner and each one is worth $300 dollars each.

To continue buying boxes from guys on street corners, read on

More reading:

My analogy with the shop is not entirely accurate. It was used for simplification and illustration.

What is a more fitting analogy is that we go into a shop called “LinkedIn Ads” and we buy 357, homogeneously packaged brown paper boxes.
We take those boxes home, after having paid $3.57 for them, because they cost 1 cent each.

When we unwrap those boxes we find out that 14 of the “Brown Lead Boxes” from LinkedIn contained customers inside.
When we open the customers from inside the brown lead boxes, we find out some of those customers are worth $2 and some of them are worth $300.

If you take good notes, pay attention and take proper care, there are ways to increase your chances of buying boxes with customers in them.

Having a solid financial analytics framework in your company helps you decide which shops you should spend your money in based on their past performance. 

Having a great marketing and sales tech stack can sometimes help you peek through the brown wrapping to see what's inside. But peeking costs money. 

Again, financial analytics can help you decide when it's profitable to peek and when it's best to shop elsewhere.