Demystifying the Customer Acquisition Cost

May 17, 2015

12:00 pm

For many small and medium sized businesses (SMB), the customer acquisition cost (CAC) is a vague term. But it’s one of several metrics that can help manage a growing business. The simplest way to look at it in layman terms is for (x) paying customers in a period how much in marketing/sales (y) in same period did the business spend?

One might ask why does it matter especially for early stage businesses who are experimenting to achieve product market fit. Marc Andreessen famously emphasized ‘the only thing that matters is getting to product market fit’. But actually it is a pretty useful metric if only because it builds discipline in learning to manage the unit economics of a business. While it seems relatively straightforward, there are various factors to consider.

For example if you are a B2B SaaS business, you are probably driven by direct sales, referrals, and some content marketing via your website or social media. Are you tracking distribution channels by which your customers are coming through? How many weeks does it take? How much are you spending per distribution channel? What’s the conversion rate (number of potentials in your sales funnel eventually buying)? Can you improve it, ie hack the channels? Are you spending too much on sales/marketing?

CAC cannot be held in isolation, it ties quite closely with price and sales cycle. You can have a high customer acquisition cost and relatively high sales price but low sales cycle which trends toward a high average revenue per customer/user (ARPU). Although it will be important to understand customer churn to truly understand CAC. Likewise, low price and longer sales cycle which isn’t great (low ARPU) and in such a case the customer acquisition cost would shed some insights on your ability to scale or stay in operation. This post provides insights from some leading Silicon Valley operators on shortening sales cycle.

SaaS venture capitalist David Skok simplifies the aforementioned KPI cocktail by stressing awareness of one important metric – Long Term Value (LTV) of a customer and to check that at a minimum, LTV is 3x greater than CAC. As is seen in the formula below, LTV is a function of price, sales cycle, customer churn and the customer account management cost

(ARPU x Average Lifetime of a Customer – the Cost to Serve them)

To summarize, managing CAC is a great way to improve the unit economics of a business.

 

Image Credit: Gili Benita

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Chaney is Founder and CEO of VendorMach, a supply chain trust scoring platform. Former technology integration and risk product lead at Humana Inc, he is a sought after speaker on big data and AI trends. He has degrees from Booth, Kings College London and Howard University.

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