Customer Acquisition Cost Explained!

[00:00:00] Intro

[00:00:10] Hi everyone, welcome back to the channel. If you're new here, I'm Greg Moran from evergreen mountain equity partners, evergreen growth partners. And I'm also host of the founder's journey podcast and a startup founder for 20 plus years. And, uh, have, uh, been lucky enough to have a couple hundred million dollar exits along the way.

[00:00:27] So I've been through the same stages that you're going through today. We're going to dive into a key metric today that every entrepreneur, every marketer, every business owner needs to understand, and that's customer acquisition costs or shorthand CAC, right? Customer acquisition costs, whether you're running a startup.

[00:00:46] Are you managing an established business? You've got to know your CAC because it's really crucial for long term sustainable growth. So let's take a couple minutes here and really break it down. So first things [00:01:00] first, what exactly is customer acquisition cost? There's tons of stuff all over the place. A lot of it is conflicting information.

[00:01:07] So let's set it straight first. In simple terms, CAC is the total cost that you have associated with acquiring a new customer, just a new customer, not an expansion on the current customer, which is one of those things that I think gets confused a lot. So this is going to include all of your marketing and all of your sales expenses, just those two things, but all of it.

[00:01:33] Right? So everything on your P and L or income statement that you would classify as a sales cost and a marketing cost, that's That goes into the expense side of the CAC formula. The formula itself is pretty straightforward. You add up all the costs associated with customer acquisition, again, sales costs plus marketing costs.

[00:01:52] And then you're going to divide that number by the total number of customers that you've acquired in a specific [00:02:00] period. So if you're really high volume business, you might be measuring this monthly, might be measuring this quarterly, annual may suffice if you're more of enterprise, where the number of deals you're closing, uh, really over a long period of time.

[00:02:13] So let me give you an example of this. Let's say you spend 10, 000 on sales and marketing costs in a month, right? So all your sales costs, all your marketing costs, and you acquired a hundred new customers within that month. Your CAC is going to be a hundred dollars, right? 10, 000 divided by a hundred. That hundred dollars is what it costs you to acquire a new customer, your customer acquisition cost.

[00:02:42] Right? Sounds simple, but there's a lot more to this number than this basic calculation. So why is CAC so important? Well, it's because that knowing your CAC helps you determine the effectiveness of your sales and marketing efforts. It allows you to benchmark those efforts [00:03:00] against similar kinds of companies as well.

[00:03:02] So if your CAC is really high, so it's costing you a lot of money to acquire a product, you A new logo. It might mean you're spending too much to acquire your customers, which will ultimately hurt the scalability of your business as well as your long term profitability. On the other hand, though, a low CAC really could indicate that you're efficiently acquiring customers, but you're not investing enough in growth.

[00:03:30] This is actually, I see both of these two things routinely, right? Where a business could be growing a lot faster than it is. Because they've got a really scalable, repeatable system to acquire customers. With just a little bit more investment, they could increase that, their rate of growth. On the other hand, I see it all the time too, where they're just spending an exorbitant amount of money to acquire any customer.

[00:03:54] Your CAC is always going to be higher when you're in early stage startup, when you're figuring this out, but it should [00:04:00] go down over time. So one key concept to keep in mind is the relationship between what's called customer lifetime value. And CAC, so I'm throwing another term at you here, sometimes known as LTV, customer lifetime value, LTV.

[00:04:16] Ideally your LTV should be higher than your CAC, right? So this means the revenue you expect to earn from a customer over their lifetime should exceed what you would, what you spent to acquire them. So what this is really going to tell you, your customer lifetime value. Let's say that. Somebody stays with you for an average of three years before they churn, right?

[00:04:43] Before you lose that customer, you're going to have three years of revenue that will determine that lifetime customer value. And maybe, you know, your CAC is going to be some proportion of that. What that, what you spent in the first year, that's healthy. So you want to be looking at those two [00:05:00] things. How long do you keep a customer?

[00:05:01] What's the lifetime value typically. And then how does that compare to your customer acquisition costs? So let's talk about how to calculate CAC accurately. It's not just about tallying up your ad spend, which is something I see quite a bit. You need to consider all costs associated with acquiring customers.

[00:05:21] So again, I mentioned before, all of your sales costs, all of your marketing costs, this includes salaries of your sales and marketing teams, the tools that they're using, the cost to the cost to for content production, Even overhead costs like office space. If you really want to get exact about it, the more accurately you can account for these expenses, the more precise your CAD calculation will be.

[00:05:46] And again, it's an important number because this is really going to determine the long term scalability of your business. It's also going to determine your long term value. Of your company. If you haven't listened to our other videos [00:06:00] on understanding your valuation, it's a big part of it. You know, if you've got a scalable, repeatable sales process that's highly efficient, your value as a business is gonna go up significantly.

