Building a strong customer base is critical to small business growth. But do you know how much your business is spending to get new customers?
Maybe you’re underspending, and your business isn’t investing enough in marketing and sales. By not investing enough in marketing and sales, your business risks losing out on bringing in valuable new customers. This sets your business up for “field of dreams marketing”, where businesses are overly optimistic about their ability to bring in new customers, and underestimate the investment needed in marketing.
On the other hand, perhaps your business has a problem with its sales or marketing efficiency. If revenue from a customer is less than your business is spending to acquire that customer, then you may have to price the product too high – which can further slow down the sales process.
You Can’t Manage What You Can’t Measure
The key here is to measure the costs of getting new customers so you can manage your marketing/sales budget and strategy, and adjust accordingly. This is where customer acquisition cost (CAC) comes in.
Customer Acquisition Cost (CAC) is a metric used to determine the total average cost your company spends to turn a sales lead into a new customer.
To calculate CAC: Take your total sales and marketing spend for a specific time period and divide by the number of new customers for that time period.*
- Sales and Marketing Costs: Include items such as advertising spend, business blogging, social media management, SEO, salaries, commissions and bonuses, overhead for that time period (month, quarter, or year)
- New Customers: Total number of new customers for the same time period (month, quarter, or year)
Formula: (Sales and Marketing Costs) / (New Customers) = CAC
*Note: If a sizeable portion of your total marketing and sales expenses is for retaining existing customers, rather than acquiring new customers, then subtract that amount from the total marketing and sales expense.
Adjusted formula: [(Total Sales and Marketing Costs) - (Total Customer Retention Costs)] / (Number of New Customers)
What’s a Good Customer Acquisition Cost?
A good customer acquisition cost really depends on your industry and your business model. Generally, you want to have a low average CAC. However, there are times when a high CAC makes sense if your customers also have a high lifetime value. For instance, if you have a lot of repeat business, and if those repeat customers spend a lot of money, then they have a high lifetime value. And, the higher the lifetime value, the more you can afford to spend to acquire new customers.
Why should I care about my CAC?
By determining your CAC, your business will have a clear picture of exactly how much it costs to acquire new customers. This number can serve as a simple scorecard that will allow you to make adjustments and refine your sales or marketing processes accordingly.
Just make sure you’re not letting “field of dreams marketing” or too much optimism blind you during the tally and calculation process. Take time to examine some of the less-obvious hidden costs, so your numbers are as real and as accurate as possible.
Once you’ve taken the first step to calculate your business’s customer acquisition cost, then you’re ready to dig deeper. You’re ready to examine the bigger-picture ROI of your business’s marketing efforts.
To help you understand six of these critical small business marketing metrics, we’ve put together a handy cheat sheet. This cheat sheet contains quick and easy how-to notes for each marketing metric: 6 Marketing Metrics Every Small Business Owner Needs to Care About.
Editor's Note: This post was originally published in May 2014 and has been updated for accuracy and comprehensiveness.
Photo by Jon Sullivan; public domain image