Tips & Guides — 23 Nov 2022
How to Cut Customer Acquisition Costs
Over the last six years, the cost of acquiring new customers has increased by 60%. This is a daunting statistic for ecommerce entrepreneurs, many of whom are intent on quickly increasing their customer base.
The truth is, scaling a business inevitably involves mounting customer acquisition costs. Once you’ve experienced an initial surge of interest and conversions, new shoppers become consistently more costly to reach. These shoppers may lay on the fringes of your typical market, calling for a change of tactics to successfully convert them.
This fact lands business owners in a difficult place: if they spend less, they will miss out on valuable customers; but if they spend more to attract those customers, they will become unprofitable. Cracking CAC (customer acquisition cost) can be a fine balancing act, reliant on solid data.
Thanks to the rise in real-time analytics via ecommerce platforms, sellers can use CAC to quickly identify which areas of their marketing strategies are working for them, and which need adjusting. These figures can guide marketers into new profitable areas of acquisition strategy, such as partnership and affiliate marketing.
Read on to discover how to calculate and analyze your CAC, and how to use your findings to reduce the cost of customer acquisition.
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In brief, customer acquisition cost is the total cost to your business of acquiring one customer and is indeed part of vital Saas metrics to consider. Broken down, this consists of product and labor costs, marketing expenses, advertising spend, and any other budget allocated to a successful conversion.
As customer acquisition is a common and reliable measure of growth, CAC can help you to understand the true cost of your company’s growth, and whether your scaling is sustainable.
This figure gives a realistic picture of the earnings you need to gain from each new customer in order to keep your business profitable. If you’re spending more on increasing traffic than you’re gaining from product sales, you’re not going to be able to stay in business.
Of course, customer lifetime value or LTV has a large role to play here: if a customer becomes a loyal repeat customer, their LTV will quickly override their CAC, making the initial spend on reaching and attracting them money well spent.
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Thanks to their worldwide reach, ecommerce companies have an enormous potential customer base at their disposal. This means 65% of small businesses seek to drive growth through regular acquisition of new customers, getting as many shoppers into the sales funnel as possible with the expectation of a profitable proportion converting.
This is a costly priority: it can cost upward of five times more to acquire a new customer than to maintain an existing one, and costs are only increasing. In 2020, digital ad spending was estimated to increase by 13%, paid social advertising surged by 24%, and paid search increased by 17%.
However, without a constant stream of new acquisitions, startup companies risk going under before they’ve really begun.
With so much emphasis on customer acquisition, CAC can make or break a business. Allow the cost of acquiring new customers to rise above the earnings you take from them, and your ecommerce business is no longer viable.
Therefore understanding this figure becomes crucial: by knowing and analyzing your CAC, you can gain realistic figures for the profit margin and cost of goods you’ll need to implement to be successful.
CAC can also work on a case-by-case level, helping business owners understand what’s working via A/B testing. For example, marketers can run the same advert via paid social and partnership advertising, and see which has the best CAC.
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The basic formula for CAC is the total spend divided by the number of new customers.
However, the factors that go into the total amount are different for each business – for example, companies selling a physical product will need to account for production, postage, and packaging costs, while SAAS companies selling a digital product won’t have the same ongoing costs to factor into their user acquisition.
For example, let’s say a company with $250 product costs and $250 advertising spend each month brings in ten new customers over a month. The cost of acquisition will be $50 per customer.
The business will therefore need to sell products for more than this amount to remain profitable or increase the monthly number of new customers without increasing costs.
While the basic formula for calculating CAC is simple, and a great way to gain a sense of whether your marketing is working for you, a deeper dive can reveal new benefits.
Break down your total spend into the individual costs that keep your business running for a closer understanding of your average customer acquisition cost and overall profitability. By factoring in figures such as your average order value and gross margin, you can understand whether or not your business will remain profitable, and what needs to change to ensure it does.
As covered, if you’re selling physical products from your ecommerce store, you need to factor in the costs of manufacturing to understand your true CAC. This includes everything from the cost of raw materials to the labor involved in creating products to the logistics of getting your products from factory to fulfillment center.
