Every business aims to gain new buyers and grow its market share. But at what cost? It can be tempting to get new customers using all possible methods—regardless of the time, cost, and energy required. However, to run a successful ecommerce business, you need to find a balance. That’s where customer acquisition cost comes in. It’s a critical metric that indicates the cost of marketing and sales efforts you are putting in to get a new buyer. To scale your business while still profitable, you must keep track of your customer acquisition cost and continuously optimize it.
In this guide, we explain what is cost of customer acquisition, why it matters, and how you can calculate and reduce it to improve your profitability.
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What Is Customer Acquisition Cost (CAC)?
The customer acquisition cost is a metric that informs how much it costs the business to acquire one new customer over a specific timeframe. It’s the money you spend to convince a new buyer to purchase your products. CAC varies depending on your business maturity, opportunities, and goals. For example, a new ecommerce venture will have a high CAC as you spend more to get the word out. A more mature business with a loyal customer base may lower CAC for some time. But a new product launch could spike the metric again.
A lower CAC is preferable as it signifies efficient resource allocation and an effective business model. However, when CAC is too low, it can be a sign that you are missing growth opportunities. The optimal CAC depends on a few factors, such as your industry and the length of your sales cycle.
Why CAC is so important to a business?
Successful entrepreneurs understand that a sustainable business, in the long run, comes down to keeping costs low and margins high. They use CAC to measure profitability and growth opportunities. The importance of this metric has grown with the rise of digital marketing as it allows businesses to better track their customer acquisition efforts. Some benefits CAC brings include:
- Efficient analysis of the scalability and growth potential of new businesses.
- Opportunity to periodically review and optimize customer acquisition strategy using CAC data.
- In-depth business intelligence, when combined with other business metrics like customer lifetime value (explained later)
How to Calculate Customer Acquisition Cost
In this section, we cover how to measure customer acquisition costs. You must apply a mathematical formula that compares some business income against certain marketing expenses.
You can calculate CAC by dividing the cost of acquiring new buyers over a specific timeframe by the number of new customers acquired in that period. You can use a month, a quarter, or a year as a timeframe.
Using a simplified example, let´s say your company spent $1,000 last month on marketing and sales. During that same period, you gained 50 new buyers. Your CAC would be $1,000/50 = $20. This means you gained a new customer for every $20 spent on acquiring them.
Marketing Costs to Include
Here are the main cost groups you can include in your CAC calculation.
- Paid advertising - how much you spend on paid marketing campaigns, like social media, search, influencer, and Amazon ads
- Marketing and sales software - all the tools you use to attract and convert customers
- Payroll costs - Salaries and payment of freelancers, consultants, agencies, or employees you use for marketing.
- Logistics costs - Costs of printing, storage, and distribution of marketing material like flyers and brochures.
Costs Not to Include
You should not include any non-marketing costs (for example shipping, inventory or Amazon fees). Additionally, not every CAC calculation includes all marketing costs. Some businesses choose to exclude payroll or logistics costs from this calculation; they focus on direct marketing and sales expenses (the first two cost groups).
Depending on your reporting objectives, you can choose which costs not to include in your business CAC calculation.
What Is LTV to CAC Ratio?
Lifetime value (LTV), also referred to as lifetime customer value (LTCV), is an estimation of the sales one customer brings the company throughout their relationship with it.
The LTV to CAC ratio (LTV:CAC) compares a buyer´s expected value to how much it costs to acquire them. This metric is one of the most important metrics that informs the effectiveness and efficiency of your business model; it´s also an indicator of business success in the long run.
To find your LTV to CAC ratio, you first need to calculate your LTV, then divide that number by your CAC. Let´s say you expect to generate $2,000 from a customer during their lifetime and it costs you $1,000 to acquire them. Your LTV:CAC would be $2,000:$1,000 = 2:1. This means you´re making 2 times what you spend to earn that customer.
What is a good LTV to CAC ratio?
If your LTV:CAC ratio is closer to 1:1, then you´re in a break-even situation - you´re spending on your customers just as much as they are spending on you.
A LTV:CAC ratio that resembles 5:1 could mean you are leaving money on the table. By increasing your customer acquisition expenses you can potentially earn more buyers.
The golden mean depends on a few factors, including the average customer lifespan in your specific industry and business, the lengths of your sales cycle, purchase value, and buying frequency. There is a consensus among marketers that a good LTV:CAC ratio should be at least 3:1 for your business to be sustainable and profitable.
Customer Acquisition Cost Examples
So your company has a CAC of $20? Is that good? Bad? Well, it depends. As we said, CAC as a metric needs to be evaluated against other factors to give us valuable insights. Let´s take the examples of two hypothetical ecommerce companies, both with a CAC of $20.
Example #1: Ecommerce store
The fictional company in this example is an ecommerce store selling handcrafted jewelry.
In a simplified calculation, let´s say the company spent $20,000 last month on marketing, sales, and other customer acquisition costs. During that month, the ecommerce store sold 1,000 products to first-time buyers. This means that the company spent $20 to acquire every new purchaser. We have to look at a few other factors to evaluate whether a CAC of $20 is good or bad for this company.
