How to calculate CAC: finally, the answer
How to calculate CAC seems a question for novices, but it’s not.
Calculating CAC is everything but straightforward. It requires some effort to be calculated, although the effort is worth. Having the CAC of your business, and having it regularly updated, is fundamental to understand your business profitability.
It is, in fact, one of the two parameters used to determine the business profitability, represented by the LTV-CAC metric (you can find out more about why LTV-CAC is the metric to monitor rather than LTV/CAC in this previous article).
In the LTV-CAC metric, LTV calculation is easy like drinking a glass of water. You just need to have the list of sales by customer and the direct costs of each sale (e.g. Paypal or Stripe fee, cost of goods sold). You can check out my guide about how to calculate LTV.
On the other hand, calculating CAC takes a bit more effort. First, to define what it means for you. Second, to compute it, since it may involve trickier calculations.
Why “how to calculate CAC” is the right question to ask
By definition, the CAC is the marketing and sales spend to acquire customers in a given timespan over the number of customers acquired in such timespan.
The CAC definition can be useful to grasp the concept of CAC. But how to actually calculate CAC stands in another page of the book.
The definition still plays the role of conceptual reference, but we should find a way to translate it into real-world practice.
What, in the CAC calculation definition, does not apply to real-world practice?
The number of new customers acquired over a timespan is easily retrievable in the practice, whatever your online business is (e.g. e-commerce, SaaS).
The marketing and sales spend dedicated to acquiring new customers is not a number immediately available in the real world.
The main reason why it is not immediately available in the real world is that we have in place an omnichannel marketing strategy, plus the customer takes time to decide and is influenced by our actions on different touchpoints, both owned and earned.
Therefore, we can not distinguish so clearly the marketing and sales budget allocated to acquire new customers rather than the budget employed to pursue other goals like branding and retention.
An example of the tricky point
Let’s consider a newborn e-commerce brand, using Facebook as its only marketing channel. It seems very easy to retrieve the CAC.
The brand has just written an interesting series of articles to be published on the brand’s website and conveyed to the audience using Facebook posts, aiming at empowering the brand and acquire new customers sharing the same brand’s values.
The articles discuss the fine materials the products in the store are made of, the people behind the brand, the brand story and some testimonials. Such articles are distributed on Facebook using sponsored posts, to reach the whole fanbase and its friends.
At the end of the campaign, we can summarize the results as follows.
- 100 sales in total, of which 50 from new customers and 50 from existing ones.
- 2000€ spent on Facebook PPC advertising.
- A full week of work of the Content Manager to write the articles.
Now, what’s the CAC of the 50 new customers?
An extremely simplified and ordinary scenario like this doesn’t lead to an immediate and straightforward answer. For this reason, I’m going to show you how to actually calculate CAC.
How to actually calculate CAC
To understand how to actually calculate CAC, we should first take a step back to the nature of costs.
In the case above, the newborn e-commerce brand, the campaign cost is made up a direct cost, the PPC budget, and an indirect cost, the personnel cost.
By definition, all the costs directly accountable to a specific activity are direct costs, while all the costs not directly accountable to a specific activity are indirect costs.
Generally speaking, all the costs to promote content on earned media are direct costs for a specific campaign. While personnel costs are indirect costs, since the time of the person (and hence the cost) is divided into different activities.
For these reasons, we can say that the cost of the campaign above made from the PPC budget (direct cost) and the cost of the Content Manager time dedicated to that activity (indirect cost).
Well, would this figure be the customer acquisition cost? No, we calculate the marketing campaign cost. But, since the campaign goal was acquisition and branding, the figure should be split between acquisition and branding.
It may be different if the campaign content was intended to promote a special discount for new customers. In this case, we may consider the campaign cost is fully accountable to the CAC.
How to actually calculate the CAC, then? The way is simply by defining your rules about what is in and what is out. Once done that, you’ve solved the enigma.
I know it seems a vague answer, but it is the best takeaway you could have, believe me. In any case, I try to give you an actionable insight into how to calculate CAC.
Long story short about how to calculate CAC
The truth about how to calculate CAC relies upon good sense. The latter suggests that CAC may be an overused performance metric, for two reasons.
The first reason is that it is very tricky to calculate and, especially in the early days of the venture, all the time needed to get the figure may not be available to the founders of anyone in charge of developing the business.
It is missing one point. You spend a lot of time calculating the CAC to be then compared with the LTV in the metric LTV-CAC to understand the business profitably. But, computing the metric LTV-CAC, you’re comparing the whole lifetime value of the customer with the mere cost to acquire him. You’re not including all the marketing costs to retain him and transform the first-time customer into a repeat one.
So, long story short, you can the Full Customer Marketing Cost instead of the CAC by following these steps:
- take all the direct and indirect costs of marketing and communication;
- retrieve the direct and indirect costs of activities 100% belonging to branding/communication and take the figures out from the whole spend;
- divide the remaining part of the spend by the whole customer base.
You now got the Full Customer Marketing Cost (per customer, of course) and you can compare it with the LTV to get a clearer and more complete view on your business profitability.
Simply, when someone tells you about his CAC, you now have a question to ask: “how do you calculate the CAC?”.