This would give you a new formula for CAC: (Total Marketing Spend + COGS) / New Customers
By separating your COGS from your total marketing spend, you give yourself a greater number of options when it comes to making your business profitable. For example, you may discover that your marketing budget can remain as it is if you find a way to cut production or logistical costs.
Your average order value is the mean amount spent each time a customer places an order. You can calculate it by dividing your total revenue over a certain time period by the number of orders during the same time period.
Taking this metric into account alongside your CAC can guide your next steps. For example, while the cost of acquiring each new customer is, say, $50, if each customer is spending an average of $100 or more, you can comfortably increase the CAC to take on new high-value customers without it negatively affecting profits.
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Your gross profit or gross margin is the total sales revenue retained by your business when the expenses of producing your goods are taken away. For example, if your business makes $5000 over a month but spends $3000 on labor and raw materials, your gross margin is $2000, or 40%.
This is a useful metric for understanding your CAC, as profitability relies on your gross margin remaining higher than your average CAC. If the cost of acquiring new customers starts eating into what should be your revenue, you can see it as a warning sign.
On the other hand, if you have a very high gross margin, you may feel confident in investing more funds into acquiring new customers, knowing you will recoup the loss later down the line.
According to economist Vilfredo Pareto, 20% of a business’s customers should represent up to 80% of total sales. Your customer lifetime value is the metric that shows how this stands up.
You can work out an average CLV by multiplying your customer value by the average customer lifespan. Your customer value is your AOV multiplied by the average number of times a buyer makes that purchase over a given time span. Your customer lifespan is the average number of years a customer continues to buy your products.
For example, let’s say a business is selling skincare products marketed to teens. The average order value is $10, but the average customer will rebuy the product on a monthly basis. This gives a customer value of $120 per annum. If the average then-teenager relies on these products for an average of eight years, this gives a customer a lifetime value of $960.
Spending money on attracting new clients is inevitable – but keeping those clients coming back for more offers consistent revenue at a far lower cost. From mailing lists and loyalty programs to customer service, the cost per interaction with customer will reliably come out lower than the costs associated with gaining new customers.
Customer acquisition cost runs on the assumption that each customer will make a single purchase. By taking a customer’s lifetime value into account alongside CAC, you can understand how much money you’re likely to make long-term for each customer you acquire. This will show you how good an investment your CAC truly is.
Cost per acquisition is a central metric for any business hoping to grow sustainably. By continually monitoring and analyzing acquisition costs, you can build strong and data-centric strategies to reduce your costs and propel your business to the next level – without breaking the bank.
Reducing CPA can be achieved in multiple ways. You can reduce expenditure on marketing or production costs, or you can increase the number of new customers. In many cases, increasing new customers also increases marketing costs, but there are ways around this. For example, focusing on the user experience can increase conversions from existing site visitors.
In order to achieve this, it’s crucial to have a good handle on your sales and spending data. Take time to transfer all of your digital marketing data onto a single platform for quick and quality analysis going forward.
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Allow your CAC to inform smart pricing decisions. Lower prices will appeal to a greater number of customers, potentially opening your product up to a yet-untapped lower-end market. Sales and limited-time offers are great ways to draw new customers in and give you an edge over the competition.
You’ll need to be aware of how this plays out in figures, however. While a sale or a drop in prices could bring in more customers, reducing your CAC, it could also lead to a drop in your gross margin if the cost of goods sold remains the same.
Alternatively, you can always increase the cost of your products. This gives you a higher average order value, allowing you to keep spending the same amount on customer acquisition and still increase your gross margin.
Optimizing your budget is the first port of call when it comes to bringing your CAC and gross profit into harmony.
You can reduce costs sustainably by lowering the COGS. Explore cheaper shipping and fulfillment options, or renegotiate volume discounts on raw materials. This will allow you to sustainably lower prices, or alternatively, raise your gross margin.
If you’re decentralizing your logistics to cut costs, make sure you invest in inventory tracking solutions to keep stock of your products from production to fulfillment.
Make your customer acquisition budget work harder by increasing the value of each checkout.
