Calculate & maintain a healthy customer acquisition cost

Step-by-step Playbooks
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Based on How to Calculate & Maintain a Healthy Customer Acquisition Cost (CAC) by Tom Whatley

Business benefits

Ensure your business is profitable and efficient.

Calculate your customer acquisition cost: CAC = Total Spend on Acquiring Customers / No. of Customers Acquired

Total spend on acquiring customers can include:

  • Salaries of sales and marketing teams.
  • Advertising spend on acquiring new customers, such as Search or Display ads, social ads, and sponsorship.
  • Cost of software or hardware used in sales and marketing.
  • Agency, PR, or any third-party costs involved in sales and marketing.

For example, over a 3-month period, your revenue and costs might look like this:

January February March
Sales/Marketing Salaries $10,000 $10,000 $15,000
PR Agency $2,000 $0 $0
Google Ads $20,000 $20,000 $30,000
Social Media Ads $1,000 $1,000 $1,000
Software/Hardware Costs $2,000 $2,000 $2,000
Total Acquisition Cost $35,000 $33,000 $48,000
New Customers 1000 1200 1100
CAC $35 $28 $44

But if you offer a free trial, this complicates your calculation, because there’s a significant delay between the costs and your customer acquisition. Offset your calculation to allow for the delay.

For example, if the average conversion from free trial to customer takes 30 days, use the previous month’s acquisition costs in your CAC calculation instead. So you’d take February’s acquisition costs and March’s customer acquisitions to calculate March’s CAC:

CAC for March = costs in Feb / acquisitions in March 
= 33000 / 1100 
= $33

If, however, you offer a fixed free trial of 14 days, you need to essentially apply half of this month’s costs and half of last month’s costs:

CAC for March = average of costs in March and Feb / acquisitions in March
= ( (48000 + 33000) /  2 ) / 1100 
= $37

Calculate the average lifetime value of your customers: LTV = (Average Revenue Per Customer in a Month) x Gross Margin / MRR Churn Rate

According to most experts, the LTV/CAC ratio should be at least 3 for a sustainable business. A new customer should bring at least 3 times the value of what they cost to acquire.

LTV/CAC of less than 3 is a red flag, as it indicates you’re overspending on acquisition. It’s a sign that you need to review CAC of your prominent channels and look at the growth marketing funnel to understand where the fault lines are.

The opposite is also true: three or higher means you can afford to spend more aggressively to acquire new customers.

Calculate CAC for each customer segment and for each channel, like search ads, social, and content marketing.

To segment CAC, you need to have flawless tracking. You should be able to attribute the customer to specific marketing channels, even if there is a delay in conversion. Involve your data team in the process of channel attribution and creating conversion pixels to ensure that tracking in your centralized dashboards aligns with the data in different marketing tools.

For example, if your CAC is $100 and LTV is $250, your LTV/CAC ratio is 2.5. While this is less than 3, it still doesn’t give the full picture. Maybe in certain markets, CAC is low while LTV is high, giving a higher LTV/CAC ratio. By simply shifting spend across different markets, you might be able to bring overall LTV/CAC over 3.

Keep track of conversion rates across the entire funnel and optimize funnel stages where leaks are occurring.

Reducing leakage at any stage will have a direct impact on CAC.

For example, HubSpot Academy wanted to increase its signup rate. It used a simple exit-intent survey widget from Hotjar to ask visitors why they were about to leave the page.

image

Visitors gave answers such as: I don’t know how this will help me with my career? or I cannot make an account. The form keeps asking me about a company name while I’m a jobseeker.

By making adjustments in its landing page based on the feedback, HubSpot Academy was able to increase conversions by 10%, leading to a direct impact on the CAC.

Calculate the payback period: PP = CAC / (Average Annual Revenue per Customer)

Payback period is the number of months it takes to recover CAC from a customer.

In subscription-based businesses, it generally takes a few months to recover CAC. Most experts recommend a business should be able to recover CAC within a year. However, it varies considerably depending on your industry.

Calculate your churn rate: (Lost Customers / Total Customers at the Start of Time Period) x 100

Churn affects your LTV/CAC ratio. A monthly recurring revenue churn rate is more effective for products with flexible pricing. Also note that churn rates can vary depending on the nature of your product or market.

