Why is the cost of acquiring a customer important?
Growth is beneficial, but growth at any cost is terrible.
The world’s top marketers support their firms’ long-term growth. But every so often, it seems like marketers experience a wave of collective madness where we stop thinking about the “long term” aspect of the conversation and begin to focus just on achieving growth. Marketers may make disastrous business judgments due to inattention, ignorance, or exuberance.
So how do we defend ourselves against ourselves? How do we ensure that we are world-class businesspeople as well as world-class marketers?
A simple shift in our perspective on the world can actually be one of the most effective tools at our disposal. Let’s examine the costs.
How to consider expenses when developing your client acquisition strategy
Imagine you’ve been testing different versions of your ads to see which will bring in the most money as the busiest time of the year approaches.
You ran three commercials, and each one brought in ten customers. If your only concern is customer acquisition optimization, you can assume that all three of your advertising are equal and distribute your budget appropriately.
Do these advertisements have the same cost per new customer?
But is that truly the best perspective to take? Will treating each ad equally enable you to increase your growth? Without a doubt, the answer is no. In fact, carrying it out that way is wholly inappropriate for your company.
Pure client acquisition metrics are common, but dangerously imprecise, instruments for gauging and scaling the expansion of your business. If you want to expand in a scalable and lucrative manner, you must think strategically about more than just acquiring new clients.
Cost of acquiring a customer Lifetime value
What is the cost of customer acquisition (CAC)?
The most accurate way to estimate the whole cost of obtaining a new client is to use customer acquisition cost. In general, it should take into account factors like advertising expenses, marketer salaries, salesperson expenses, etc., divided by the quantity of customers attracted.
expense of acquiring new customers
It’s a great helpful figure to utilize when gauging your investment and making sure you’re choosing the best course of action for your growth.
Why is it important? Simply said, you will run out of business if your customer acquisition cost exceeds your revenue over an extended length of time. A bit of a deal, you say?
Let’s see how this usually functions in real life.
How customer acquisition cost (CAC) functions on a daily basis
Returning to our three adverts, let’s now. It’s great that they are all creating the same number of clients, isn’t it? Perhaps not. Let’s dig a little further and get out our reliable calculator.
Why it’s important to evaluate customer acquisition costs
Assume you purchased 100 clicks for each ad, but you paid various prices for each click. The cost per click for the first advertisement was $5, the second was $10, and the third was $20.
We paid $500 for 10 consumers with Ad 1, $1000 for 10 customers with Ad 2, and $2000 for 10 customers with Ad 3 after multiplying clicks by cost per click.
That’s useful, but it’s far simpler for a novice marketer’s mind to conceive in terms of a single client, so let’s simply divide the total number of consumers by the cost of each advertisement. As a result, we can see that your cost per customer varies considerably between each advertisement. We just pay $50 per consumer for Ad 1! It appears that we should run Ad 1 as much as feasible before turning off the other two.
From where we started, this degree of knowledge is already a breakthrough. We now have a far better idea of which ads to aggressively promote throughout the holidays and which to promptly discard thanks to the addition of fundamental costs to the equation.
Is that, however, the best we can manage? Wait a minute.
Even if all you do is factor in advertising costs when adjusting your methods, you will have made progress. However, advertising only accounts for a portion of the cost of customer acquisition:
Almost sure, a marketer is evaluating data while you prepare your ad approach; after all, you do pay them a salary.
Since they charge a fee, you most likely hired a company to assist you place the advertisement.
You did pay them fee because someone had to create the creative assets and write the copy.
You have to pay a payment processing fee when the buyer completed their purchase in your shopping cart, correct?
What about the salary and commissions for your sales team?
To make sure you’re keeping an accurate record of how much it costs you to acquire a customer, take into account each of these variables in your CAC calculations.
In fact, this implies that you’ll be performing your CAC calculations at two speeds because all of that data originates from various sources at various times. You and your internet marketing team will be optimizing on a daily, weekly, and monthly basis using the CAC and customer volumes that your advertising tools report. Your marketing, sales, and finance departments will use a more comprehensive perspective of CAC on a longer-term basis (monthly, quarterly, and annually).
how to employ CAC
Pairing CAC with client lifetime value (LTV) is an even more effective approach to use it.
The attention being paid to customer acquisition costs, however, may possibly be seriously harming your company. And here is the reason: Costs are not always a negative thing!
Costs are not always a negative thing.
Costs in an expanding company should only be seen as investments. Some of them are wise investments, while others are absurd ones. How do you distinguish between the two?
by taking a look at client lifetime value (LTV), which is the amount of money you make from a customer over the course of their relationship with your company.
What is lifetime value of a customer (LTV)?
The revenue you receive from a specific customer over an extended period of time is essentially lifetime value. Most companies commonly calculate LTV over 1, 3, or 5 years. If your business is very new, you may model subscription renewal rates (in a subscription business model) or repurchase rates (in a more transactional business), which is relatively simple (for someone smarter than me). LTV is a very important measure you can use to complement your understanding of cost and advance the maturity of your business decision making, but it may be very difficult to understand in a young or digital organization when there isn’t a lot of historical data.
