Customer acquisition cost (CAC) measures how much businesses spend to attract new customers. CAC is a critical business metric for determining the resources to acquire and onboard new customers, and it helps assess your company’s overall health and profitability.
- There are several ways to measure and interpret CAC. The standard formula divides marketing and sales expenses incurred over a period by the number of customers acquired in that period.
- Customer acquisition cost is often evaluated with lifetime value (LTV). The ratio of LTV to CAC measures the ROI of each dollar spent on acquiring a new customer.
- Improving CAC involves increasing the number of new customers (the bottom of the formula) and reducing the sales and marketing expenses incurred to acquire those customers (the top of the formula).
- Strategies that help improve CAC include identifying your target audience, optimizing website conversions, focusing on organic channels, increasing customer value, and using sales and marketing automation tools.
What is CAC?
CAC stands for customer acquisition cost and refers to the total cost of resources and efforts a business allocates to gain new paying customers. CAC compares how much money companies spend on acquiring new customers over a specified period against the number of customers they acquire.
Calculating CAC is important for determining the ROI and overall efficiency of your customer acquisition strategies. Businesses become profitable and scalable once they learn to grow their customer base while keeping their CAC low.
How to calculate customer acquisition cost
There are multiple ways to measure and interpret CAC, so you must understand which formula best serves your company’s needs.
The standard customer acquisition cost formula
This is the standard customer acquisition cost formula used by most companies. To accurately calculate CAC, divide marketing and sales expenses incurred over a certain period (e.g., a month, a quarter, or a year) by the number of customers the business gained in that period.
For example, Company A spent $1,000 over one month on its sales and marketing efforts and acquired 25 new customers during that month. In this case, CAC = $1000/25 = $40/customer. From this simple calculation, Company A learns that it spends $40 on average to obtain a new customer.
The general CAC formula accounts for two main spending categories—marketing and sales. These are the data points that usually go into calculating CAC:
- Ad spend: The money businesses pay for advertising campaigns, including ad placement expenses and agency fees.
- Sales and marketing employee salaries: The costs associated with employing sales and marketing professionals.
- Content and creative services: Internal creative team salaries or outsourced creative agency fees for design, content creation, copywriting, and editing.
- Sales and marketing tech stack: The cost for buying and maintaining the technology your marketing and sales teams use to acquire new customers. These include CRMs and tools for email marketing, marketing automation, website management, reporting, and more.
- Production costs: The money spent on physically creating content. For example, companies need to rent a studio and purchase video and audio equipment to create a video that attracts new customers.
- Product costs: The costs incurred to maintain and improve products, including employee salaries and technology costs. For example, a SaaS company may need to update its software to optimize the customer experience.
Fully loaded CAC = All costs associated with customer acquisition / Number of new customers
The fully loaded CAC formula measures every cost associated with your company’s customer acquisition efforts. In addition to typical marketing and sales expenses, fully loaded costs include:
- Overhead costs like desk space or office rent for sales and marketing employees
- Costs of legal services to create contracts for sales and marketing teams
- Special offers and discounts for new customers
This comprehensive approach to measuring CAC may be excessive for marketers, but the fully loaded CAC formula indicates how much your businesses can scale. That’s why it works well for investors and founders raising capital.
The paid CAC formula
Paid CAC = Marketing and sales expenses (without salaries and overhead costs) / Number of new customers gained via paid channels
Paid CAC is a more specific performance metric that evaluates the effectiveness of paid channels. The paid CAC formula excludes salaries and overhead expenses from the calculation and only accounts for new customers acquired through paid channels.
To get the paid CAC calculation right, companies must define the attribution rules for paid channels. Digital analytics tools like Amplitude enable marketers and product managers to attribute conversions across channels to the right touch points in the customer’s journey.
For instance, if a customer visits your company website after viewing a Google search ad, followed by a Facebook banner ad, Amplitude can assign credit for that visit to multiple touch points using multi-touch attribution. In this case, Google and Facebook each receive credit for the visit.
Use the LTV/CAC ratio to evaluate company profitability
CAC represents the costs companies spend to acquire new customers. To understand if CAC is worth the investment, you should compare it to customer lifetime value (CLV), also known as lifetime value (LTV).
The LTV formula
LTV measures how much revenue each customer generates for your company throughout their lifetime as a customer. To calculate LTV, use the following formula:
Here’s a simple example. You predict Customer A will purchase your product worth $1,000 twice a year over a 5-year relationship with your business. The LTV of Customer A equals $1,000 * 2 transactions * 5 years = $10,000. If you have a SaaS product with recurring revenue, you can calculate SaaS LTV using a similar formula.
