Melody founded Rhythm Road, a curated music subscription service specifically for in-car entertainment, just out of college. It was an instant success, and she leaned into each curve along the journey of building her business. Her social media ads were everywhere, her podcast sponsorships were hitting their stride, and new subscribers were signing up every day.
Unfortunately, you’d never guess her success based on her financial books. Despite the influx of new users, her profit margins were razor-thin, and she had a feeling she was spending money faster than she was making it. The problem was, she had no idea how to find the right balance between spending enough dollars to get customers in the door, but not too much so she wastes money.
Melody was spending too much to get her customers, and it was devastating her business’s financial health.
Before she secured a Fractional CFO, Melody felt like one of her customers, driving her car at night down a winding mountain pass without visible lane lines. She had plenty of gas in the car, and knew where she wanted to go. But for all she knew, she was an inch from the road’s edge about to fall off a cliff… or on the wrong side of the road speeding into oncoming traffic. She desperately needed someone to illuminate the lane lines so she could get to where she wanted to go in one piece.
Customer Acquisition Cost (CAC) is the lane line that Melody needed. She, like many business owners, treated sales and marketing like a “black box” – throw money in and hope customers come out. If you don’t know exactly what it costs to bring one person through the door, you can’t know if your business is actually viable in the long run. I’d love to paint reflective CAC lane lines for your business to ensure your expenses are right-sized for your revenue and business growth. Schedule a discovery call with me today to learn more about how knowing your CAC can keep your business’ financial health in check.
What is the formula to calculate Customer Acquisition Cost (CAC)?
You can calculate CAC by taking your total Sales and Marketing expenses spent on new customers (advertising, consultant fees, and the salaries of anyone on your sales and marketing team, etc.) and divide that by the number of new customers acquired within that same period.
While this formula is helpful, you should consider it more of a guideline than a precise number. When you are driving down the road, you don’t need to stay in the exact middle of the lane in order to be safe. You just need to stay within the lane lines – you have some wiggle room. The same is true for CAC because you will never know exactly how much of your expenses correlate to each customer.
Not every dollar spent in “Marketing” is for new customers; some of it is for retaining the ones you already have. That’s why the formula dictates sales and marketing expenses spent on new customers. You’ll never know the true percentage, but can estimate. For Melody, it was about a 70/30 split: 70% of her team’s time was spent hunting new business, while 30% was spent keeping current customers happy. For your business, it might be more 80/20, or even 40/60. Whatever the percentage, multiplying it by your total costs reveals a more accurate number.
Pro-Tip: Marketing dollars spent in January rarely result in customers in January. It might take three months for a listener to hear a podcast ad, visit the site, and finally hit “subscribe.” While the math looks exact, it’s a “soft” number. Take the monthly data with a grain of salt – the trend over time is the most important thing to watch.
What should every business owner know about CAC?
Calculating your CAC is just the beginning. To truly use this number to keep your business on the road, you need to understand how to maintain it. Here are a few tips to make sure your CAC is as accurate as possible and helpful as you handle the twists and turns of the business road.
Ensure your financial books are clean. You wouldn’t try to drive down a mountain pass with a tachometer covered in sticky notes, right? In the same way, don’t try to run a business with “messy” books. Tracking your expenses via specific categories in your general ledger is non-negotiable. You need a “Sales and Marketing” section that tracks relevant expenses to customer acquisition. Without a clean set of books, your CAC is just a willy-nilly guess—and willy-nilly driving is how you end up in a ditch.
Meticulously track your return on investment (ROI). Once your books are clean, you can look at the data from a different lens: ROI. You need to know which “road” is actually most efficient for leading customers to you. Use tracking tools like coupon codes, unique website landing pages, or Urchin Tracking Module (utm) tracking for different ads so that you know exactly where your customers are coming from. You can also use A/B testing to see what’s working and what isn’t. If you don’t know which marketing spend is failing, you can’t reduce those expenses. Experiment with different options and cut the dead weight. Then you can reroute those dollars to the channels with the highest ROI.
Watch out for diminishing returns. More isn’t always better when it comes to marketing. At some point, throwing another dollar at an ad campaign won’t result in more customers – just a higher CAC. Your last marketing dollar will rarely be as impactful as your first. Reach out to a Fractional CFO (like me!) for help finding that “sweet spot” before you hit diminishing returns.
Pro-Tip: How long do your customers stay on the road with you? This is what we call the “stickiness factor.”
High Stickiness: If you provide a service that is hard to replace (like a complex CRM or accounting software), customers are more likely to stay. Because they stay longer, they have a higher lifetime value, which means you can afford a higher CAC.
Low Stickiness: If you’re more like a gas station – where a customer can pull over anywhere else for the same product – you have low stickiness. You must keep your CAC very low to stay viable. Converting one-off purchases into recurring subscription payments (like Melody’s subscriptions) makes your business “stickier” and significantly more valuable when it comes time to sell.
Check your CAC regularly. Your CAC serves as lane lines that move with the road before you (and based on what you are doing), so keep an eye on it. How often you check it depends on your business. For example, a software subscription company should look every month. If your service is less “sticky,” you need to keep an even closer eye on it.
How can I right size my spending and improve CAC?
Balancing CAC with your profitability goals is a frequently-needed calibration. Don’t try to biggie-size your revenue without right-sizing your expenses. I can help you ensure every dollar spent is a dollar that grows your bottom line.
If you are ready to paint reflective lane lines on your business’ finances, let’s get your books cleaned up and your CAC calculated. Together, we’ll find where you’re getting the most “bang for your buck” and ensure your business is built for the long haul. Schedule a consultation with me today!
