What’s the most you should pay for a customer?
If you’re a CMO or hold any decision-making marketing position and don’t know your maximum allowable customer acquisition cost (CAC), please resign. Quit now. If you’re an advertising or marketing agency and don’t know this metric for your client, fire yourself immediately. You may be spending their money irresponsibly and wouldn’t even know it. Feelin’ a bit uneasy? Then this is for you.
What is customer acquisition cost?
Simply put, CAC means how much you spent to make a real sale -- as in revenue, cash in the register, Benjamins. I cannot overstate this. Too often in marketing, this holy business metric is overlooked, misunderstood and sometimes, purposely ignored. An acquisition is commonly misrepresented as a sales lead, a registration, an email sign up, or any other action that sounds promising. The term acquisition should always refer to the amount of money spent to acquire an actual customer.
Forget for a moment all the marketing metrics (conversions, impressions, clicks, etc.). Rather, let’s get down to actual revenue and profitability -- the stuff that keeps the lights on, pays all the salaries and, if you’re doing really well, affords that lavish holiday party. I will explain why it’s important to know your maximum allowable customer acquisition cost and how to calculate it.
Why I am passionate about customer acquisition
In my professional career, I have founded and steered three different companies. I currently lead a digital marketing agency, and I disclose this so that you understand that I am deeply experienced in marketing, advertising, sales, and the precious data generated from them. However, executing on the economics to build, grow, and maintain a stable company has to come before the marketing. Any marketer who focuses solely on impressions, clicks, and form fills is incomplete. Marketing supports the business, never the other way around. With this mindset, I take a business approach when consulting and marketing for my clients. Profitable results are my goal and marketing is my means.
How to assess your CAC
Look at it in reverse
You often hear about cost of acquisition, but it’s almost always in the past, as in what was paid to acquire that customer rather than what should be spent. Touting that you got a new customer for $20 without first defining maximum allowable CAC has no context, no meaning. Is that a good number? Who knows.
Calculate your maximum allowable CAC
I don’t want to go all CFO on you, so I’ll keep this pretty top level. To define maximum allowable CAC, there are two business models to consider. You may want to solicit input from the CFO and COO to make sure you’re working with the right numbers.
Model 1: One-time sales
For businesses with one-time sales transactions, CAC can be calculated on a single sale. To grasp what goes into this calculation, here’s an oversimplified example:
ABC company sells their product for $1,000
Model 2: Repeat customers or subscriptions
For companies with a model based on repeat business, first define your average customer lifetime value (CLV). There are many online calculators and resources for this. However, I strongly recommend that you look at first year revenue and expenses only, so as to not over inflate what can be allotted for acquisition and to not push returns too far out in the future. The same core line items in the example above will apply and the CLV will serve as your sale price. Expenses and profits will be factored for 12 months.
The maximum budget per sale has now been defined, which will guide all future efforts. This is important because it establishes a concrete marker to work and evaluate against. Rather than being reactive, marketers can now look forward, giving them the ability to forecast results/spend, make immediate and meaningful pivots, and have real context for profitable acquisition.
In the example I provided above, a $100 customer acquisition cost for a $1,000 sale equates nicely to a 1-to-10 ratio. That means that, for every dollar spent, $10 should come back. So now we can forecast and plan. If the client gives the agency a $1,000,000 annual budget, $10,000,000 in sales should be generated. This ratio and CAC gives both short-term and long-term guidance for tracking performance, pacing, and analysis of the marketing. Keep in mind that we've been discussing the maximum spend. As agencies, we always want to do better, which directly increases profit margins.
In digital marketing, sophisticated tracking of online and offline activities can be captured and mapped back to specific tactics. In addition to this data, companies need to routinely share their sales and customer data with marketers to best complete the dataset. Marketers must have the complete sales cycle of data. Without it, the process breaks down and marketing and spending again could jump the rails and no one will know why until it’s too late.
This allows for monthly and even daily analysis of what's being spent to initially engage a prospect. It provides guidance for what could be spent on click costs, conversions, placements, content development and distribution, search engine optimization, and all other costs that go into acquisition.
"We can't do that"
I can feel the pushback from agencies already. “There are too many variables. We can’t sign on for that. What next – performance compensation?!?!?”
If there is a deep understanding and sharing of information between client and agency, CAC-driven marketing is the only responsible approach. It requires meticulous tracking of efforts, sales data, and regular communication. It requires a deeper partnership with a real understanding of all the challenges in the sales chain.
"That’s too expensive!"
If I told you that for every $100 you gave me I would give you $200 back, you would quickly come to the conclusion that you should give me as much money as you can. This example makes it really simple to understand that it makes sense to spend $100 given the return.
Paying a $99 cost-per-click may sound super expensive, but if you have a clearly defined maximum allowable CAC that is higher than $99, this may actually be a bargain. Conversely, super cheap 25-cent clicks on a Facebook ad may be a complete waste of money.
While these are standalone examples and attribution may be calculated across multiple tactics, it still comes down to simple math. You must first know how much you can spend to make a sale. A $5 CPC with a $2 CAC would produce a loss. You’re sinking the company. Guided by this single metric, CAC removes the obscurity that comes when focusing on impressions, clicks, and the other common marketing metrics.
Next steps toward the right way
So, establish your maximum allowable CAC as soon as possible. Communicate this to your team, your agency, and your stakeholders. Even if it makes the creatives’ heads hurt. Everyone needs to work back from a single metric.
Agencies, don't ignore this any longer. Request your clients’ maximum allowable CAC. If they haven't calculated it, explain to them why it's important and how to approach it. Doing anything short of this is incomplete marketing. A break in the circuit. Dare I say, irresponsible?
David Sonn is president of Arc Intermedia, a digital marketing agency located in the Philadelphia area.