LTV/CAC calculation methods and benefits
Simply said, LTV/CAC aids in determining whether the clients we are acquiring will generate more revenue than they cost.How to figure out LTV/CAC
When you can divide your LTV and CAC into the categories that are most relevant to your company’s operations, things get really fascinating. Let’s revisit our three commercials to better understand the effects of including LTV.
Example of LTV/CAC calculation
By introducing the idea of lifetime value, we have changed how we think about the “best” ads. Despite the fact that Ad 1 initially appeared to be the clear victor in terms of the value it contributes to our company, we can now see that Ad 2 is a superior place for our investment. Ad 2 will eventually add the most value.
Why LTV improves your permissible CAC effectively
Marketing professionals may typically unlock more funding for their programs by understanding LTV/CAC. For example, it can assist you in deciding whether you should be permitted to spend more money obtaining larger customers who would probably keep around longer and pay more overall.
An “allowable CAC” denotes something similar. The maximum allowed payment for a consumer is your allowable CAC. In essence, it’s a cap that we pre-arrange with our finance staff. If your LTV is higher, you can justify a higher permitted CAC.
Here are some additional, highly intriguing approaches to consider LTV/CAC and related questions:
Metrics at the channel level:
What is the profitability of my advertising channel in comparison to affiliate marketing, by channel?
How profitable is my Google advertising compared to my Facebook advertising, by sub-channel?
What is the profitability of my Google brand advertising against Google non-brand advertising, by campaign?
What is the profitability of my bids on a certain keyword?
What is the profitability of an enterprise customer compared to a mid-market customer?
By location, how profitable are customers from Brazil compared to those from France?
What is the profitability of a consumer buying Simp’s Dog Food as opposed to Simp’s Dog Toys?
The options are limitless, but a word of caution: don’t get sucked into this to the point where you start micro-optimizing everything. You could cut your business by 75 different dimensions in pursuit of a growth opportunity, or just focus on the big ones and actually go and do your job. I advocate for the latter.
“You could cut your business by 75 different dimensions in pursuit of a growth opportunity, or just focus on the big ones and actually go and do your job. I recommend the latter.
An even better (perhaps the finest) perspective on CAC
As my Finance colleague once wrote, LTV CAC is where most marketers end their analysis. However, a crucial third variable—payback periods—would be absent. This is the PhD level calculation most Finance people think about but most business people (especially marketers) barely acknowledge. Our head of Finance, Bobby, uses this as a test for evaluating performance marketers, and we VERY rarely find someone who passes on the first try.
I’ll be honest: I failed.
A payback period is the rate at which you can get cash from your paying customers; this dictates how quickly you can reinvest in your business and ideally is a component of how you calculate CAC.
Payback times are important since cash flow is important in a well-run company. It’s better to have money today that lets you scale and grow more quickly than it is to have money 5 years from now.
How to spread CAC across channels
Very small businesses tend to grow with a single tactic or channel (e.g., events). That makes it really simple to compute your costs, because it’s all visible and straightforward. However, as your business gets more complex you have more channels and more ways that potential customers interact with your company, and that means you have to start thinking about CAC in a new way. Learn more about this in our free book, SimpSocial on Marketing.
Bigger and faster growing companies tend to combine many sets of tactics, each with its own CAC characteristics, into an overall portfolio of marketing tactics. Some will have very low CAC (e.g., a great blog) while others will be very expensive (e.g., bidding on competitor terms in Google Search). By understanding your CAC at a channel level, you can balance your budget across different aspects of your portfolio depending on what your business needs.
Need to grow super fast at any cost? Spend big in high volume channels even at a high CAC.
Want to optimize for company valuation? Focus on LTV/CAC, to maximize customers that will pay you the most over the longest period of time.
Need to optimize for cash? Look for ways of acquiring customers cheaply and with a fast pay-back period.
Looking to lower your CAC? Here are 3 ways live chat can help
Live chat is super interesting for performance marketers because it is one of the only communication channels which threads an entire customer journey, from prospect to loyal customer. It enables teams to use conversational marketing and conversational customer engagement strategies to engage leads and customers in a personal way.
1. It removes friction for high-intent leads
Live chat lets you go from prospect to Close Won in a single chat session. What’s more, with the right live chat product you can proactively engage visitors who meet certain qualifying criteria. That means you’re spending a lot less of your marketing efforts and money driving people down the funnel.
2. It increases LTV
Our own data has found that customers who chatted with us first pay 13% more over their lifetime. They spend more with us over time because they’re more loyal over the long run – they have a relationship.Live chat ROI
3. It gives you more opportunity to sell
Live chat gives companies more opportunities to talk to visitors and customers at the moment they’re most receptive to learning about you. More opportunities to talk means more opportunities to sell. If a seller is doing a good job, they’re only selling useful features and ideas that help that customer do their jobs better.
Growth at any cost is a recipe for disaster – get started today
The challenge of including LTV, CAC and payback periods in your calculations is that it’s difficult to do. Data tends to be messy and inconsistent and startups especially haven’t been around long enough to accumulate quality data.
Nonetheless, as responsible marketers trying to drive growth, you owe it to your business to use costs and lifetime value to optimize your programs. If all you can do to get started is use the costs reported from your advertising tools, then so be it – that’s better than nothing.
If you can partner with your finance team on LTV and payback period – even better. But no matter what, don’t wait. Growth at any cost is a dangerous way to run a business.
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