Understanding and optimizing customer acquisition cost (CAC)

Marketers can get laser-focused on conversion, and that’s normal. But that also means nothing throws a wrench into your marketing and sales efforts like a high customer acquisition cost (CAC). You may feel like this metric, a critical aspect of any marketing strategy, can make or break your online business—but that isn’t quite true. A high customer acquisition cost isn’t the end of the world as long as it’s in balance with the rest of your business and fits in your marketing expenses. Below, we’ll peel back the layers on CAC—without all the drama. Yes, customer acquisition needs to be efficient and effective, but customer acquisition cost isn’t one size fits all for e-commerce brands.

What is CAC and how is it measured?

Customer acquisition cost (CAC) is how much a company spends to acquire a new customer. It’s a simple but powerful way to understand the sales and marketing efforts of your business. Combined with other metrics, like customer lifetime value (LTV or CLV), CAC helps marketers and business owners understand if their marketing efforts to acquire new customers are effective in the context of their brand’s target market and current client base.

It’s complex, but not tricky, to calculate customer acquisition cost. Different organizations measure it in different ways, which we’ll explain more below. We also believe it’s critical to look at your brand’s customer acquisition cost in the context of its customer lifetime value. We’ll explain how to calculate customer lifetime value as well, even though this metric deserves its own post eventually (we’ll get there).

How to measure customer lifetime value (LTV)

Marketers need to understand the long-term value of maintaining relationships with their customers by calculating customer lifetime value. It helps make informed decisions about how much money to invest in acquiring and retaining new customers. Understanding the total worth of a customer to your brand over the entire course of the relationship helps you understand how to allocate your marketing resources efficiently.

There’s a general and detailed way to calculate LTV. (It’s worth noting that we’re not talking about actual lifetime value here, but LTV as a metric that’s time-boxed, generally to a year.) To calculate CLV, you need three basic pieces of information:

• Average purchase value: Calculate this by dividing your company’s total revenue in a period (e.g., a year) by the number of purchases in the same period.
• Purchase frequency: Divide the number of purchases by the number of unique customers who made purchases in the period.
• Customer value: Multiply the average purchase value by the purchase frequency.
• Average customer lifespan: The average number of years a customer continues purchasing from your business.

A straightforward formula to calculate CLV is:

CLV=Customer Value×Average Customer Lifespan

This means you multiply the customer value (average purchase value times purchase frequency) by the average number of years a customer stays with you.

For a more detailed approach, incorporate the gross margin per customer lifespan and the discount rate (this can be factored into the average purchase value). The formula can be expanded as:

CLV=(Average Purchase Value×Purchase Frequency×Gross Margin)×Customer Lifespan

Understanding where your LTV is for your existing customer gives you a baseline of how much you can spend to acquire new customers while remaining profitable. We’ll go into that further down in this article. A healthy benchmark to target is a 3:1 LTV: CAC ratio.

How to measure CAC

If you read about business metrics online, there’s one explanation for how to calculate CAC, and that customer acquisition cost formula looks something like this:

CAC = Total cost of all sales and marketing expenses / total number of new customers

But you’ll notice how vague the numerator in this equation is. Articles online will lead you to believe that this number needs to include organizational expenses like the salaries of sales and marketing staff—but it doesn’t have to include those costs.

There are two things that matter most when your company is calculating CAC:

• It’s measured the same way every time
• Everyone knows how the company is measuring it

Here at Prescient AI, the metric you see in our dashboard (Modeled CAC) could be referred to as Marketing CAC or even Marketing Spend CAC. That’s because we don’t include operations costs like team salaries in that calculation. Ours is focused specifically on the money you spend on your digital marketing campaigns.

We believe this is an effective metric to consider alongside other information about how your digital marketing campaigns perform to understand their efficacy. But that doesn’t mean you can’t supplement this marketing metric with a different CAC calculated internally for your organization that includes operational costs. Your C-suite may appreciate the additional number to help empower staffing decisions.

Where contribution margin comes in

Not to complicate things further, but we do need to quickly address contribution margin here. Contribution margin (CM) is the revenue that remains after subtracting the variable costs directly associated with producing a product. In other words, it represents the leftover revenue that contributes to covering your fixed costs (like rent or administrative costs), and beyond that, to profit.

