What Is Customer Acquisition Cost? (and How to Reduce It in 2023)

Abstract coins spilled across a vibrant gradient surface

Earning a sale—and hearing the cha-ching from your Shopify app—feels great. But how much did you spend to acquire that customer? Was the transaction profitable? If you can’t answer these questions, you may not have a grasp on your customer acquisition cost (CAC).

Spending the right amount to acquire a customer can be a tricky prospect. Spend too little and you miss out on sales, spend too much and your business is unprofitable. 

While finding the right balance might sound daunting, there are a few simple formulas you can use to calculate your CAC—and get it on track. Ahead, learn why customer acquisition cost is important, find out how to calculate it for your store, and get advice for reducing it.

What is customer acquisition cost (CAC)?

Customer acquisition cost is the total cost of acquiring a single customer. This includes sales team costs, ad spend, marketing costs, and any other expenses that contribute to getting your product into a customer’s hands.

Hand types on a calculator

It’s important to understand your CAC because it directly informs profitability. Your CAC tells you how much you need to earn from each customer in order to have a profitable business. Put simply, if you’re spending more on business costs to acquire customers than customers are spending on your products or services, your business model is not viable.

📝 Note: The basic formula for CAC doesn’t include all your costs like cost of goods sold (COGS) and other operation costs. It focuses on marketing efforts and the costs associated with those only (marketing staff or agency, ad fees, etc.). Later, dive into several formulas for gaining a true snapshot of your profitability.

What is the difference between CAC and CPA?

CAC and CPA (cost per acquisition) are similar terms in that they calculate the cost of achieving a single business goal. While CAC measures how much it costs to acquire a paying customer, CPA measures the cost of acquiring a lead. For ecommerce businesses, a lead may be as simple as email capture from a newsletter signup.

What’s included in CAC?

CAC takes into account a number of costs associated with acquiring new customers. This includes both the direct and indirect costs of your marketing and sales efforts. When you calculate CAC, don’t forget to include:

  • Ad spend (Facebook Ads, Google Ads, traditional advertising)
  • Sales and marketing team wages
  • Marketing software company fees
  • Agency fees
  • Creative costs (hiring designers or photographers to execute creative or design software subscriptions)
  • Publishing and PR costs
  • Production costs (videographer fees or production equipment)
  • Influencer partnerships (as part of a social media marketing budget)
  • Inventory maintenance

📝 Note: As a rule of thumb, you shouldn’t spend more than 5% to 8% of your business budget on marketing.

Why is customer acquisition cost important?

A woman sits at a small cafe table contemplating her work on a laptopUltimately, CAC is a key metric for determining a business’s viability and profitability. But understanding CAC for your business offers other benefits:

  • CAC determines the effectiveness of each marketing channel or campaign. Which marketing efforts are the most effective and which aren’t performing? You can use CAC calculations to measure all marketing channels as a whole or at the specific channel and campaign level.
  • It’s the first step to reducing costs. Knowing your CAC is the first step in evaluating how you can reduce it—and boost ROI.
  • CAC helps find roadblocks in your sales funnel. Examining your CAC will uncover areas where you may be spending too much to get a customer to the next stage of the funnel. This allows you to focus on the specific areas where inefficiencies are happening.

📝 Note: CAC is always higher for acquiring new customers (versus retaining existing ones). While reducing your CAC is important, it’s equally critical to invest in customer retention strategies.

How to calculate customer acquisition cost

Marketing for a small business can sometimes feel like throwing spaghetti at a wall. Understanding the effectiveness of your marketing efforts can help you keep costs low and invest more in performant channels and campaigns.

CAC is only one piece of the puzzle, however, so this guide also covers how to consider other factors and calculate CAC as part of a larger formula to determine your true profitability.

1. Use the basic CAC formula

The basic formula assumes that your only costs are marketing costs. It’s an effective calculation for early stage businesses and those struggling with marketing costs in particular.

In this example, a business spent $500 on Google Ads and those ads resulted in 10 customers. The customer acquisition cost would be $50.

Graphic of a basic CAC formula

🪄 Formula: Total Marketing Spend ($500) / New Customers (10) = CAC ($50 per customer)

2. Factor in COGS

Marketing accounts for only some of a business’s costs. These include day-to-day operations and cost of goods sold (COGS). COGS includes costs and expenses directly related to the production of your products, from raw materials to manufacturing labor. It excludes indirect costs, such as marketing and sales. Adding COGS into the calculation gives you a more accurate CAC. 

Graphic of a basic CAC formula with COGS

🪄 Formula: (Total Marketing Spend + COGS) / New Customers = True CAC

3. Consider average order value

Average order value (AOV) tracks the dollar amount spent for each customer order on your website or in your store, and determines an average across all customers. To calculate your business’s average order value, divide total revenue by the number of orders.

🪄 Formula: Total Revenue / Number of Order = AOV

4. Determine your gross margin

To get the calculation of your profit, you need one more figure: gross margin. Gross margin represents the total sales revenue your company retains after the direct costs associated with producing your goods. Gross margin may be calculated as a dollar value or as a percentage.

