How to manage & Reduce Customer Acquisition Cost (CAC)

A huge Customer Acquisition Cost is the first iceberg that drowns a new business. Startups tend to spend so much on getting new customers that they sometimes forget that they are supposed to be making a profit. Are you a digital startup wondering how much your Customer Acquisition Cost should ideally be? Or, are you looking for ways to reduce your CAC? 

Then you should definitely keep reading. 

You have to spend money to make money. We all know that famous idiom. Customers aren’t going to magically appear and start buying from you. You need to invest time, effort, and most importantly, money to acquire them. 

But how much money is too much money? After all, you’re trying to make a profit. 

In this article, I’ll cover those very topics. How much should your CAC ideally be? And how can you reduce it if it is higher than the ideal?

What is Customer Acquisition Cost?

Simply speaking, this refers to the money that you spend in acquiring a customer. 

And remember, we’re talking about the cost of acquiring a new customer here. Keeping an old customer is way more economical. But targeting new customers is a must if you have a startup. You don’t have a loyal and sizable customer base that you can count on to keep returning. So you need to pay close attention to your Customer Acquisition Cost so that you don’t go overboard. 

The formula for calculating Customer Acquisition Cost is: 

This numerator (costs devoted to acquiring new customers) included both the cost of sales and the cost of marketing. However, I’ll give you a detailed list of what exactly you need to include within this total cost:

What is included in the customer acquisition cost? 

Why is Calculating Your CAC important? 

We all know the saying- Customer is King. 

Hence, companies do everything in their power to cater to their customers. And it’s justifiable why they do that. After all, there’s no lack of options in today’s day and age. If you fail to impress the customer for a moment, they’ll simply move on to your competitor. 

But does this mean that you need to cater to the customer, no matter what the cost?

Not really. Why? Because bending over backwards to keep one customer might be preventing you from looking at the bigger picture. 

What is the bigger picture? The revenue that you make. 

Several companies boast about the huge number of customers they are acquiring without looking at their ROI. FoodPanda is a stellar example of this. Its insane “Desserts for Rs.1” sale enticed thousands of new customers to partake in this scheme. But did FoodPanda benefit from this? Of course not, because they were paying out of their pockets. 

The exact same happened with their marketing budget which was ridiculously high. That budget wouldn’t have mattered from Zomato or Swiggy, which can make that money back. But it sounded the death knell for FoodPanda. 

You cannot complain about a low ROI if you do not calculate your investment at all. How can you manage something that you haven’t calculated in the first place?

This is exactly why having a clear idea of your Customer Acquisition Cost is important. 

Now, it’s also important to remember that CAC varies based on the revenue model of a company. For example, a company with plans of late monetization is prioritizing on customer acquisition initially. Their CAC is supposed to be high because getting new customers is what they are focusing on. 

However, if you have a startup that plans for direct monetization, you need to be extremely careful about your CAC. I’ll elaborate on this further towards the end of this article. 

But before that, you need to know about another business metric that is tied to CAC. 

CLTV or Customer LifeTime Value. 

What is CLTV and why does it matter?

CLTV refers to the amount of money you can expect to make from a customer throughout their lifetime as a paying customer. 

The formula for this is fairly simple: 

Now, there is a very important relationship between CLTV and CAC. The CLTV: CAC ratio is perhaps more important than CAC in and of itself. 

What are the limitations of calculating CAC alone? 

1. The money that you’re spending on sales and marketing, are not just meant to get new customers. Retargeting and customer upkeep take money as well. Separating this cost from the cost of solely getting new customers is difficult. 
2. You should not spend the same amount of money on each customer. Why? Because some customers are one-time buyers whereas others are repeat buyers. The CLTV value of the latter is obviously higher than the former. And this CLTV value is used to understand who your most loyal and ideal customers are. Why would you spend the same amount of money on both one-time and repeat buyers? Especially when retargeting is so much cheaper?

These are the reasons why you cannot just solely concentrate on the CAC value. A higher CAC value is perfectly justifiable for a customer segment with higher CLTV value. Whereas, the opposite is true as well. A lower CLTV warrants less investing. 

This is exactly why the CTLV: CAC ratio is so important. 

What is a good CTLV: CAC ratio? 3:1

That is the perfect CLTV to CAC ratio. If you have anything significantly higher like 6:1, that means you are not spending enough on your customers. If you have something significantly lower, like 1:1, then you are spending too much. And of course, you are not making a profit. Why? Because the money you are spending on your customers is the exact amount they are bringing back to you. 

And if your CLTV: CAC ratio is even lower, it’s a no brainer. You’re running at a loss. 

What should my Customer Aquisition Cost be?

The reason for keeping your CAC low is simple: lower the CAC, the more profit you make. But does that mean you can not spend on customer acquisition at all? Of course not. Then you wouldn’t have any customers to make any profit from. 

Keeping the balance is important. If your CAC is too low, you won’t have any customers. And if your CAC is too high, you won’t have any profit. 

So how do you make sure your CAC porridge is not too hot and not too cold either? By reaching the perfect CAC score.