It’s probably clear already that there’s some gray area here. The deeper you look, the more you can make an argument for a cost to be factored into CM or, just as plausibly, CAC. So we’ll draw a very clear line here for the purposes of this article. At Prescient we calculate just based on ad spend to help normalize this cost across platforms, yet some brands will choose to also include additional costs like those associated with bringing a product or service to the market, which can include ad spend, production costs for creating advertisements, etc.

There’s an argument to be made for tracking CM more closely than CAC since it factors in all the expenses of your business and can, therefore, be a proxy for “enduring profitability”—but that’s a subject for another article.

How to calculate customer acquisition cost

Knowing that CAC can be calculated in different ways, we’ll walk you through how to calculate this metric for your organization—whatever that means to you.

Step 1: Choose a time period

You’ll need to choose what time period you’re considering to move forward. Eventually, though, you may want to look at your customer acquisition cost over different time periods, including:

• The length of a given campaign
• A special event, like Black Friday/Cyber Monday
• A specific season, like summer
• The last month
• The last quarter
• The last year

Step 2: Choose the cost that matter to you

This is where calculating CAC gets individual for your business or even department. There’s a lot to consider. Figure out if you want to include:

• Sales and marketing salaries
• Software costs for the sales and marketing teams
• Costs associated with creating ad collateral
• Discounts given through campaigns or affiliates

Consider these questions when making this decision and make sure your entire team is aligned on your definition of this metric.

Step 3: Calculate your CAC

Now that you’ve decided your time window and the costs you want to consider, the rest is simple. You’ll use the customer acquisition cost formula below to figure out your customer acquisition cost.

Customer Acquisition Cost Formula:

CAC = (Revenue – Total Costs) / New Customers Acquired

What is a good customer acquisition cost (CAC) for your business?

We can’t give you an exact number—even though we know you want one—because the answer to this question depends on other business metrics unique to your brand. The best we can give you is this: a good customer acquisition cost is one that’s lower than your customer lifetime value (LTV). We often see customers set specific payback periods based on reaching certain LTV / CAC ratios, ranging from achieving profitability on first purchase to waiting a few months (especially for products with high repeat purchase potential).

How to improve customer acquisition cost

We’ll start generically and work toward a more specific answer. Since CAC is a way to measure your brand’s costs against how many new customers you’re bringing in, there are a few obvious levers you can pull to improve CAC:

• You can decrease your costs, whether that’s your ad asset creation or team salaries
• You can decrease your campaign spend
• You can increase the amount of new customers you acquire

We don’t find any of these generic items truly helpful for marketers. Most likely, you can’t decrease the costs of your campaign assets—and you probably don’t want to sacrifice your ad quality to make it happen. You likely also want to keep the team you have. You also wouldn’t be here reading this article if you could magically make more new customers appear to drive down your CAC.

If we look one layer deeper, we uncover some strategies that may work for DTC companies like yours. If you’re calculating your CAC across your entire site, you can:

• Ramp up lower CAC efforts to balance higher CAC strategies. This may mean leaning into your content strategy and search engine optimization to increase qualified organic traffic to your website in order to balance out higher CAC on your paid campaigns if you’re not ready to lower your spend.
• Increase customer retention or average order value. If you acquire customers that stick around for longer and/or spend more each time they return, you may be able to cover your CAC without addressing your costs or your campaign spend. If your average customer lifespan is longer or your existing customers have a higher average purchase value, you skew this CAC to LTV relationship without having to change your customer acquisition cost. Maybe customer relationship management needs to be a bigger part of your business strategy.
• Identify inefficiencies in your higher CAC strategies. If the CAC on your paid campaigns is too high, lowering your spend may not be the answer. It may be possible to identify where potential customers are falling out of the conversion funnel and fix it.

Modifying CAC sometimes requires better understanding your user journey. If you can shorten that journey (when they hear about you, and when they decide to buy)—you would inherently need to spend less to acquire them.

Post-purchase surveys, through tools such as KnoCommerce or Fairing, are one way to get there. Keep in mind that surveys are user inputted responses and if not structured in a smart way can lead to potential bias (and should be taken into context with other forms of measurement).

Troubleshooting your paid campaigns

There’s no need to pull the plug on your paid campaign budget just yet. Sky-high customer acquisition costs aren’t great, but there are plenty of points along the funnel for leads to “leak” out. That may make it sound like there’s a lot to do, but it’s actually a good thing. You may be able to find the source of the leak and plug it once and for all to turn your inefficient campaigns into your best performers.

