“Marketing is expensive!”
“I can’t afford to spend thousands of dollars getting customers.”
These types of statements are all too common among entrepreneurs. Before jumping to conclusions, the marketing questions you should ask yourself include:
“How much is a customer worth to my business?”
“How can I afford to acquire new customers?”
In my software businesses this is referred to CAC or Customer Acquisition Cost. But CAC is not just for software/tech companies. CAC is important in every business. Knowing your CAC will give you the insight you need in order to properly scale your business.
If I told you to give me $100 dollars, and next month I would pay you back $200 – would you do it?
I told you to give me $1,000,000, and next month I would pay you back $1,500,000 – would you do it then?
Believe it or not, that’s the simplistic version of how to measure CAC and if it’s working for your business. There is a saying out there used by some of the great marketers that says, “He or she who can afford to spend the most to acquire a new customer, wins.”
They are not lying! If you can afford to spend more than your competitors you will win all of your customers.
Just go with me here…I am not saying to blow all your marketing dollars in areas you do not know very well. BUT once you know your CAC, you should spend that amount every time. No questions asked.
Calculating your CAC
It’s a simple process and will work for any business. I use it for my software businesses as a general rule of thumb and also use the same formula with my mentor business.
Now there is some math involved…but don’t get frustrated. You do not have to be a math genius to calculate your CAC. Sometimes you may not even have all of the variables, especially if you are just starting.
Just use what you can and if you have to estimate the numbers for now, then do so. This is an ongoing formula that you will constantly update to know your most current CAC.
1. How much is the customer worth?
This is simply how much revenue you generate from a typical customer over the life cycle of that customer. Another term for this would be CLTV (Customer Lifetime Value).
To calculate this, you simply need to know how many customers bought your product and how much total revenue you generated. After that, just choose a date range/term (pick 12 months as an example) and simply divide the total revenue by the total number of customers. Here are some examples:
- Your product is $100/month, and the average customer pays for 14 months before cancelling. Your CLTV would be $1,400.
- Your product cost is $50, but the average customer buys the same (or other products) an average of 10 times. If the customer buys 11 products on average, then your CLTV would be $550.
2. Know Your Churn
The next step is to figure out how many customers cancel or ask for a refund. If you don’t have enough data for this, you can use 10% as a conservative benchmark (if you are higher than 10% you need to focus on getting this lowered). Moving forward, I am just going to use the $1,400 CLTV product to calculate a sample CAC. So…example using 10% from the numbers above:
- 10% of $1,400 would be $140
3. Know Your Cost (including OPEX)
Then, you will want to subtract all cost associated with your product and your business. Of course this figure can vary quite a bit.
For example, my software companies have the cost of servers where a physical product would have the cost of packaging, shipping, etc. Don’t forget about other OPEX (operating expenses) such as payroll, utilities, rent, software, accounting, legal expenses, etc. Add it all up, and get a percentage of revenue that you can allocate to your costs. For example using the number above, let’s say our cost is 30% of our revenue…you would then subtract 30% to your CLTV.
- 30% of $1,400 would be $420
4. Subtract Your Churn And Cost From CLTV
Now, let’s calculate everything! Your equation will like this: CLTV – Churn – Cost
So, using our example again, our equation would look like this:
- $1,400 – $140 – $420 = $840
5. Decide Your Profit Margin
This is another variable based on your business model, industry, and/or cash flow situation. For my businesses, I shoot between 20% – 40%. Now remember you can’t just take what’s remaining and dedicate that to profit because you would have $0 to spend on acquiring customers. Using the numbers above, I would have 60% of my CLTV left.
- Let’s stay conservative and say I want to get a 20% profit margin and spend 40% acquiring a customer:
- 20% of $1,400 = $280 in profit. That would leave us with an awesome $560 to spend in customer acquisition.
- 40% of $1,400 = $560 in profit. That would leave a much smaller spend to acquire the customer of $280.
So let’s say you are the conservative type and decide that 20% is a healthy margin for your business. That means based on all the metrics above, you could spend $560 to acquire one customer!
Using your CAC To Measure Other Metrics
Now you have a general idea of how to calculate your CAC. But there is more you have to think about when looking where to spend the dollars. The infamous question I get from people is, “What’s a good cost per click that I should be paying?” Well…like anything. It depends!
Let’s take a real life example using the numbers above. If I know my sales team converts 10% of leads to customers, then that means I can spend $56 to acquire a lead. I calculated this by taking the percentage of the CAC ($560 * 10%).
Let’s say your Facebook ad, landing page, or whatever you choose to use to capture leads converts at 50% of visitors to leads. That would mean you can afford to spend up to $28 per click ($56 * 50%)!
Remember, these are highly subjective and dependent on your exact business model. Let’s continue on as if these sample numbers were accurate to your business. Let’s go back to that Facebook ad or landing page that converted at 50%.
If you spent $10,000 to send 10,000 people to that page ($1 per click), you will get 5,000 leads. That results in a cost per lead of $20. But remember, that’s assuming your Facebook ad or landing page is converting at 50%. What happens if it only converts at 25%? Well your cost per lead would be $40. This just proves that the two variable pieces you need to concentrate on are your conversion rates in your sales funnels and the conversion rate of your sales team.
Some benchmark metrics I always shoot for are:
- 40% for lead magnets
- 10% for trip wires
- 10% for core offer conversion (sales team)
Knowing these types of metrics will help you make the right decisions in your business in order to scale quickly. So using the example, above our cost per lead was $20 because our funnel was converting at 50%.
Let’s assume the sales team closed 10% of the leads received which equals 500 customers with a CLTV of $1,400. Remember, our product cost was $100/month. Assuming the campaign lasted 30 days you would of added $50,000 in MRR (monthly recurring revenue) for your $10,000 investment.
Hedge Your Bets
Since we figured out that a comfortable number was $56 per lead, that just means we can continue to scale up that campaign until our CAC increased from $20 to $56. That’s 280% increase assuming all metrics stay the same.
- $10,000 original first month spend * 280% = $28,000 marketing spend in Month 2
- $28,000 = 28,000 clicks ($1 per click)
- 14,000 leads (50% conversion page)
- 1,400 new customers (10% conversion of leads)
- $140,000/month added in new customers
Now again, don’t get scared about the numbers or the equations. Every business is different, but the principle is the same. What’s important is NOT that you have the same funnel as the above or even that your numbers are close to the example above. This is just an example.
What matters is that you know your business. You know your numbers. I made a lot of assumptions to get to the numbers I made above. For example, the campaign was assuming you converted those leads in a 30 day campaign. For example if your campaign took 6 months at $28,000/month to convert 1,400 new customers it’s an entirely different story.
The point is to know your numbers. By now, you should be able to at least figure out a rough estimate on your CAC. It doesn’t have to be exact, but it can be used to figure out the right direction for your business.