Calculating the Cost of Customer Acquisition

It can be tricky to determine where to invest money in your business to help it grow. What will give you the return on your investment without negatively impacting your business? Learn to calculate the cost of acquiring a new customer for your business.

Attracting new customers to your business while retaining your existing customer base is the key to sustainable growth. But we all know that new customer acquisition is more expensive than customer retention. The better equipped businesses are to quantify their customer acquisition costs, the better they will be able to factor these costs into their budget and ensure that they invest appropriately in customer acquisition as well as retention.

Here, we’ll look at what businesses need to know about taking control of their acquisition costs and growing their business without compromising their carefully balanced budgets or overspending on marketing channels that offer low returns on their investments.

CAC: Customer acquisition cost explained

Customer Acquisition Cost or CAC calculation enables businesses to identify how much they are spending on each newly acquired customer and therefore ascertain which marketing channels yield the most ROI.

For instance, let’s say you allocate £5,000 of your marketing spend this year to social media marketing. This includes a combination of paid ads and organic content marketing and encompasses the human resource costs for your marketing and any analytics tools or other overheads incurred.

Your combined social strategy yields 250 new customers. Therefore, your customer acquisition cost was £20 over the course of the year.

Customer acquisition cost is an important metric for businesses that determines the efficacy of their marketing strategy in attracting new customers. The lower their CAC, the more effective their marketing is in acquiring new customers.

Customer acquisition cost formula

The CAC formula is fairly straightforward. Simply combine the cost of sales and marketing and divide this figure by the number of new customers your efforts have acquired.

CAC = (cost of sales + cost of marketing) / new customer acquired

You can do this across your entire marketing spend or carry out separate calculations for each marketing channel to see which offers the best ROI. Here are a few examples of channels that your business may include in the formula above:

  • Social media campaigns

  • Paid advertising

  • Email marketing

  • Paid sales

  • Marketing and sales employees

  • Outdoor advertising such as billboards or signs

  • SEO (search engine optimisation)

  • In-person events such as pop-up shops, exhibitions or conferences

  • Direct mail

CAC & marketing budget

By rule of thumb, companies that sell directly to consumers should aim to spend between 5% and 10% of their overall revenue on marketing while B2B companies should generally aim to spend 2-5% on marketing. Despite the grim realities of the economic climate, 39.5% of UK businesses expect to increase their marketing spend in 2023 and 2024, with only 15.3% anticipating spending cuts according to the most recent IPA Bellwether Report.

Across the country, savvy businesses are not hacking and slashing their marketing budgets. Still, they are looking more closely at how hard their marketing strategies are working for them, investing in areas with lower acquisition costs and higher ROI.

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Customer acquisition cost and lifetime value

Businesses want new customers to be worth more to them than a single transaction. Therefore, CAC and customer lifetime value (LTV) are commonly used together to gauge the total revenue a business might expect from new customer relationships.

One popular formula for calculating this is as follows:

Customer Lifetime Value = (Annual Customer Value x Average Customer Lifespan in Years)

The customer value input above can be calculated by multiplying their average purchase value by the average number of purchases. Businesses can ascertain their LTV:CAC ratio by dividing LTV by CAC. This ratio is an effective way to analyse the long-term impact on your investments in customer acquisition. Businesses should aim for their LTV to be higher than their CAC, as this number represents the amount they spend to acquire a customer in relation to the amount of money a customer generates for the business. There are many ways to improve LTV from cross-selling and upselling to exclusive offers and personalised discount codes.

Square sellers can use their Square Dashboard to identify which are new and returning customers, and manage customer profiles through their Customer Directory – Square’s free CRM.

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Determine your budget

In The CMO Survey for 2022, CMOs surveyed responded that marketing budgets accounted for about 13.8% of the overall budget on average. Business to consumer (B2C) product companies spent 22.7% of the overall budget on marketing, and B2C service companies spent 12.3% of the overall budget on marketing.

So, how much budget should you spend on acquiring a new customer? Your budget will ultimately depend on many factors, such as what industry you are in, how large your company is, and more. For example, businesses selling products rather than services may want to invest in marketing that includes visuals of those goods. Each business will require different investments in order to acquire a new customer and in turn will require different percentages of your potential budget.
Customer acquisition cost and lifetime value

Lifetime value or LTV is a way to gauge the total revenue a business might expect from a single customer relationship. Looking at the lifetime value of a customer in relation to the cost of acquiring that customer can give you additional insights into the potential return on your initial investment. There are multiple ways you might calculate lifetime value. Here is one formula you might try:

Customer Lifetime Value = (Annual Customer Value x Average Customer Lifespan in Years)

The customer value input above can be calculated by multiplying average purchase value by average number of purchases. This combined look is the LTV:CAC ratio, found by dividing your LTV by your CAC. This ratio can be used as a way to analyze the long term impact on your investments in customer acquisition. Typically, the goal is for your LTV to be higher than your CAC, as this number represents the amount you are spending to acquire a customer in relation to the amount of money a customer brings to your business during the time in which they are your customer.

If you are a Square seller, you have access to Customer Directory, a tool to create, import, and manage customer profiles. This tool is built into your Square payment tools and can integrate with your business data. You can also see which of your customers are new vs. returning within the Square Dashboard.