This article is for educational purposes and does not constitute legal or tax advice. For specific advice applicable to your business, please contact a professional.
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? Perhaps you’re focused on retaining your current customer base, or maybe you are trying to expand to a new set of customers. Before you launch a sales or marketing campaign, consider the true cost of acquiring new customers and how you might think about the amount of budget to set aside in order to meet those goals.
What is Customer Acquisition Cost or CAC?
Let’s say you have launched a new business and, to spread awareness and attract customers, you’ve invested $2,000 in marketing spend on social media for the year. This spend yields 200 new customers. The cost is to acquire each of these customers in this case would be $10 over the course of the year. This cost is what we refer to as the cost of acquiring a customer.
Customer acquisition cost or CAC is the amount of money a business needs to spend to acquire a new customer. Money spent on sales and marketing contributes to this cost. Businesses typically seek to lower this cost, as it indicates that efforts to attract a new customer are more efficient.
How do you calculate CAC?
You can calculate your CAC by combining the costs of sales and marketing and dividing it by the number of new customers you’ve acquired.
CAC = (cost of sales + cost of marketing) / new customer acquired
Here are a few examples of channels you might market in and what you would potentially include in the formula above:
- Social media campaigns
- Paid advertising
- Paid sales
- Marketing and sales employees
- Outdoor advertising such as billboards or signs
- SEO (search engine optimization)
- In-person events such as pop-up shops or conferences
- Direct mail
- Email marketing
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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.