But this is where the complexity lies. I cannot give you a clean figure like the perfect CLTV: CAC ratio. Why? Because your ideal CAC depends on many factors. 

1. Do you plan on direct monetization of late monetization?
2. Which industry does your startup belong to?
3. What is your CLTV?

As I have answered before, companies with late monetization plans can deal with a relatively higher CAC. This was the exact plan of the Cred App creator Kunal Shah. He spent Rs. 727 to make Rs. 1 and did not treat this as a major loss. Why? Because he never intended to properly monetize the business within the first 21 months. 

On the other hand, if you have plans for direct monetization, you cannot afford a high CAC. Because you simply won’t be making enough money to sustain your business. You need to convince your investors to keep funding you after all. Unless you can show them that you’re making money, you won’t get any money to spend on new customers. 

David Skok calls CAC the “Startup Killer”. With a name like that, you’re bound to pay close attention to it. 

Why does he call it that? Because most entrepreneurs get so swept up in the optimism regarding their products, they forget all about customer acquisition. When asked, they always state vague plans of digital marketing without having any real figures in their head. 

This is a major problem. Because not only is your business not going to grow, you’ll be nipped at the bud by your investors. 

The second thing you need to keep in mind is, all industries have different ranges of CACs. Travel, for example, has a really low average CAC value of $7. Whereas, the average CAC of software is as much as $395. This is why most SaaS struggle to understand how much they should be ideally spending on their customers. 

Your CAC will also depend upon the competition that you have in the market. And also the demand for your products. If you’re selling a unique service, you don’t need to promote as competitively as a service that has existing competitors in the market. 

The third criterium is the most essential and I have already elaborated it before. You cannot start calculating your ideal CAC without knowing your CLTV. But CLTV actually makes the process of calculation easier. It’s a quantity which is easy to calculate and it does not depend upon you, but the customer. So, you have two fixed values: the CLTV: CAC ratio (3:1) and the CLTV. You can now calculate your required CAC in no time. 

How to Reduce Customer Aquisition Cost?

Increase Conversion Rate 

Instead of trying to get a horde of new customers, you should focus on getting a sizable portion to convert. 

Conversion refers to the act of your potential customers taking the desirable course of action that you assigned them. In other words, if they press your Call-to-Action button, they are converted. If you are an e-commerce startup, this conversion will mean buying products from you. If you produce content, this might mean signing up for your newsletter and so on. 

Stop trying to widen the top of your sales funnel. You’re better off focusing on the neck of the funnel where the decision is actually made. Just getting a steady flow of website traffic means nothing if they are not purchasing anything.

Take a look at our article on Conversion Rate Optimisation to know exactly how to increase your conversion rate.

Retarget

Retargeting is the process of bringing back customers who have left your sales funnel. 

Not everyone who leaves your sales funnel does so because they actively hated your product. Sometimes they might get distracted or bored and just forget about it. Therefore, showing them ads for the items that they had viewed is a great idea. You can use either Google or Facebook Ads to achieve this purpose. 

Worried about the costs of ads? There’s some great news for you. 

Retargeting ads are way cheaper than the usual Pay Per Click ads. Yes, PPC ads can cost you as much $2- $3 per click. Compared to this, retargeting ads have an average cost of $0.20 to $0.60. 

And not just this, retargeting works wonders for your conversion rate. It’s way easier to convert someone who has already known an interest in your product. Than someone who is a newcomer to your site. 

Retargeting does not require email addresses or names. So, you can pretty much retarget everyone who gets lost in the very top stages of the tunnel.

Focus on Customer Retention

What’s easier than customer acquisition? Customer retention. 

This basically means providing the best quality customer care possible. And no, not just when your customers are looking for a fix. You need to take care of your customers in general. 

For SaaS, this means offering timely updates and asking for feedback. Most big companies invest in Customer Relationship Management for a reason. 

These CRM teams are meant to capture the loyalty of customers. This might be done in a variety of ways. SaaS startups can never afford to stop developing their software. It’s your job to find out what improvements your customers are expecting and then deliver them. 

Ignoring your existing customers by not updating your product is the easiest way to lose them. This is why most companies keep offering their existing customers newer deals to keep their attention. 

Will CRMs cost you a significant amount? Yes. But it’ll still cost less than new customer acquisition. And remember, you’ll just be growing the CLTV value of the existing customers. So, the ratio remains the same even if you are spending more. 

Focus on Repeat Customers

You don’t need to guide repeat customers through the entire Sales Funnel again. That saves you a huge lot of money on customer acquisition. 

How can you specifically focus on repeat customers? Segment your customers while marketing. For example, if you practice email marketing, the tools will let you know who your most highly engaged customers are. Focus on them specifically. 

With repeat customers, you don’t need to offer the entire sales pitch once again. They already know your products. So you can just cut to the decision stage of the Sales Funnel directly. 

Also remember, repeat customers are great for getting good reviews. If they’re buying from you again, you can be sure that you pleased them the first time. 