Graphic of a gross margin formula two ways

🪄 Formula (dollar): Net Revenue – COGS = Gross Margin
🪄 Formula (percentage): Net Revenue – COGS / Net Sales x 100

5. Calculate your profit

Now you’ve determined your CAC, COGS, and gross margin, you can put it all together to get a true picture of your profitability. 

Graphic of a profit formula
🪄 Formula: (Average Order Value x Gross Margin) – Customer Acquisition Cost = Profit

📝 Note: Another way of looking at profit is through a break even analysis. Once you have a clear picture of your profit margin, you can do an analysis of your costs and find ways to increase it.

How customer lifetime value (LTV) affects CAC

Customer lifetime value (LTV) is important to the overall picture of profit because it measures the potential revenue you can earn from a customer through the lifetime of the relationship.

The link between CAC and customer lifetime value is determined through the LTV:CAC ratio. This ratio is important in determining the profitability of your business. The metric can confirm whether the value of the customer is higher, lower, or the same as the cost to acquire a customer. 

A healthy LTV:CAC ratio for ecommerce businesses is around 3:1. Any lower than that and your business is at risk. A higher ratio is good news but it could be a signal that you’re ready to scale up. As such, this is a useful calculation when you’re revamping your overall business strategy and marketing strategy.

Graphic of a the LTV to CAC ratio

🪄 LTV:CAC ratio: (Customer Lifetime Value) / (Customer Acquisition Cost)

5 ways to reduce customer acquisition cost

  1. Prioritize organic marketing
  2. Focus on your AOV
  3. Lower your cost of goods sold
  4. Improve retention
  5. Tap into the power of AI

A calculator and a percentage sign on a table with a graphic paper padIf your LTV:CAC ratio is less than 3:1, your business isn’t operating efficiently and you’ll eventually run out of money. The good news is that there are tried and true ways to reduce your CAC to improve this ratio and start down the path to profitability.

1. Prioritize organic marketing

Organic marketing ideas including email marketing, SEO, and referral marketing are effective at driving customers to your website without costs associated with other types of paid marketing. Many of these ideas are more resource-intensive than other methods. Therefore, don’t forget to factor in the cost of marketing teams’ wages and other indirect costs associated with organic marketing.

2. Focus on your AOV 

CAC and pricing go hand in hand. CAC can be an indicator that you’re spending too much on marketing but it can also signal that your prices are too low. If your marketing budget looks good, take a closer look at your prices—they may need an increase. Doing so will increase your average order value (AOV) and help offset your CAC.

Aside from raising prices, you can increase average order value in different ways: 

  • Offer free shipping with a minimum order value
  • Bundle products or create gift packs
  • Upsell or cross-sell complementary products

3. Lower your cost of goods sold

So you’ve rid your marketing strategy of any inefficiencies and your pricing strategy is sound. Now what? Lowering the cost to produce your products is another way to lower CAC. Ask yourself:

  • If you’re purchasing raw materials, is your supplier competitive on price? Are there cheaper materials you can substitute that won’t impact your brand? Can you comparison shop with competitors?
  • Can you lower manufacturing costs through negotiation with your manufacturer or by switching producers?
  • Is there any way to streamline the production process and lower labor costs?
  • Have you negotiated your shipping costs? Can you consolidate shipping or increase order quantity to reduce these costs?

4. Improve retention

A happy woman carries a plastic basket full of kaleAs outlined earlier in this article, it’s more expensive to gain a new customer than it is to retain an existing one. Implementing retention strategies like loyalty programs, repeat purchase discounts, referral incentives, and customer perks can help to offset a high CAC.

5. Tap into the power of AI

Reducing your CAC may mean reducing some of the human costs associated with marketing. Automate some of your marketing efforts to free up more of your time to explore other marketing ideas and grow your business. AI chatbots, automated email campaigns, and smart recommendation tools can all deliver personalized marketing experiences to customers while you focus elsewhere.

Keep customer acquisition costs low—and profits high

Acquiring customers shouldn’t cost more than the value they bring to your business. If it does, it’s time to evaluate your marketing expenses, business practices, and pricing strategies. To improve customer acquisition cost, you need to look at it within the larger picture of your business. Once you understand how these calculations can help you run your business, you’re on track to keeping it profitable.

Remember customers acquired offer more value over time when you can retain them, as your acquisition costs are much lower. As you look to reduce your CAC, focus at the same time on customer loyalty through experiences and incentives.

Wrapping Up:

We at ShopShipShake have been working with businesses like yours with fulfilling experiences. We offer one-stop services, including an efficient supply chain, over 10 thousand of China’s suppliers, over 1,000,000 SKU and more. With a successful track record of over 100,000 clients, we are sure to deliver your orders requirements.

Let’s get in touch to build, sustain, and grow your businesses! If you would like to know more details about us, please contact us:  blog.shopshipshake.com. If you are interested in cooperating with us. Please register on: https://shop.shopshipshake.com/shop/register/business

The article refers to: https://www.shopify.com/blog/customer-acquisition-cost

5 Steps To Supercharge Your Customer Referrals

Customer Referrals are the bread and butter of any business owner.

