Being able to consistently acquire customers while staying profitable is becoming more and more difficult, yet, it’s key to longevity. So, why is customer acquisition cost so important?
You need to understand your customer acquisition cost (CAC) across different channels to build out your advertising budget and price products properly. It impacts your profitability, the sustainability of your business, and more.
We’ll walk you through calculating CAC below and show you ways you can try to lower it, making it easier to acquire customers while staying profitable. More importantly, you’ll learn about the correlation with customer lifetime value (LTV).
LTV speaks to how much money a customer brings your business over their entire relationship with you. If you have a higher LTV, you can afford a higher LTV. On the other hand, businesses that struggle with a low LTV will find themselves bottlenecked when acquiring customers.
Fortunately, boosting LTV is easier than lowering CAC. With a Shopify loyalty program you can effortlessly encourage repeat purchases and get more value out of every customer you acquire. Learn how below.
What is Customer Acquisition Cost (CAC)?
Let’s first define CAC so we’re all on the same page. This is the total expense your brand takes on to get a customer to make their first purchase. It shows you how much you’re paying to earn a sale. It’s that simple - but there is a lot more that goes into really understanding CAC.
Some of the various costs that will make up CAC include marketing efforts, sales activities, advertising, and any other outreach that contributes to driving new customer conversions.
Knowing your brand’s CAC - and segmenting it across various channels - empowers you to make more informed decisions about marketing.
More importantly, it gives you an idea as to the long-term viability of your business model. We’ll talk more about LTV and its connection later on, but if you’re paying too much to acquire customers relative to what they bring in over the course of time, you’ll never end up profitable.
How to Figure Out Your Brand’s CAC
Calculating CAC requires some data gathering. You’ll need to know all direct marketing costs - that includes paid ads, content creation, and social media campaigns.
You’ll also need to factor in salaries for your marketing and sales teams, software or tools used for customer acquisition, and any other relevant costs tied to customer acquisition efforts. With all that on hand here’s how you’d calculate CAC:
- Sum up all marketing and sales expenses during the period you’re measuring.
- Calculate the number of new customers gained during that period (excluding repeat buyers).
- Divide your total acquisition costs by the number of new customers acquired.
So if you spend $50,000 over a quarter and bring in 1,000 new customers, your CAC would be $50 ($50,000 / 1,000). Now, whether that figure is good or not will depend on how much you earn on the initial sale along with the overall course of the customer's life.
But before we get into all that, why is customer acquisition cost so important?
Why is Customer Acquisition Cost So Important?
Knowing your CAC isn’t just about tracking spend - it’s about seeing the full picture of how effectively you’re converting marketing dollars into paying customers.
It’s easy to overlook it if you’re profitable every month, but you could be wasting money in certain areas without realizing it. Keeping your finger on the CAC pulse also helps you identify when things are starting to move in the wrong direction so you can pivot.
Impact on Profitability
It’s no secret that CAC directly impacts your bottom line. Every dollar spent to bring in a customer is a dollar that has to be recovered through that customer’s purchases.
However, a high CAC relative to the revenue generated by a customer leads to thin profit margins. Growth becomes financially unsustainable, and you have to question the longevity and viability of your brand.
For example, if a business spends $100 to acquire each customer, but each customer only generates $80 in revenue over their lifetime, the business is operating at a loss on every new customer. Something has to change - be it lowering CAC or raising LTV, or ideally, both.
Considerations for Growth
It’s nearly impossible to scale (sustainably) with a high CAC. You won’t have any cash on hand to test new SKUs, create new content, or explore new advertising channels if you’re taking a loss on every customer purchase.
Efficient CAC management opens up pathways to scale without sacrificing financial health. It’s totally normal for CAC to fluctuate over time as customer reach, marketing channels, or competition evolves.
However, you need to monitor CAC vigilantly to actually be aware of these changes and respond accordingly. We’ll talk more about the importance of ongoing customer acquisition cost management in a moment.
Influence on Pricing and Budgeting
Your brand’s CAC will be central to pricing and budgeting decisions. Businesses with a high CAC need to price products at a premium to stay profitable. They also need to be stricter with where they allocate capital.
On the other hand, efficient CAC can allow for competitive pricing that attracts more customers. It also supports risk-taking, as you can be aggressive with new opportunities knowing your business will stay afloat if you swing and miss.
Budget allocation is also shaped by CAC. For example, if a brand’s CAC is significantly higher on one channel than another, it makes sense to reallocate the budget to the more efficient channel. This will lower overall CAC and boost ROI across the brand.
Importance of Tracking CAC Over Time
While it’s worth figuring out your CAC today, you'll need to regularly revisit it so that as market dynamics, customer behavior, and ad efficiency change, you’re ahead of the curve.
If acquisition costs are rising, it will warrant a look at the channel that’s most affected - or a tightening of budget across the board. On the other hand, seeing a drop in CAC suggests something is working and frees you up to spend more aggressively.
The Link Between CAC and Customer Lifetime Value (LTV)
We know you came here to learn about the importance of customer acquisition cost, but on its own, it doesn’t tell you anything. CAC should always be considered in relation to LTV. After all, a high CAC is fine if the LTV still leaves plenty of profit.
Defining Customer Lifetime Value (LTV)
LTV is the projected revenue a customer brings your business over the entirety of their relationship with you. It’s a way to understand the full potential of each customer, not just their initial purchase.