Start by going down this list of points in your funnel and the questions you want to ask yourself about them:

• Keyword Targets
  • Are you targeting the best keywords for this campaign?
  • Are your competitors going after other keywords?
  • Can you find keywords adjacent to the ones performing the best?
• Target Audience
  • Does your target demographic align with those seeing and interacting with your ads?
  • Can you make your audience more targeted?
  • Are you leveraging first party data sources to create custom audiences?
• Ad Frequency
  • Are people seeing your ad too often?
  • Are you reaching the audience limit of a certain marketing channel or tactic?
  • Do you have effective retargeting strategies across multiple ad platforms?
• Campaign Content
  • How engaging is your ad content?
  • What are your click through rates like?
  • Is there too wide a gap between your impressions and your clicks?
• Landing Page
  • Is the value of your product clear and above the fold?
  • Does your landing page have a compelling call to action?
  • Does the landing page load quickly, and is it easy to navigate?
  • What are bounce rates like on this page?
  • What is the average session time on your landing page?

Assessing these elements will help you work in the right place. You won’t lower your customer acquisition costs by adjusting your keywords if your landing page is losing potential customers. Identifying the leak and working where it’s needed may help positively influence your CAC.

But, to navigate these complexities with ease, using an advanced attribution and budget optimization platform like Prescient AI can be incredibly beneficial. We built our dashboard with the goal of helping marketers maximize their revenue and optimize their media budgets. And our automated, machine-learning based Optimizer tool lets you simulate how adjusting your spend would affect your bottom line—before you actually change anything.

How Prescient AI views CAC (customer acquisition cost)

If you’ve read this far, you have a good idea of how we like brands to frame the costs of their customer acquisition. We don’t think successful companies need to view CAC as the end-all-be-all metric to evaluate a marketing channel. Is knowing your average customer acquisition cost important? Absolutely, but some things are far more helpful for understanding your marketing efforts:

• Looking at your LTV to CAC ratio: Understanding the efficacy of your marketing strategies means a lot more when you know how much revenue you can expect from your new paying customers based on their average purchase frequency and average order value.
• Factoring in your profit margin: If you’re already examining your average customer lifetime value and your CAC, you can gain an even deeper understanding of your acquisition costs if you know whether your profit margins significantly reduce your revenue.
• Considering your contribution margin: We mentioned this before, but your CM may be more helpful for looking at the profitability of your entire business, not just the marketing arm.
• Working up the hierarchy: Measuring marketing costs is helpful—but limited. It’s much more valuable to turn measurement into prediction and prediction into optimization. We think our tool does this—it allows you to shift your focus from defining your CAC to optimizing it.

Ultimately, we’d rather that most of our clients keep their eye on the prize: optimal campaign revenue relative to costs. That’s why our Optimizer tool helps marketers do exactly that. Maximizing ROAS will ensure you’re operating efficiently and making money from your ad spend. Finding the optimal point of revenue saturation will ensure you squeeze as much from revenue from your paid marketing cost as possible.

Customer acquisition cost FAQs

What is an example of acquisition cost?

Imagine you run an e-commerce business that sells custom sneakers. In the month of May, you decide to run a series of online marketing campaigns to attract new customers. Here’s how you’d calculate your CAC for May:

• Total Marketing Expenses for May: Suppose you spend $5,000 on online ads, $1,000 on social media marketing, and $500 on email marketing campaigns. So, your total marketing expenses for May would be:

$5,000+$1,000+$500=$6,500

• Number of New Customers Acquired in May: Let’s say that as a result of these marketing efforts, you acquire 130 new customers in May.
• Calculating CAC: Now, to calculate the CAC, you’d use the formula mentioned above:

CAC=$6,500/130

CAC=$50

What is the difference between CPA and CAC?

Cost Per Acquisition (CPA) and Customer Acquisition Cost (CAC) are both key metrics in marketing, but they have distinct focuses. CPA is the cost of acquiring a single action from a prospect, such as a sale, click, or form submission, and is often used to measure the effectiveness of specific advertising campaigns or channels. CAC is broader, focusing on the total cost of acquiring a new customer across all marketing and sales efforts. While CPA is campaign or action-specific, CAC provides a holistic view of the cost of gaining a new customer.

Does CAC include salaries?

You can calculate CAC using the salaries of marketing and sales team members since they’re part of your brand’s resources for acquiring customers, but you don’t have to. What matters more is that everyone on the team knows how you calculate customer acquisition cost and that it’s calculated the same way every time.