Mostly I hear that acquisition costs should be as low as possible. In this article, you’ll learn why that just is not true. The customer acquisition cost is the price you pay for someone to buy your product. If you are stingy with these costs, not many will buy your product. If you pay too much for customer acquisition, you lose your business in the long run.
So the problem is finding the right amount of customer acquisition costs. This blog post will give you a guide to it.
Why Acquisition Costs Can Be A Businesses Killer
Very often, the English term Customer Acquisition Cost (CAC) is used for the acquisition costs. In the episode, I would like to use the abbreviation CAC, because it is easier.
What startups usually do well, is to invent an original product and set up a great team. It is said that the most common death of a startup is the missing market. So nobody needs this great product. But the second most common death is that no one has considered that most products do not sell themselves. It needs marketing and sales and that also costs a lot.
If these costs were not considered from the outset in the pricing, then the entire business model collapses. This problem is not only found in startups. Companies that suddenly have to make marketing and sales because of changing market conditions are also faced with this challenge.
What is often done is that marketing and sales are being tasted in such a light dose that it just barely accommodates the low cost. Homeopathy in the health sector is strongly doubted by the science and I guarantee homeopathic marketing and distribution certainly does not work. Maybe there is a placebo effect and you feel good because you have done something about the loss of customers, but it does not really help.
The golden formula
Clever people have found that there is a golden formula for the number of acquisition costs. This formula considers the ratio of a customer’s Live Time Value (LTV) to the cost (CAC). The LTV is, very simply, the contribution margin of a customer over the term.
The recommendation is that the ratio LTV: CAC should be higher than 3: 1. But not much higher. Because if this ratio is much higher, then you save money for customer acquisition. On the other hand, you are giving market opportunities. Because you could win more customers with higher expenses. If the ratio is lower, you spend too much money on customer acquisition.
Basically, one can say if the ratio LTV: CAC:
- Less than 1: 1, then your business will soon no longer exist
- 1: 1, then you lose money with each new customer
- 3: 1 is, that’s the golden formula, that’s the way it should be
- 4: 1 or larger, that’s good for profitability, but you’re forgiving yourself of market opportunities. You could grow more.
What does that mean in practice?
Let’s take a typical inbound marketing example. For example, a smaller consulting company that uses inbound marketing to generate leads and acquire a new customer each month.
The marketing and sales funnel could look like this:
- Visits: 5,000
- Leads: 100
- Sales Ready Leads: 10
- Graduations: 1
In practice, I can say that for such an inbound marketing program costs about 8,000, – per month. The costs are mainly for:
- Content production
- Content Promotion
- Marketing Automation
- Ongoing optimization
- Project management and implementation
Of course, there are also the distribution costs. So let’s say 10,000 CAC a month.
What does the results page look like? Even smaller consulting companies attract orders of 50,000 to 100,000 euros on land. Often orders follow other orders. I now assume the contribution margin at 30%. It is reasonable in this case to assume an LTV of about 30,000.
In this case, we have a ratio LTV to CAC 30,000: 10,000 is equal to 3: 1. This could basically be a good starting point for a good business case.
What security is there
In theory, the calculation of customer acquisition cost sounds pretty reasonable. The big question they could ask themselves is: But what if, in our case, one customer per month is not won?
What collateral do marketing methods generally offer? The problem is that marketing has changed. Much of what worked years ago does not work today. Trade fairs, outbound calls, advertisements and much more do not deliver the results as they used to.
For new marketing methods, such as digital marketing on the Internet, there is often no experience in companies. However, the advantage of digital marketing methods is that every step of the process generates data that makes it easy to adapt the strategy and the measures at any time. This allows a quick reaction and result deviations can be better corrected.
The absolute assurance that your business case customer acquisition does not exist. But you can make these arrangements, so you are not completely wrong:
- You must reasonably include the CAC in the final price of your products and services. Almost no product sells itself. You have to pay for someone to buy your product.
- You need a reasonable orientation on how high the CAC must be. The golden formula LVT: CAC is equal to 3: 1 can be such an orientation.
- Please do not assume that the CAC should be as small as possible. Remember, if you pay little for customers to buy your products or services, then it’s easy for you to stop using your growth opportunities.
- When calculating the CAC, consider all costs, not what you spend on Google advertising, for example.
- Make sure your CACs are sustainable. Not all new digital marketing methods are sustainable. If you’re primarily interested in getting Google advertising from advertisers, be aware that you’re constantly spending money to reach customers. You may want to invest in your website, content, etc., to optimize costs in the long run.
Conclusion customer acquisition cost
If you do not consider customer acquisition cost, you will not sell. The art is to show the right costs in the whole pricing. The Golden Rule LTV: CAC of 1: 3 is a good orientation. With the cost per lead in the different channels, you can optimize the CAC.
One more tip: With this turnover calculator you can calculate how many visits and leads you to need for the desired turnover.