We know that running an online store is no walk in the park. You're juggling marketing, customer service, and product sourcing—and on top of all that, you've got to keep an eye on the numbers that matter.
In this post, we're introducing one of your business's most critical metrics: Customer Acquisition Cost (CAC). Understanding this metric is crucial for informed decision-making and can empower you to make strategic choices for your business.
This first illustration will present the factors in calculating the metric and how its value could vary depending on the customer segment.
Why Customer Acquisition Cost Matters
As an e-commerce owner or marketing manager, you're constantly looking for ways to attract new customers to your site.
But here's the kicker—do you know exactly how much it costs you to acquire each new Customer? And do you know that the acquisition cost varies depending on the channel?
By simple definition, CAC measures the total cost of acquiring a new customer, which includes everything in your marketing budget: salary, tools, advertising expenses, etc.
Think of CAC as a guiding principle for your marketing efforts, helping you to allocate your resources effectively and make informed decisions.
For instance, if your CAC is significantly higher than your LTV, it might be time to reevaluate your marketing strategy. But how do you know if you spend too much to acquire customers? That's when CAC meets its best buddy, the Customer Lifetime Value or LTV.
Let's say you run a TikTok campaign promoting a product. You assign a $3,000 monthly budget and get 20 new customers.
A simplistic calculation will tell you that your CAC is $150.
Then CAC's best buddy, LTV, tells him that each new Customer purchased 2 items for $150 each, a total of $300. This 1:2 ratio in the CAC: LTV metric means that for every $ 150 you spend on acquiring a customer, you're getting $ 300 in return. That's a metric you want to see.
That means you will receive $300 in return for each new Customer, allowing you to run another month at $3,000.
But what if your customers purchase from you more than once? Then your LTV is not $300; it could be more. This potential for increased LTV with repeat purchases should give you hope for a solid and healthy acquisition channel.
Not all CACs are the Same
The Customer Acquisition Cost is different in B2C companies than in B2B companies, as it is different in subscription-based businesses where the LTV could potentially be more than 12 months.
What you need to know from your acquisition cost is that it needs to be framed into your ability to retain and monetize customers. This means not only attracting new customers but also keeping them engaged and encouraging repeat purchases.
Example with GlowBite
Let's use GlowBite, our hypothetical e-commerce company, to illustrate Customer Acquisition Cost (CAC), Customer Lifetime Value (CLV or LTV), and the CAC ratio.
Customer Acquisition Cost (CAC) Example for GlowBite
GlowBite runs paid advertising campaigns and influencer partnerships to attract new customers. Over the past month, they spent $10,000 on marketing and sales efforts and acquired 500 new customers.
Total Acquisition Costs: $10,000
New Customers Acquired: 500
CAC = Total Acquisition Costs / New Customers Acquired
CAC = $10,000 / 500
CAC = $20
So, GlowBite's Customer Acquisition Cost is $20 per Customer. This means that for every new Customer GlowBite gains, it spends $20 in marketing and sales efforts.
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Customer Lifetime Value (LTV) Example for GlowBite
GlowBite's average Customer spends about $100 per order and makes 3 purchases over their relationship with the company. The gross margin on their products is 40%.
Average Customer Spend per Purchase: $100
Number of Purchases per Customer: 3
Gross Margin per Purchase: 40% (or 0.4)
LTV = Average Customer Spend × Number of Purchases × Gross Margin
LTV = $100 × 3 × 0.4
LTV = $120
GlowBite's Customer Lifetime Value is $120. This means the average Customer generates $120 in gross profit over their relationship with the company.
CAC Ratio Example for GlowBite
Now, we can calculate the CAC ratio to assess GlowBite's profitability for each customer.
CAC: $20
LTV: $120
CAC Ratio = LTV / CAC
CAC Ratio = $120 / $20
CAC Ratio = 6:1
GlowBite's CAC ratio is 6:1, meaning that for every dollar spent on acquiring a customer, the company earns six dollars in gross profit over the Customer's lifetime.
Key Takeaways
Customer Acquisition Cost (CAC) is a Critical Metric for Growth
Understanding your CAC allows you to make smarter decisions on how much to invest in acquiring new customers. Knowing how much it costs to bring in each customer can help you allocate your budget effectively and ensure you’re not overspending.
The CAC Ratio Helps Evaluate Long-Term Profitability
The CAC ratio reveals the return on investment from each customer over their lifetime. A higher ratio, like GlowBite's 6:1, means your marketing efforts are profitable and sustainable. Always aim for an LTV that comfortably exceeds your CAC to maximize your return.
Not All CACs are the Same—Channel and Business Model Matter
CAC varies based on acquisition channels and business models. B2B companies or subscription models often have higher CAC but also higher LTV due to longer customer relationships. Tailoring your CAC strategy to your business type and retention goals is crucial for long-term success.