[00:06:11] So let's break this down again. Going back to the CAC calculation, marketing costs, this is gonna include your online ads, events, content creation, so on sales expenses, things like salaries, commissions. Tools like CRM software, other tools that you may be using, um, overhead again, if you want to get highly precise, the percentage of overhead.

[00:06:34] So let's say 10 percent of your Salesforce is sales and marketing. You take 10 percent of, you know, office space or things like that. If you want to get super precise, if not, you can skip that part and just hit the direct sales and marketing costs. So reducing CAC is a really key objective. For any business, because again, what that means is you're driving efficiency.

[00:06:57] Now, before I get into some strategies that can help you reduce the [00:07:00] CAC here, let me just make this really clear. If you're an early stage startup, just getting customers is the most important thing, right? There are proof points, there are stories that you can tell, case studies. Things like that. So if you're very early in your first year or two, let's say you're under a million, a couple million in, in overall recurring revenue, don't worry so much about this yet.

[00:07:28] Just don't run out of money, right? If you're getting over, if you're over that point, you're really starting to scale. This is where you really want to be thinking about how do we make our sales and marketing efforts, our customer acquisition. more efficient. So here are some strategies that can really help you do it.

[00:07:43] Number one, you want to look at optimizing your marketing channels, focus on the channels that are delivering the highest ROI. Don't just spend in a bucket, really be looking at those channels and saying, where am I driving leads? Where are those leads converting? Focusing there and [00:08:00] starting to get rid of the other stuff that you kind of, those channels that you sort of collect along the way that maybe they're not working so much.

[00:08:06] So track the performance, shift budgets to the most effective channels. You want to improve your pipeline conversion rates. Um, and this could go from the top of the funnel as well. So the better your website or your sales team is at converting leads into customers, the lower your CAC is going to be. So just small improvements in conversion rates can make a huge difference in lowering that CAC.

[00:08:30] So really focus there. You want to focus on large customer revenues. leveraging customer referrals. So happy customers can be your best marketers. They're also your cheapest marketers. Referral programs can really lower your customer acquisition costs by bringing in new customers at little to no cost to you, uh, which can have a huge effect.

[00:08:53] You want to increase customer retention. The longer you keep a customer, the more value you get from your CAC [00:09:00] investment. Remember what I talked about before, we'll get into LTV lifetime value in another video. But that balance between lifetime value of a customer and CAC, the longer you, the longer you keep them, the more you can actually afford to have a little bit higher CAC, uh, higher customer acquisition costs because you're going to keep them longer in your lifetime values.

[00:09:23] Great. So focus on delivering great service, obviously. Keep them around. So before we wrap up, let's talk about just a couple of common mistakes. Businesses make, we see them all the time when calculating client acquisition costs, first mistake, not actually accounting for all costs, especially indirect costs, like software tools, team salaries, things like that.

[00:09:47] And they just, you know, focus on commissions or whatever. Another common mistake is looking at CAC in isolation. Talked about this before, but CAC needs to be viewed in context of your high, of your. lifetime value [00:10:00] to your LTV, a high CAC can be justified if your LTV is significantly higher. For instance, if you're selling enterprise SAS software, you can have a much higher CAC, uh, number because your LTV is presumably going to be much higher.

[00:10:17] If you're doing high volume transactions. Low recurring revenue or no recurring revenue at all. You really, you've got to look at, you know, keeping that CAC as low as you possibly can to make sure your customer acquisitions really as efficient as possible. So don't forget to segment your customer acquisition costs, different customer segments might have different acquisition costs.

[00:10:41] So. As you want to start to get more and more granular, if you're going into different markets, you want to understand this by market because it can vary a great deal. Understanding these differences really can help you allocate resources more effectively. I'll give you a good example of this. I've seen a number of times when companies have multiple industries that they're serving [00:11:00] within their ICP, Some of those industries are paying them, you know, they're closing quick.

[00:11:05] They're doing great in terms of their customer acquisition costs. They go into another industry as a, as an ICP segment. It's just much more expensive to get into sales cycles or longer. They're spending a lot more money. It's just not a profitable, um, and really scalable segment for them. So you really want to be looking at this over time, really digging into.

[00:11:29] customer segments, markets, things like that as well. All right, that was a deep dive into customer acquisition costs. Remember, understanding and optimizing your CAC is really crucial for the health of your business, for the growth of your business, and for the long term value of your business. If you found this video Make sure you like it, you subscribe it, hit the bell icon to get notified when we post new content here.

[00:11:56] If you have any questions or topics that you want me to [00:12:00] cover or any questions about this in specific, drop them in the comments below. Thanks for watching. We'll see you in the next video.