One metric that can put entrepreneurs out of business very quickly is customer acquisition cost, and surprisingly many don’t know what it is or how to calculate it.
Research shows that most businesses fail within the first 5 years, and that statistic has held true for a long time.
In my article on Why Most Small Businesses Fail, I’d say customer acquisition costs would fall under reason #9 “They don’t have a plan and they don’t stick to it”. Customer acquisition costs is a highly important metric that shouldn’t be taken lightly on any business plan because it can SHUT A BUSINESS DOWN QUICKLY.
Unfortunately, as entrepreneurs, we have this invisible metric called “Optimism”. We need optimism to invest in an idea without seeing it physically. Our optimism fuels many of our initiatives in the startup phase and as we’re growing, but sometimes, when we let optimism lead without being anchored onto facts and data, we can overlook very key metrics like customer acquisition cost.
- 1 Story
- 2 All Customer Acquisition Has a Cost
- 3 A Good Business Model Vs. A Bad One
- 4 The Plight of Every Business
- 5 How To Calculate Customer Acquisition Cost
- 6 The Correlation of Customer Acquisition Cost and Lifetime Customer Value
- 7 An LTV Example
- 8 Final Words on How to Calculate Customer Acquisition Cost
- 9 Now, it’s Your Turn…
I’m guilty for sure! I’ve written about several “business ventures” I’ve taken a shot at: from fish farming to ATM machines, and in the beginning of my entrepreneurial days, I was strongly led by optimism.
Nowadays, I’m much more careful. I’ve seen the pattern of how inflated my optimism can be when it doesn’t have facts grounding it, and I’ve noticed how customer acquisition costs can creep up on you.
All Customer Acquisition Has a Cost
Even the cheapest perceived marketing tactics can add up in costs quickly. For example, alot of the “hoopla” is about content marketing, PPC, and Facebook ads nowadays.
However, these things take time and money, and often times the people who are making blog posts saying these are good tactics to try are not adding in all of the costs: time, money, and energy. They are flashing tactics as if they’re easy when they all require work.
Content marketing takes an average of 6 months to see results even if you’re blogging daily (more than 1500 word posts) like I’ve done here. You have to let the content incubate after you’ve created it. Your site has to mature. You have to establish a trustworthy presence on the search engines and in the market. All factors that make content marketing work take time.
If you look at PPC (including Facebook ads) as another alternative, it takes time and effort too. From my experience, PPC is a significantly quicker path to results like traffic, but it’s also a significantly faster route to business shutdown IF customer acquisition costs are not measured closely.
A Good Business Model Vs. A Bad One
In his article, Startup Killer, David Skok talked about viable business models in comparison to ones that won’t work for long. In all business models, you have to balance customer acquisition costs with lifetime customer value.
A business that’s on the verge of shutting down looks like this…
(Image Source: For Entrepreneurs with David Skok)
A business that is thriving and has a bright future looks like this…
(Image Source: For Entrepreneurs by David Skok)
The Plight of Every Business
Every business starts out in the negative. It requires an investment.
You have to get your 7 systems set up: the lead generation system, the lead conversion system, the client fulfillment system, the branding system, the job prototypes, the branding system, the management system, and the leadership system.
The startup begins with a cost even if you use as many frugal and organic methods as you can. At the startup phase all businesses start off as an imbalance.
Customer acquisition costs are higher than lifetime customer value because you have to purchase everything for client fulfillment setup (maybe office space, computers, software, must-haves for product development, etc.), your lead generation(labor–even your labor has a cost!–automation software, web hosting, paid advertising, keyword research tools, training, etc.), your lead conversion (optins, landing pages, labor costs, and email marketing), the branding system (logos, brand style guides, and time to build trust), and we can go on.
In summary, everything costs, and in order to get out of the startup phase and to scale as a viable business model, you have to manage the costs by first clearly knowing what they are.
How To Calculate Customer Acquisition Cost
Now to the meat and potatoes of the article…
The best thing to do is to calculate the customer acquisition costs for all customers over a specified period of time rather than doing averages or picking a few optimistic examples from the bunch.
You do this by…
1. Calculating All of Your Direct Marketing Expenses
You may use ad platforms like Facebook, Bing, or Google Adwords. You have to track how much you’re spending daily, weekly, monthly, and quarterly.
Added onto paid advertising, maybe you use automation tools like eClincher, Hootsuite, Onlywire or some way to automate your social media marketing, track your mentions, and stay organized.
SEO takes time. Many people like to think of content marketing and SEO as “organic” or free, but that’s an absolute myth. There’s web hosting, training, plugins, and labor that costs.
If you make $0 from SEO efforts, you have to make up for it by getting income to pay your bills from somewhere, therefore, there’s an inerrant labor cost. What do you want to be paid monthly? Your labor costs is a cost.