A/B Test Your Website

A/B Testing is done for the exclusive purpose of increasing the conversion rate of your website.  It’s the process of offering your users two versions of your webpage so that you can understand which one they are more likely to choose. 

Through this process, you understand which elements are working out better for your site. And I don’t just mean the basics of the user interface here. You can test out the form and look of the content that you are putting out as well. 

What you get in return is cold, hard data on which you can base your further website development or business decisions. 

How does this help you cut down on the Customer Acquisition Cost, though?

Because A/B Testing takes away the element of guesswork. A/B testing is neither based on guess work, nor does it give you data that requires you to do further guesswork. 

Whenever guesswork is involved, you stand to spend a whole lot of money without the promise of getting a similar return. Both website development and marketing takes a whole lot of money. You shouldn’t just hire a team of experts and tell them to make changes on what you FEEL isn’t working right. You have to KNOW what works and what doesn’t before you start spending money.

A/B Testing itself takes money but it also saves you money in the long term. 

Use Marketing Automations

Marketing Automations will themselves cost you money. So why am I recommending it? Because they will also cut down on your cost of labour. 

And not just that. You don’t just pay people, you pay people according to the time spent in doing a particular work. This means the more time it takes for a marketing campaign to be organised, the more you pay. 

But automated marketing campaigns obviously take way less time and manual effort to set up than regular campaigns. Since your marketing budget is the prime component that makes up your CAC, lowering your marketing costs obviously lowers your CAC as well. 

But that’s not the only perk of using marketing automation. If you have ever used an email marketing tool, you’ll know how effective these marketing automations are. These tools show you exactly which segment of customers are engaging with you the most. So if you are focusing on customer retention, these tools will let you cater specifically to a loyal customer base. 

So, yes. Marketing automation WILL cost you money. But they’ll save you money in the long run.

Referral Programs

Most small businesses depend heavily on referral programs. This is one of the surest ways of getting new customers without spending a lot of money. 

Provide your existing customers with discounts if they successfully manage to get you new customers through referral. Won’t these discounts cost you money? They sure will. But then, you’re still spending a lot less than you would have to with regular marketing. I mean, think about it. The CPC of some keywords is $3-$4! This means you have to pay this money every single time someone clicks on your ad. And this click does not even guarantee you buyers. 

Even if you have to offer a customer a $30 discount to get a new customer, that’s still a win! 

Also, there’s an added perk that you should be considering. When customers recommend you to others, these new people are much more likely to trust their reviews. After all, customers trust other customers more than the business owner. So, you get the added element of social proof along with a guaranteed new customer.

Reduce Customer Churn Rates

Customer Churn Rate refers to the percentage of your site visitors who abruptly stop engaging with your site. 

Remember, having a large number of customers is not just enough. If you cannot RETAIN these customers, your churn rate will be huge. This basically means you have to spend money all over again to get new customers. 

So you’re basically spending two or three times the money to keep the same number of customers. 

This is why you need to figure out quickly what is leading to your increased churn rate. Figuring this out will basically help you to plug a hole in a sinking ship. Only after you have done this, can you start focusing on anything else. 

The first thing you need to do is reduce your bounce rate. Using a heatmap tool or a screen recording tool is a great way to figure out why people are leaving your site. Maybe you have bugs, maybe they’re getting confused by too many CTA buttons. Or maybe they cannot find your CTA button at all! No matter what the reason is, fix it. Fast. 

Remember, some people are always going to leave your site without buying or stop buying from you after the first time. That’s completely normal. But the key is to reduce this number as much as possible. 

Focus on the long-time loyal customers. The more you focus on customer retention, the lower your churn rate will be. The lower your churn rate is, the less you have to spend on new customer acquisition. 

Choose Low-CAC Marketing Options

Take a look at this chart first. 

Not all kinds of marketing cost the same. 

As I’ve told you before, participating in Google’s PPC campaigns takes a LOT of money. If you’re a startup, you should probably not be aiming for paid search marketing as your first option. 

Try SEO/Content marketing first. Yes, this is not a very targeted form of marketing. But it’s almost free. Google even provides a host of free Google tools to boost your SEO. 

If you think that’s not enough, go for email marketing. This is also almost completely free till you get a lot of subscribers. Plus, the ROI on email marketing is WAY higher than that of social media marketing. Tools like Mailchimp are completely free till you reach 2000 subscribers. 

Choose wisely. You can always use the more exciting forms of marketing when you start earning big. But doing a lot of paid promotions right after starting out isn’t a great idea. 

In Conclusion

Remember, CAC is not a crucial metric in isolation. It depends on other factors like CLTV and your own business model. If you want to delay your monetization process like Kunal Shah, feel free to have a high CAC initially. But if you don’t want to take that risk, do follow the advice in this article. 

This article covers every aspect of Customer Acquisition Cost. What is it? How to calculate it? What should your CAC be? How does CAC relate to CTLV? And most importantly- How to reduce your CAC. 

If you have any further questions, please let me know in the comments below!

Frequently Asked Questions