Calculating each customer’s LTV manually is time-intensive and complex. To simplify this process, Amplitude offers a Revenue LTV Chart that measures each customer’s revenue over time and tracks how well companies monetize new users. You can also use this chart to identify which product features correlate with higher LTV.
In the Revenue LTV chart above, you can see the LTV for users who join a community in a hypothetical music-streaming app. The LTV for those who use this feature and join a community (green) is higher than for those who do not join a community (purple). Explore this chart yourself with Amplitude’s free self-service demo.
Calculate the LTV to CAC ratio
Once LTV and CAC are measured, it’s time to plug them into the LTV to CAC ratio. The LTV/CAC ratio evaluates how much revenue each customer generates throughout their lifetime compared to the cost to acquire that customer. The ratio represents the ROI of each dollar spent on acquiring a new customer.
A healthy ratio of LTV to CAC is around 3:1 or 3.0x—your company retains a 3x ROI for each dollar it spends to acquire a customer. Anything below 3:1 indicates your company spends too much on acquiring customers, or you’re not retaining customers over time. If the ratio is above 5:1 or at least 5.0x ROI, you should consider increasing your sales and marketing spending and boosting your growth efforts.
Setting goals and improving CAC after calculating it
After performing the CAC calculation, you may realize that your customer acquisition cost is too high and negatively affects your overall profitability. According to the CAC formula, improving CAC comes down to setting and achieving these goals:
- Increase the number of new customers (the bottom of the formula)
- Reduce the sales and marketing expenses associated with acquiring those customers (the top of the formula)
However, it’s important to understand that the customer acquisition funnel involves the entire end-to-end process from lead generation to lead acquisition to lead conversion. Improving CAC requires a powerful customer journey strategy optimized for cost and channel efficiency from the top of the funnel to the bottom.
Here are five actionable tips that may help your business improve its customer acquisition costs:
- Know your target audience.
- Optimize website conversions.
- Focus on organic channels.
- Increase customer value.
- Use marketing automation.
Know your target audience
Every effective customer acquisition strategy starts with using customer segmentation to identify your target audience, create detailed buyer personas, and establish your ideal customer profile (ICP).
Use cohort analysis to create customer segments that fit your ICP. A cohort represents a group of users with similar traits or behaviors. Behavioral cohorts group users into segments based on actions they’ve taken throughout their customer journey. For instance, you might find that customers acquired through your newsletter convert better than those acquired from social media, then optimize your acquisition strategy accordingly.
Focusing on customer segments most likely to convert into high-LTV customers ensures that you concentrate your efforts and resources on the right audience. It also helps avoid situations where you allocate your budget on ineffective channels and activities that increase customer acquisition costs.
Optimize website conversions
To ensure a site visitor transitions into a paying customer, you must invest in conversion rate optimization (CRO). CRO aims to increase the proportion of customers who perform a desired action on your website. CRO practices include:
- Improving site speed
- Optimizing your website for mobile users
- Improving landing page copy and layout
- A/B tests to enhance forms and CTAs throughout your website
- Reducing shopping cart abandonment through ecommerce analytics
CRO can significantly affect CAC—the better you optimize your website for conversions, the more paying customers your businesses will acquire.
Focus on organic channels
Generating high-quality, high-converting traffic is the biggest challenge companies face. Paid channels convert well but come at a cost—once businesses stop paying for ads, the traffic flow also stops. For companies that rely heavily on paid traffic, making large reductions to CAC is challenging.
That’s why investing in organic channels like SEO, email marketing, content marketing, and social media is a good idea for businesses looking to bring their CAC down. Organic channels may take longer to demonstrate results, but they bring consistent and sustainable traffic over time.
You can track your organic content marketing efforts through an SEO analytics dashboard like the example below. Try it yourself with Amplitude’s free starter plan.
Increase customer value
No amount of marketing can give a poor product a mass audience. To keep your customer base growing, you must ensure your product delivers real value to users. Use a product analytics tool like Amplitude to optimize your customer journey and identify:
- How quickly are customers reaching the “aha” moment
- Where are customers experiencing friction and dropping off
- Which features are the most sticky and lead to higher retention
Gathering customer feedback is another tactic to factor customer needs and wants into product updates, features, and offerings. The more value customers get from using your product, the more likely they will stick with it and make repeat purchases.
Use marketing automation
Marketing automation software like CRMs and tools for email, social media, and reporting can lower employee costs and free up your team’s time for more creative, strategic tasks. Moreover, marketing automation can bring a 12.2% decrease in marketing overhead and a 14.5% growth in sales productivity. Automation tools not only help nurture businesses but also help optimize overall sales and marketing spending.
Learn more about CAC and other critical product metrics you should be tracking in The Amplitude Guide to Product Metrics.