Why Your Customer Acquisition Cost Will Destroy Your Business (And How to Prevent It)

Source: Neil Patel

Most of the business advice I read misses a piece of critical information.

You’ll learn about increasing revenue, boosting profit margins, or better marketing tactics.

These are all helpful, but they miss something critical.

You see, at the end of the day, it’s all about customers.

Getting a new customer is one of the keys to success for every company.

Research shows that most businesses fail in the first five years — a statistic that’s held true for the past 20 years.

Many of those businesses are generating tons of revenue and sales, but without the math on customer acquisition, the costs eventually bring them to their knees.

Why don’t more people focus on this?

Probably because customer acquisition isn’t easy to measure, and it certainly isn’t exciting.

It’s more fun to get tons of new customers, but not as enjoyable to realize that they simply aren’t worth the cost.

And no business wants to turn down eager customers!

So, how do you build a thriving business that drives conversions?

The secret lies in finding and using accurate customer acquisition numbers.

In this article, I’ll present the exact formulas for getting those numbers, and then show you practical ways to improve them.

First, let’s look at what customer acquisition cost is and why it’s important.

How to find your customer acquisition cost

Perhaps the most important part of the entire process is figuring out your total customer acquisition cost, or CAC.

While we could find a few representative buyers and determine the average price to acquire each, that’s not a great strategy.

You’ll inevitably cherry-pick clients who make things look favorable (even if you don’t want to).

We’re human, and we’re almost always too optimistic — especially when it’s about our own businesses.

Instead, you should calculate the CAC for all customers over a specific time period. This will give a more accurate picture. Choose a timeframe of at least a few months.

From there, you can calculate the customer acquisition cost in two ways: a quick method or a more accurate method.

The fastest method for finding your CAC: Just use marketing costs

In this simpler method, we’ll base our calculations off of our marketing costs.

You probably use a few different ad platforms, but most work similarly. In this example, I’ll show you how to find the cost of marketing using Facebook ads.

First, log into Facebook and go to the ads manager.

Click on the timeframe button near the top of the page.

Select the “custom” range.

Click on a start date and end date, and Facebook will automatically select the range between the two.

Hit “update” to finish.

Now, you’re going to want to look at the total spending during that time.

If you’re tracking customers on Facebook (I wasn’t for the campaigns I ran during this time), they’ll appear below and can save you tons of time.

Sometimes, you can’t track customers easily with Facebook, so I’ll show a different method in just a minute.

But for now, let’s look at the better method to find total costs.

The best method for finding your CAC: Use all expenses

While you can just use marketing costs, the reality is that you’ve spent more money on customer acquisition. You have to factor in costs like office space, web hosting, software, and your time to get an accurate number.

Marketing, while most closely linked to your CAC, isn’t the only expense.

If you use a program for tracking business expenses, you can easily calculate your costs.

I’ll be using QuickBooks Self-Employed for this example, but again, you can do something similar with any budgeting software.

Unfortunately, the default view doesn’t allow for custom ranges:

To fix this, click on the gear in the corner, and go to settings. Click on “reports.”

We have a lot of options here, but we want a profit and loss statement. Click on it.

On the timeframe selection, choose “custom.”

Like before, select your start and end times for the report.

When you finish, type in your email address. It’ll prepare a PDF report to send to you.

In a few minutes, check your inbox for an email like this:

Download the PDF that’s attached. At the bottom of the report, you’ll find “total expenses.”

This number is valuable because it tells you exactly how much you’ve spent during your specified period.

Now you know how much you’ve spent (either just on marketing or on the business in total). To finish the calculation, determine how many customers you acquired during that time.

How to find the number of acquired customers

Depending on how you manage your buyers, you probably have a particular system.

In this article, I’ll be using Stripe, since a lot of business owners manage payments through the program.

First, log in and click on “customers.”

On the customer panel, you’ll see a button to filter. Click this.

Select “created date,” and change the drop-down menu from “is in the last” to “is between.”

Now enter the date range (use the same timeframe for which you calculated your costs).

Once you’ve selected that, Stripe will provide you with the total number of customers acquired during your specified range.

The final step: Calculating your customer acquisition cost

Now that you have the total cost during a timeframe and the number of customers acquired in that range, just do some basic math — divide the cost by the customers.

If you spent $1,000 in the last three months and acquired 100 customers, your CAC is $10.

Knowing that number is important, but I know what you’re probably asking yourself: “Is my number a good number?”

We’ll get to the details in a bit, but here’s a small range of acquisition costs from other industries based on statistics published in Entrepreneur magazine.

You can compare yours, but remember that a “good” or “bad” cost depends far more on your specific goals than on broad industry averages.

Now it’s time to figure out the other part of the equation: How much is a customer worth to you?

How to determine your lifetime customer value

It isn’t enough just to know how much you spend to acquire a buyer.

You also need to know how much each customer is worth to your business.

Why? Because it gives you tremendous power.

Back in 2012, Amazon founder Jeff Bezos shocked the tech world by admitting that Amazon doesn’t make a profit on Kindles.

So, why would the company spend millions developing a product that doesn’t make them money?

Because Amazon knows the total value of each customer and is willing to invest in products to increase that lifespan. In the case of the Kindle, the bet paid off.

According to Bezos, people who buy Kindles read four times more books than they did before investing in Kindles.

Additionally, they don’t stop buying paper books. Kindle owners buy hardbacks, paperbacks, and audio books, too.

The Kindle is, at its heart, a marketing strategy — a strategy that Amazon could only deploy with a solid understanding of a customer’s lifetime value, or LTV.

But shockingly, LTV is out of the reach of most businesses, according to Invesp.

Few understand this number. Let’s change that.

First, calculate the value per billing cycle

If you sell a subscription product or software-as-a-service, it’s easy to calculate the average value of a customer.

Just take each billing cycle — one month, let’s say—and figure out how much the average customer spends.

If you don’t bill for a product on a regular basis, the math gets a little trickier. You’ll need to figure out two metrics: the frequency of the purchase cycle and the value of each purchase.

For example, an e-commerce site would calculate the size of each cart and how often customers order.

A company like Starbucks, with multiple purchases per week, calculates it like this, according to an analysis by Kissmetrics.

But there may…

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