It is no secret that “Word of Mouth” or Customer Referral Business is one of the most effective ways to bring in new clients while simultaneously strengthening relationships with your existing customer base. But even though it is extremely powerful and virtually free (or at most costs very little), very few business owners use it anywhere near its potential!

Consider this:

If you got just one referral from each of your clients over the next 60 days, you’d probably double your client base! What would that mean to your potential income, and how many more people would you be helping in supportive and uplifting ways?

So, how do you maximise word of mouth in your business? Here are 5 steps you can start to take right now…

Customer Referrals Supercharge Step 1: Really appreciate your clients and consistently tell them that you value them.

This is the most important yet overlooked element of creating endless referrals. Many businesses focus more on profits than on people. Focusing on profits alone can be detrimental to success, and ‘Word of Mouth’ success comes from looking beyond just profit into how you can enrich your customers’ lives.

Your Plan of Action:

At least once a month, take the time to communicate to your clients and show them you appreciate them.

Send them something of value, something unexpected, a bonus report, a special piece of news you just found. Make it relevant to them and do it regularly.

Customer Referrals Supercharge Step 2: Create an exceptional experience each time they deal with you or your company.

If you can make doing business with you an exceptional experience, your clients will want to tell many people. People want amazing experiences!

Here is an example:

There is a Business Coach who has a special relationship with a coffee shop (a past client). Once every 8 weeks, he invites his in-person clients to a ‘brain trust’ meeting, and the coffee and cake are on the house. Every client that attends gets a card and a voucher from the coffee shop owner to say, ‘Thank you for joining us today; we would love to see you again soon. The voucher is a buy one get one free coffee voucher. So they are encouraged to come back again. And because the coffee shop owner is exposing his business to potential new clients, the coach pays just the cost price of the coffee and cake his clients eat. Normally about 8 clients attend, and the cost is around R800. Just a little extra touch can make dealing with your business that much more of an exceptional experience!

Your Plan of Action:

What can you do now to add little things that make an exceptional experience? Perhaps you can use the above example or something similar in order to network with other professionals while simultaneously providing amazing value to your clients. So remember, start creating exceptional experiences today.

Customer Referrals Supercharge Step 3: Give your customers incentives for giving you referrals.

You’re sitting on a gold mine if you’re passive about referrals. Come up with ways of rewarding your clients for referring business to you. For example, they could receive free gifts, such as a 60-minute coaching session with you, a certificate for a massage or a nice dinner, or perhaps even a financial reward (i.e. R500 gift card). No matter what you choose, the key is making sure that whatever you choose to offer is something that your client will really be attracted to!

Your Plan of Action:

Reward your clients for referring people to you. Come up with rewards that will be beneficial to your clients. For example, if you work with clients who routinely use a lot of equipment in their job or enjoy shopping, a Takealot gift card might be a very motivating reward for them! Perhaps you can give them a 10% cash referral. And if you are stumped on a gift idea, remember that money is always a great motivator as well!

Customer Referrals Supercharge Step 4: Make it easy for clients to give you referrals.

If you want to get many referrals, you must make it incredibly easy for your clients to tell their friends. Don’t expect them to go way out of the way to help you grow your business. Make it as simple as possible.

Your Plan of Action:

Develop a ‘referral package’ that you give to your clients. Ask your clients to be ambassadors for your business as you wish to work with people similar to them. The package would include a professionally designed document explaining why referrals are important to you and a series of referral cards/invites/links that your client can easily share with others and post to their social media accounts. Always make sure to present everything very professionally to increase the perceived value of your offer/services and put your best foot forward with your new potential clients!

Customer Referrals Supercharge Step 5: Ask at the right time!

When is the best time to ask for referrals? Any time! If you have followed the steps listed above…you’ve let clients know they are appreciated, you have consistently given them an exceptional experience, you have provided an enticing incentive to share your message with friends, and you have made it incredibly easy for them to do so. At this point, you should not only be able to ask your clients for referrals at any time, but you should also receive very positive results from it as well!

Your Plan of Action:

The key is to do something now! Draft up an email today and just send it off to your clients, letting them know how much you value them and how much you have enjoyed working with them in the past, and include something that will be helpful/provide some value to their lives. Then over the next 4 to 6 weeks, develop your ‘referral package’ and start to use it. Take yourself out of your comfort zone and take action…Your business and new referral clients will definitely thank you for it!

Wrapping Up:

We at ShopShipShake have been working with businesses like yours with fulfilling experiences. We offer one-stop services, including an efficient supply chain, over 10 thousand of China’s suppliers, over 1,000,000 SKU and more. With a successful track record of over 100,000 clients, we are sure to deliver your orders requirements.

Let’s get in touch to build, sustain, and grow your businesses! If you would like to know more details about us, please contact us:  blog.shopshipshake.com. If you are interested in cooperating with us. Please register on: https://shop.shopshipshake.com/shop/register/business

The article sources from: https://jtbconsulting.co.za/5-steps-to-supercharge-your-customer-referrals/