Start by offering free shipping beyond a certain order value. Customers will be encouraged to add another item to their carts in order to reach the necessary threshold, even if this pushes the price over the minimum spend.
Product bundles are another smart way to increase the average spend. Analyze customer behavior to see which products are most commonly bought together, then offer a discount to customers who buy them all together. These could include accessories for a consumer electronics product, or a “get the look” type of bundle for a fashion retailer.
It’s competition that drives up digital marketing costs, from bidding on keywords to the rising cost of Google ads. Explore different areas of your market to find a less competitive niche. This will allow you to reach, attract and convert new customers more easily – and for a lower CAC.
This can lead to significant up-front costs, such as redesigning a product to fit a different need or creating a whole new marketing strategy from the ground up. Make sure you do your research before taking the leap, understanding your new audience, and performing competitor analysis.
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Investing in a user-friendly and accessible online store will ensure that your advertising money isn’t wasted further down the funnel. Once shoppers are attracted by your messaging and click through to the site, they may be put off by an unappealing website or awkward customer journey.
Optimize your site for a higher conversion rate by designing an experience that is eye-catching without being overwhelming. Ensure that your product pages contain well-written descriptions and beautiful product photography.
69.8% of ecommerce shopping carts were abandoned before conversion. Avoid losing customers late in the game by ensuring your checkout process is streamlined and uncomplicated. Remove any unnecessary form fields, and integrate a trusted payment platform.
It’s perfectly possible to reach the right audience and convert customers with a marketing budget of 8% of your revenue. If your CAC is reading too high, swap out some of your pricier paid ads with organic marketing channels.
Invest your time in content marketing campaigns via social media, email marketing, SEO, and referral marketing to increase web traffic for less. By creating quality content that will catch shoppers’ eyes and draw them into a conversation around your product, you can create a trust-based relationship that will pay off in the long term.
Consider a keyword-optimized blog on your website, informative video shorts on your social profiles, or a referral scheme that gets your customers advertising on your behalf.
Make sure you complete regular reports on the profitability of your advertising channels. This will help you to avoid wasting your marketing budget on platforms that aren’t driving conversions.
If you shift your focus from customer acquisition to customer retention, you may find your CLV offsets your CAC, making the initial investment worthwhile in the longer term. After all, 90% of satisfied consumers are more likely to purchase again.
An ideal CLV to CAC ratio to aim for is 3:1. This should ensure a stable increase in profits without overstretching your customer acquisition budget.
Complete regular customer experience analysis to ensure that your service is as customer-friendly as possible. Ask for feedback on how you can improve your product and UX while reassuring customers that their experience is important to you.
Show your existing customers that you value them by automating follow-up emails and thank you notes. These could include a small discount on their next purchase, prompting them to remain loyal to your brand. A loyalty program takes this one step further, incentivizing repeat custom and referrals with early access, discount codes, and exclusive content.
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CAC optimization isn’t a quick fix. It’s an ongoing process that will need regular analysis and adaptation as your business grows and your market changes. This is why it’s important to connect your data across advertising and sales platforms to maintain a true picture of your profitability.
For young companies, assessing CAC can prove a challenge without a backlog of historical data to devise averages from. In this case, it pays to keep an eye on industry benchmarks.
If your company is prioritizing rapid growth, an increase in customer numbers is always a good sign. However, without crunching the numbers, you could be losing revenue unaware.
It’s important to develop a close understanding of your customer acquisition cost and the factors that play into it if you want to monetize your customers and increase revenue. Your CAC can offer a reliable insight into how your business is doing, as well as a key indicator for testing new approaches.
As your customer base grows, your product-market fit is likely to wane, and you need to be ready to adapt creatively. Whether this involves new marketing platforms, adjusting the cost of production, or redesigning your ecommerce shop, make sure your decisions are backed up by data.
Written by
Jessica Day is the Senior Director for Marketing Strategy at Dialpad, a modern business communications platform that takes every kind of conversation to the next level—turning conversations into opportunities. Jessica is an expert in collaborating with multifunctional teams to execute and optimize marketing efforts, for both company and client campaigns.
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