If there is one metric that is always under the microscope with growth marketing, it is customer acquisition cost (CAC). CAC informs you of how much it costs to acquire one paying customer with the formula, acquisition cost / net new paying customers. It is a measurement of paid acquisition effectiveness, but effectiveness can be interpreted differently depending on the cost inputs used. Being aware of the cost inputs and how they change the story being told will help us not only understand our business better but also how we to read CAC ratios to estimate the future impact of our current investment. In this article, I will discuss the various ways the CAC formula is defined and how different CAC ratios reveal additional insights about our acquisition performance.
Three Common CAC Formulas
Marketers are the most common users of CAC and use it to measure individual acquisition channel effectiveness, as well as to evaluate the acquisition program as a whole. Advertising spend is commonly the only cost considered in these cases. However, are advertising costs alone the best representation of acquisition cost? The answer to this question varies depending on who you might ask. For marketers, the purpose of CAC is how effective are our advertising dollars, but for departments like Sales or Finance, the inputs and interpretation of effectiveness will be different. It is important to understand these differences as alignment on is crucial to properly guided strategic decisions and in the table below, I highlight three common CAC formulas that can help you to distinguish the nuances that come with this measurement.
|Fully Loaded CAC||(Total cost of everything associated with acquisition) / (Total net new customers)||- Raising capital - Investing in a business||Costs examples include: Wages associated with marketing efforts, overhead, creatives, advertising, tools, discounts|
|Blended CAC||(Sales and marketing expenses (excluding salaries and overheads)) / (Total new customers acquired)||- Precise performance measurement that is not very picky||Includes both Organic and Paid acquired customers|
|Paid CAC||(Sales and marketing expenses (excluding salaries and overheads)) / (Total new paid attributed customers acquired)||- Measure paid channel effectiveness|
Other CAC Considerations
CAC is by no means perfect as you might have interpreted from the information in the previous section. It is an approximation of acquisition effectiveness, rather than a definitive value and its ambiguity requires a champion to communicate how it's measured and ensure confidence in how it's being reported. This champion is not only tasked with determining the needs of different departments in formulating CAC’s definition but should also consider factors outside of cost that can influence the story being told.
Lag from Sign Up to Paying Customer
In cases like a SaaS business, users who sign up are not likely to become paying customers immediately. There might be a freemium offering, fixed trial duration, or a long sales cycle associated with their product. Due to these sales lags, it isn’t accurate to measure CAC based on the net new customers within the same period as the costs created. This would not capture a fully mature cohort generated by the money spent during a given period and if interpreted incorrectly, can lead you to misguided strategic decisions like removing spend from an effective channel.
How you can adapt to lag is by offsetting the periods used in the numerator (acquisition costs) and denominator (net new customers) of the CAC formula. If we had a business model where there is a 30-day trial prior to the subscription being charged, it would be worthwhile to offset the costs to 30 days prior and divide by the net new customers in the current period to have a more accurate reflection of how many customers were acquired by investments made when the user register or took an action indicating intent to purchase.
Incremental CAC (iCAC)
Most CAC values are taken at face value as an estimate of how much it costs to acquire a new customer, but this value doesn’t signal if we would have acquired this customer if we didn’t spend money on the ad. Incremental acquisition costs (iCAC) provide you with a more accurate representation of ad effectiveness by measuring customers who would not otherwise have been acquired without the ad interaction. Why this is important is it segments out customers that you would have received if you hadn’t run that marketing campaign. This metric definition is a better representation of our marketing effectiveness than assuming all of the advertising spend was effective in delivering a new customer and can lead to better guided strategic decisions. However, getting an accurate read on iCAC is not straightforward and requires complex experimentation and statistical modeling like geo experiments and media mix modeling that model data and simulations to prove out the lift. The output of these experiments will help to fine-tune your CAC’s and improve their accuracy.
CAC alone provides us with valuable insights, but using it as a ratio with other important measurements gives us additional information that will be valuable to us in estimating the future impact our current investment will have on the business. Provided in the table below are a few ratios that you can use and the value they provide.
|CAC / MRR||- Tells you how many months it takes to recoup your CAC|
|CAC / ARR||- Tells you how much it costs to acquire a dollar of revenue|
|CAC / (MRR * (Gross Margin (expressed as %))||- Tells you how many months it will take to recover your full acquisition cost|
Making sense of it all
CAC provides you with a valuable estimate of the effectiveness of an acquisition program. While it is just an approximation, the measure is versatile and one of the most important metrics for a growth marketing program. The key to extracting the most value out of CAC is determining how to adapt the formula to your business model and have alignment on the definition and interpretation across the organization.