The average order purchase value of this ecommerce store is $50 and it has a 20% profit margin, which is considered a good margin. Hence, the company earned $50,000 from the 1000 new customers and made a $10,000 profit.
A $20 CAC is good when the buyer spends $50 on average per order. However, the profitability of the company may suffer as they scale if the customers only make a one-time purchase.
Example #2: Subscription-based Ecommerce Store
Here, we take the example of an ecommerce store with a subscription-based business model. The company sells convenience products like razor blades.Similar to the above example, this company spent $20,000 last month on acquiring customers and gained 1,000 new ones. The average order purchase value for this company is $42. With a 20% margin, the company earns $8.4 per order.
While this ecommmerce company has a lower profit than the first example, they have implemented a subscription model directly through Amazon. Therefore, they can expect to receive orders regularly, without having to drastically expand their marketing and sales efforts. In this case, a CAC of $20 is considered good and sustainable in the long run.
How to Reduce Customer Acquisition Cost
The below strategies can help you reduce your customer acquisition cost and boost conversions.
Deliver More Value
Customer value is the difference between the perceived benefits buyers receive and the costs they encounter from using your products. The perceived benefits and costs go beyond the product functionality and the cost. Perceived benefits include factors like social status and enjoyment. Besides the price, perceived costs also include the time and energy it takes for customers to make a purchase.
You should aim to increase the perceived benefits of your product and reduce the perceived costs. The more valuable consumers find your offerings, the more likely they are to purchase from you. Added value can look like:
- New product features
- Free fixes and repairs
- Discounts on new versions of the products
- Implementing a subscription model.
- An efficient and hassle-free checkout process
Another way to increase the perceived benefits of your products and deliver more value is by investing in your brand. Share your brand story and be proactive in asking for feedback. Pay attention to what your audience is saying. Then, give them what they are asking for. Fissler pressure cooker highlights advantages like time saved in cooking, energy saving, and lifetime warranty in their product listing copy.
Optimize PPC Campaigns
PPC campaigns tend to account for a large chunk of CAC. A lower PPC cost leads to a lower CAC. PPC optimization entails improving different campaign elements to increase the number of clicks your ad receives. Keyword targeting, ad creative, and landing page are some of the PPC campaign elements you can optimize for.
If you run an Amazon ecommerce store, the PPC optimizer for Amazon by Semrush can assist you in launching profitable PPC campaigns. The tool can completely automate this process or you can manually make the optimizations yourself.
Another way to optimize your PPC campaigns is through A/B testing, which takes us to the next section.
60% of businesses say that A/B testing is an effective conversion rate optimization technique. Higher conversion rates equal more customers using fewer resources, which in turn results in a lower CAC. You can A/B test different parts of your landing page, website, email campaign, advertising copy, call-to-actions (CTAs), and product listing.
Just make sure you are not testing everything at once. Test one change at a time while keeping the other variables the same.
Invest in organic marketing to generate free traffic and sales - all while establishing your brand as an authority in your industry and increasing your perceived value. Organic marketing includes creating and distributing valuable content across your free channels. The content should align with your customer needs and aim to build long-term customer relationships.
Part of your organic marketing strategy can be creating a blog, launching a podcast, and building a strong social media presence. This content, when created and distributed strategically, adds to your search engine optimization (SEO) efforts. Incorporate keyword targeting to ensure your products show up when consumers are looking for your products and services. Use the Keyword Manager for Amazon tool to manage all your Amazon keywords from within one place.
What´s more, marketing channels build upon each other. Your organic marketing efforts serve to build your brand. A user might follow your blog or social channels for a long time without purchasing from your business. One day, they receive an Instagram ad from you at the right moment. Being familiar with your brand from your organic channels, they are more likely to convert.
Customer acquisition cost is an essential metric that measures the effectiveness and efficiency of your business model. This metric is often evaluated in comparison to other business metric like customer lifetime value.
By knowing how much it costs to acquire a new buyer, companies learn to better allocate resources and adapt their acquisition strategy. Reducing your CAC ensures your business is profitable in the long run.
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People Also Ask
How Do I Improve Customer Acquisition Cost?
You can improve your customer acquisition cost by delivering more value, optimizing your PPC campaigns, running A/B tests, and building an organic marketing strategy to generate free traffic, and boost brand awareness and conversions.
What Is a Good CAC?
CAC on its own does not tell us much. This metric is typically evaluated against customer lifetime value. A good LTV:CAC ratio is 3:1 - the ideal ratio depends on factors such as your business and the industry you´re operating in.
Which Metrics to Include in The CAC?
You calculate CAC by diving the total cost of acquiring new customers during a specific period of time by the number of new ones gained during that period. The total cost of acquiring new customers includes your paid advertising costs, the cost of your marketing and sales software, and salaries paid to employees and third parties working in marketing.
You can also reduce customer acquisition costs by increasing customer satisfaction. Our Ecommerce customer satisfaction- The Complete Guide shows you how.