Written by Faiz A. Rahman
For those running tech startups in any vertical, it is very essential to track what matters to the company’s future success. Tracking relevant metrics is important in order to understand how well your startup is doing. Those metrics will help entrepreneurs identify progress on marketing, sales and customer service as well to avoid unnecessary burns.
One of the most important metrics for any tech startup companies is CAC, or Customer Acquisition Cost, or some others call it Cost of Acquiring Customers. Basically, they all mean the same thing: how much it costs to acquire one customer to your startup.
However, every industry vertical has a different way of interpreting and calculating CAC. In this article, we’re going to focus only on eCommerce companies.
Why does CAC Matter?
Before we go further into CAC calculation and how to improve it, we need to understand why this particular metric is very important for eCommerce companies?
Simply put, it is because your online store needs to make money and optimize investments on marketing, which means you need to get a return on investment (ROI) from your marketing and sales campaigns as well as from the commission or salary you paid to your sales force team.
In other words, if the costs to extract money from customers can be reduced, the company’s profit margin can improve.
However, CAC is not only important to the internal side but also to the external parties such as investors. Investors use this metric to analyze the scalability of these technology companies. They usually use it to estimate a company’s profitability by looking closely at the difference between how much money can be generated versus the cost of extracting it from the customer.
How to calculate CAC?
In its simplest form, CAC can be calculated by:
Dividing the total costs associated with acquisition by total new customers, within a specific time period.
For example, if an eCommerce company spent $1000 on marketing in a year and acquired 100 customers in the same year, their CAC is $10.
Let’s say, for example, a fictitious company called LaperBoss which sells donuts online spent $10,000 on advertising last month, and its marketing team recorded 1,000 new customers ordering within that period. This suggests a CAC of $10, but this figure doesn’t mean anything yet.
Hypothetically speaking, if the average order size by customers who bought donuts from LaperBoss is $25 and has a gross margin of 50%, on average, the company makes a margin of $12.5. Deducting the CAC of $10 per customer, LaperBoss essentially generates $2.5 ($12.5 – $10) from each customer to pay for operational costs.
However, this is just a rough calculation and estimate. There are some other considerations to look at, for example the Life Time Value (LTV) of a customer, retention rate and churn.
In order to calculate CAC in a complex and more precise way, the company needs to consider other customer acquisition associated factors, summarized as below:
CAC = Customer Acquisition Cost
MCC = Total marketing campaign costs related to customer acquisition
W = Wages associated with marketing and sales
S = The cost of all marketing and sales software (Including ecommerce platform, Automated marketing, A/B Testing, Analytics, etc.)
PS = Any additional professional services used in marketing/Sales (Designers, Consultants etc.)
O = Other overheads related to marketing and sales.
CA = Total customers acquired
How to improve CAC?
Once you understand why it is important and how to calculate it, how could you improve/lower CAC?
Improving CAC is always good for the business and the company can optimize CAC by trying new things, such as:
- Improving on-site customer sale conversion by enhancing overall site performance. It can be done by performing A/B testing to reduce cart abandonment rate, improving landing page, mobile optimization, etc.
- Exploring new, potentially more efficient channels to acquire customers.
- Implement effective customer relationship management (CRM) management as almost all successful companies that have repeat buyers implement some form of effective CRM system.
- Enhancing user value by introducing superior features or augmenting existing product offerings.
Now that you know why CAC matters and how to improve the metric, make sure your company has a healthy CAC in order to grow and scale faster. Please beware this is just one metric, there are tons of other important metrics to take care of. Finally, good luck and don’t forget to have fun with your business!
Photo Credit: Elite Strategies