For example, if you have 100 customers that contribute $5000 in MRR each month and one of them is a big enterprise, that constitutes almost $250 of your total MRR. Losing that customer might show 1% customer churn, but the MRR churn would be 5%, which is a much more accurate reflection of the intensity of loss.

Monitor and optimize your CAC regularly.

It’s highly unlikely that the way you define CAC will remain the same. Every team should keep an eye on CAC and understand how their work affects it.

Although CAC is included in various KPIs that impact marketing performance, it’s not a marketing exclusive metric.

Last edited by @hesh_fekry 2023-11-14T10:13:40Z

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@chadrwyatt
Fix formulas
Get rid of image that you expect readers to read
Add more detail about free trials
Add missing LTV/CAC info
Fix Segment your CAC step
Rewrite Fix any leaks in your sales funnel step

Fix formulas

For formulas, use the backtick character before and after: `
(throughout)

Use parentheses (), not square brackets.

Get rid of image that you expect readers to read.

Text-heavy images are generally bad. Discourse can create tables - the easiest way to do this is to transcribe the image into a spreadsheet, copy the cells you want, and paste into your Discourse post.

Add more detail about free trials

This is a good attempt, but you’ve left out too much information and the result is confusing. Need to add in more info from the blog post.

Add missing LTV/CAC info

This is an awesome job! Just add this bit from the blog post:

The opposite is also true: three or higher means you can afford to spend more aggressively to acquire new customers.

Fix Segment your CAC step.

This is close, but you’ve misunderstood a little. There are two points here:

  • Calculate CAC for each customer segment
  • Calculate CAC for each channel, like search ads, social, and content marketing (note the lack of capitals).

They still belong in the one step; you just need to reword the step to make it clear that you’re talking about both points.

Rewrite Fix any leaks in your sales funnel step.

Whups - no. Remove the tool reference; I think you misread.

Here’s the pertinent information:

  • keep track of conversion rates across the entire funnel.
  • optimize funnel stages where leaks are occurring.

This is a good example to include:

For example, HubSpot Academy wanted to increase its sign-up rate. They used a simple exit-intent survey widget from Hotjar to ask visitors why they were about to leave the page:
Example pop-up form from Hotjar
Visitors gave answers such as: “I don’t know how this will help me with my career?” or “I cannot make an account. The form keeps asking me about a company name while I’m a jobseeker.”
By making adjustments in their landing page based on the feedback, they were able to increase conversions by 10%, leading to a direct impact on the CAC.

3

This is pretty good; you have all the necessary info. But it’s hard to follow and confusing, because you’ve taken out too much of the explanation. And frankly, the explanation in the blog was already tricky to follow.

Here’s what the reader needs to know:

  • For example, over a 3-month period, your revenue and costs might look like this:
    (that explains the table, which currently appears with no introduction)
  • But if you offer a free trial, this complicates your calculation, because there’s a significant delay between the costs and your customer acquisition. You’ll need to offset your calculation to allow for the delay.
  • For example, if the average conversion from free trial to customer takes 30 days, you need to use the previous month’s acquisition costs in your CAC calculation instead. So you’d take February’s acquisition costs and March’s customer acquisitions to calculate March’s CAC: CAC for March = costs in Feb / acquisitions in March = 33000 / 1100 = $33
  • If, however, you offer a fixed free trial of 14 days, you need to essentially apply half of this month’s costs and half of last month’s costs:
    (calculation you already included)
4

@chadrwyatt Good effort on these edits! :sunglasses: Almost done.

5

@naomik sorry I am not familiar with using the formula exactly so wasn’t too sure on simplifying it. I have added your notes in instead.

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@chadrwyatt Nah this was made more difficult because the explanation wasn’t clear in the original blog post - we can’t expect you to magically be an expert in every topic. But you can probably see how drawing information out of these posts can get complicated at times.

An alternative would have been to flag in comments that the delayed-CAC explanation was confusing and difficult to follow; would the author please explain exactly how to calculate March’s CAC in this example with a 30-day free trial, and why we’re using this specific 14-day free trial CAC calculation?