CAC: A Hero or a Villain?
It's hard to imagine running a successful business without thinking about the Customer Acquisition Cost (CAC). This seemingly straightforward metric calculates the cost to convince a potential customer to buy a product or service. It includes costs such as advertising expenses, sales expenses, and other related costs.
CAC's calculation formula seems simple on the surface. You take the total cost of sales and marketing over a given period, including costs like salaries and overhead, and divide it by the number of customers acquired in that same period. However, despite its apparent simplicity and undoubted importance, is CAC really the comprehensive metric we need it to be?
While CAC provides valuable insight into the initial investment required for customer acquisition, it falls short in providing insights into the duration or return on that investment. Moreover, it's difficult to define what constitutes a 'good' CAC, as it heavily depends on the nature of the customer. For instance, acquiring an enterprise customer in a B2B model might be significantly more expensive than acquiring an individual consumer in a B2C model, or an SME. As businesses and customer segments become more varied, we need a more nuanced metric.
The Dawn of the CAC Payback Period: A Richer Tale of Profitability
In response to the limitations of CAC, a more evolved measure emerges: the CAC Payback Period. This metric expands on the foundations of CAC by considering the time it takes for a company to recoup its acquisition cost, factoring in the gross margin associated with each customer.
The CAC Payback Period is calculated as follows:
Calculate the CAC: (Total sales and marketing expenses) / (Number of new customers)
Calculate the Gross Margin per Customer: (Revenue per customer - COGS per customer) / (Revenue per customer)
Calculate the CAC Payback Period: CAC / (Monthly gross margin per customer)
These calculations yield the number of months needed to pay back your customer acquisition cost. One element to take into account are onboarding fees, these can significantly impact the CAC Payback Period. Onboarding fees, when applicable, are typically one-time fees charged to new customers at the beginning of their relationship with the company. These fees often cover the costs of implementing a service, setting up an account, training, and so forth. If you collect significant onboarding fees from customers, these fees could help recoup the initial CAC quicker, thereby reducing the CAC Payback Period. Although it would make sense to keep a view of payback period with and without onboarding fees.
The Journey from Static to Dynamic: The Impact of Payback Period
The key strength of the CAC Payback Period is its dynamic nature. Unlike the traditional CAC, which offers a snapshot of customer acquisition cost at a certain point, the CAC Payback Period allows businesses to understand the evolving relationship between the company and its customers over time.
The CAC Payback Period can have a direct impact on a company's cash flow and profitability. A longer payback period means a company bears the upfront cost of acquiring a customer for a longer time before it can recover its investment.
The Next Chapter of CAC: From Cost to Payback
Is the CAC truly dead? Not at all. The CAC has evolved, transforming from a static cost indicator to a dynamic tool for assessing investment returns over time. The phrase 'long live CAC' still rings true, but now, in its upgraded avatar as the CAC Payback Period, this metric continues to shape sustainable growth strategies for businesses.
As the business landscape becomes more dynamic and complex, so too must our metrics. The evolution of CAC into the CAC Payback Period embodies this shift, proving its continued relevance in guiding business decisions. In the kingdom of business metrics, the message is clear: long live the evolved CAC.
The informed reader immediately noticed we didn’t mention Customer Lifetime Value (LTV), this of course is also a key metric which is often looked at in combination with CAC. But given its important, we’ll uncover the secrets of LTV in a separate blog. Stay tuned!
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