Calculating LTV typically takes into account factors like average purchase value, purchase frequency, and the average lifespan of a customer relationship.
Knowing this metric offers insights into how much revenue each customer will generate, so you can decide how much you can afford to spend on acquiring them.
Let’s say your average customer spends $100 on each purchase and makes four purchases a year over three years. That’s an LTV of $1,200 - which is really good! Or so it would seem. You need to put LTV and CAC together to really gauge the financial health of your brand.
Why the CAC-to-LTV Ratio Matters
A $1,200 LTV is impressive if your CAC is only $50. But if your LTV is only $100 and your CAC is $50, you aren’t being left with a ton of profit to grow the business.
So, what’s a healthy CAC-to-LTV ratio? A good rule of thumb is 1:3 - meaning the revenue generated by a customer should be at least three times the cost of acquiring them. This covers acquisition costs while leaving a hefty profit margin.
If CAC is too high relative to LTV, it suggests that your business is spending too much on acquiring customers that aren’t spending enough. There are two levers you can pull here - lowering CAC or raising LTV.
Both are important - but you came here to learn about the importance of customer acquisition cost. So we’ll quickly touch on ways you can boost LTV below before diving deep into lowering CAC.
Boosting LTV to Offset High CAC
There are many techniques for increasing LTV - like implementing a loyalty program, releasing new products more frequently, engaging in customer retargeting ads, personalizing customer experiences, and enhancing customer service.
Building out a loyalty program with Rivo is one of the best methods, as you can see a tangible ROI. We’ve helped brands achieve a 3.1x repeat purchase rate, a 52x ROI, and a 4% increase in revenue driven by Rivo’s Shopify referral program platform.
Tips to Lower Your Brand’s CAC
Reducing CAC doesn’t have to mean cutting corners on the quality of your customer experience, product, or brand perception. You just need to be stricter about where you spend your marketing dollars. Here are some tips.
Optimizing Marketing Spend Across Channels
There’s a good chance that you spend on marketing across a multitude of channels - Facebook/Instagram ads, TikTok ads, influencer marketing, social media content marketing, search ads, SEO - the list goes on and on.
We recommend figuring out the CAC across each of these channels so you can see which one provides the best ROI and which is holding your brand back.
For example, if social media ads are driving more conversions at a lower cost, you can spend more there while trimming spend on underperforming channels.
Improving Targeting and Customer Segmentation
It could be that the way in which you’re targeting users is the issue - not the channel itself. The more accurately you target potential customers, the less you’ll spend on leads that don’t convert. That’s why we always recommend brands use data-driven targeting and segmentation.
Start by segmenting audiences based on behaviors, preferences, or demographics, and tailor campaigns for each group. Users are much more likely to convert when they feel they are being served experiences that are more relevant to them.
Enhancing the Customer Journey to Boost Conversions
A high CAC could have nothing to do with marketing and more with the customer experience on your website - or the journey the customer has after a marketing touchpoint.
Take the time to audit every step in the funnel, from ad to website, product page, cart, and purchase. Make sure load times are fast, navigation is intuitive, and calls to action (CTAs) are clear. The goal is to eliminate friction wherever possible.
Simplify the checkout process for as seamless an experience as possible, especially on mobile. You’ve gotten the customer 99% of the way there - don’t let a clunky cart page or checkout process cost you a sale you’ve already spent money on!
Implementing Retargeting Campaigns
So many brands allocate marketing budgets to top-of-the-funnel (TOF) traffic - which will engage users who have zero knowledge/awareness of your brand. It makes sense, as you need to constantly bring in cold traffic before you can start to warm it.
But, you need to make sure you have retargeting campaigns in place as well to actually nurture those cold leads to the point where they turn into customers. Middle-of-the-funnel (MOF) and bottom-of-the-funnel (BOF) campaigns convert at a far higher clip. This will lower CAC.
Increasing Customer Referrals
Turning existing customers into advocates can drastically reduce CAC as well, and a referral program can go hand-in-hand with a customer loyalty program.
Referral programs incentivize satisfied customers to recommend your brand to their friends, bringing in new leads at a fraction of the cost of traditional advertising.
Rather than paying advertising costs, you might offer discounts to the referrer - and the customer being referred, for that matter.
Since referred customers tend to trust recommendations from friends, they often convert faster, making referrals one of the most efficient ways to keep CAC low while growing your customer base.
This is something Rivo can help you set up as well. We’ve done the same for hundreds of other brands, and our solution is specifically designed to eliminate cases of referral fraud.
You can tailor the rewards to your customer’s desires - be it amount discounts, percentage discounts, free shipping, or even free products. Get more inspiration here as we wrap up our guide to the importance of customer acquisition cost below.
Parting Thoughts on the Importance of Customer Acquisition Cost
So, why is customer acquisition cost so important? In closing, this metric impacts profitability, growth, and long-term success.
You need CAC to stay within a healthy range relative to your LTV so that you can grow profitably over time. Otherwise, you’re treading water and slowly but surely bleeding money on every purchase.
We’ve shared tips on how to calculate CAC and improve it in your own marketing efforts. But, remember that lowering CAC will only do so much - it’s far easier to raise LTV. That’s where Rivo comes in. Request a demo today or compare your options below:
