Understanding CAC
Customer Acquisition Cost (CAC) is one of those baseline metrics you need to understand. It is one of the key costs of doing business along with your Cost of Goods (COGS), operational expenses (OPEX) and promotional plan. Often marketing costs are an aspect of OPEX, but we’re breaking it out so we can evaluate our CAC thresholds.
Definitions
CAC (Customer Acquisition Cost) = Cost to acquire a customer
CPA (Cost Per Acquisition) = Cost to acquire a lead, activation, trial, etc.
CAC is something that was introduced part way through my marketing career, and it was an eye opener. Prior to that, we simply looked at a Return on Investment (ROI) on a marketing activity. If we were making a certain amount back, that was fine. With CAC, we can set a target as a % of a product’s value which gives us a ceiling to which we control costs.
Negatives of CAC
There are some notable challenges with CAC targets:
It can be short sighted if you don’t factor in the Lifetime Value (LTV) of a customer
It can be difficult to set for companies with a wide variety of products that have different margin targets
As marketing costs go up, in can handcuff you to an unrealistic target
Cac Formula Walkthrough
Let’s look at the simplified, hypothetical scenario of selling a $100 item online.
Simple CAC formula:
Costs:
$200 Internal Labour Costs
$650 Google Ads Spend
$100 Agency Fees
$50 Tool/App Fees
Total Costs
$1,000 Advertising Costs
Number of Customers
100
$1,000 / 100 =
$10 CAC
Remember that your advertising costs should include all aspects of advertising. Your team, tools and any outsourced support has to be in that advertising line.
Expenses
Cost of Goods
Your Cost of Goods Sold (COGS) is another pillar financial number. This is needed in computing your gross profit, which helps understand how successfully a business is being run.
This number is only impacted by the costs of acquiring/manufacturing. So labour, materials, inventory, transportation from overseas; things like that. The cost of selling that good is different, which is why we have CAC. So, think to yourself, if I had sold nothing, would I have paid this cost? If so, it goes into COGS.
OPEX in eCommerce
Operating Expenses (OPEX) accounts for various cost of operating your business. Historically, we would see things like rent, utilities, sales team, payroll, etc. For eComm companies, some of these items change to things like platform fees and app fees.
SG&A
Selling, General and Administrative Expenses (SG&A) are a separate line item from COGS. These are nearly all the other business expenses apart from acquiring customers.
Margin Equation Walkthrough
big risk of always discounting your product is it decreases the perceived value of the product. If it’s worth $1000, why are you always selling it at $500? The questions I always try to answer is:
Costs
$200 Interal Labour Costs
650 Google Ads Spend
$100 Agency Fees
$50 Tool/App Fees
$1,000 Advertising Costs
Number of New Customers
100
$1,000 / 100
$10 CAC
COGS
-5 Website/ App Fees
-$40 Raw Product Cost
-$45 COGS (Cost of Goods Sold)
$100.00 Retail Product Price
-$10.00 CAC
-$45.00 COGS
$45.00 Gross Profit
45% Margin %
30% Margin Target
15% Total Amount Available for Discount
Margin Target
Your company may have targets for margin to account for profit targets and other corporate expenses that you might not have visibility into.
Related Article: Applying CAC to Search
Learn how to apply these methods to optimizing your search advertising and create measurement standards to hold your performance accountable.
Key Takeaways
Understanding CAC is critical to profitable advertising. With this formula, we can evaluate the performance of our advertising against an acceptable target.
Essentially, if you’re within your grounds of CAC, you’re acquiring customers profitably!
Having worked out all the various costs in your supply chain and sales process, you know how much meat is left on a product that can be used for ads and promotions.