Combine the Costs
Once you’ve collected all of the expenses for your marketing efforts, then you can see the expenses you incur over a specified period to acquire customers.
2. Calculating Other Costs
Maybe 100% of the traffic to your website or store doesn’t convert into a sale right away, but if you use email marketing, you can increase the customer acquisition or retention by adding them onto your email list. Email could be a viable cost for you.
You don’t want to do like I did and send all traffic to informational posts. Instead, you have to have a ratio of “money pages” also. These “money pages” can be:
- Review pages
- “Best of” pages
- Sales pages for your products or services
- Sales pages to an affiliate offer
- or Optin pages
Regardless of which option you choose for your money pages, you’ll have costs:
- Software like Thrive Themes (which I highly recommend) that gives you landing pages, optins, countdown timers, and other conversion tools
- A nice theme
- Transaction fees
A nice option for getting new customers on board is to collaborate with influencers, entrepreneurs, and bloggers in exchage for a percentage of the sale. When you have affiliates, they have to recieve a commission or payout of some sort. Commission payouts are a cost.
Maybe instead of having affiliates, you decide to have an in-house sales team who will fill their pipelines with prospects and close deals on behalf of your company. If you decide to have a sales team, guess what?
They’ll want pay!
When customers come with questions or concerns about the product or service, they need to have someone to contact. Customer service helps clear the air of important concerns. They also address payment issues, questions, complaints, and feedback. Customer service is a component that needs to be scaled as marketing does.
Anything Else Required for Marketing or Client Fulfillment
- Phone lines
- Email forwarders
- P.O. Box
- Office Space
- Video cameras
- Audio hosting
- Podcast equipment
- Company vehicles
- and others
Some costs can sneak up on us, so you may want to use your accounting software or bank statements to accurately gather the costs you have.
3. Calculate How Many Customers You’ve Acquired
Now, you have the expenses clear, and it’s now time to figure out the return on your investments. After all of that money was spent, how many customers did you get in return?
You can calculate how many customers you have by looking at your CRM software, checking out your Paypal account, or many people use Stripe. However you manage your buyers or commissions is where you would want to look to see how many customers you acquired.
4. Calculate the Acquisition Cost
Now, that you know your expenses and how many customers you’ve acquired, now you want to take your expenses and divide them by the number of customers. For example, if you spent $1000 to get 250 customers, you would know it costs you about $4 to get a customer.
The Correlation of Customer Acquisition Cost and Lifetime Customer Value
Now, your goal for your lifetime customer value has to take into account that most of your “leads” do not become “paying customers”, and the paying customers have to pay for your business expenses and leave profit.
Going back to our example, if it costs $4 to get a customer, then your lifetime customer value has to be more than $4.00 for you to have a viable business model.
An LTV Example
Let’s talk about McDonald’s…
They have television advertising, mail ads, real estate, they’re constantly changing out menu boards and promos on their windows. Their customer acquisition costs are well over the dollar menu income, right?
So, how are they able to balance customer acquisition costs and lifetime customer value?
They make each acquired customer worth the price. In my article on Customer Journey Mapping, I talked about analyzing your 7 business systems and analyzing pain points and opportunities to grow the relationship. To improve lifetime customer value you want to find:
How You Can Increase the Number of Customers
Jay Abraham recommends two ways to increase customers without adding onto acquisition costs. He says you should increase customer retention and increase referrals.
You can create more internal engagement with current customers thru blogging, newsletters, or finding other options to make a deeper more personal relationship. Being a subject authority ot trusted advisor to the customer cements a deeper relationship because they want to know your opinion on certain matters.
In addition to increasing engagement, creating a process to acquire referrals takes guerilla marketing up several notches, and large companies know this. You can ask customers if they have friends or family who would appreciate your service, you can create an affiliate program, or you can reward customers for sharing your product or service.
Increase the Value of Each Sale
Going back to McDonald’s, they know that most customers that come for the first time to buy ( even from the dollar menu) will come back more than once. Therefore, they don’t calculate their customer lifetime value as $1.
Instead, their customer lifetime value may be well over $100 because most customers think of McDonald’s as a non-threatening, low risk purchase. People buy McDonald’s over and over even when they’re broke!
An easy way they increase the value of each sale is by having the burger and the combo. The burger may seem like a low price and may have a low-profit margin, but they can make up for the thin margins by asking you, “Would you like a fry and drink with that?”. When you say, “Sure”. then they’ve instantly increased the value of the sale.
How can you increase the value of each sale in your business?
Improve the Frequency of Purchase
Not long ago, I received a card in the mail from my chiropractor with a complimentary adjustment for my birthday. I thought it was a genius way to increase the frequency of purchase.
Other companies send out a trial offer or Udemy does an amazing job with increasing the frequency of purchase with their sales. Sometimes, they offer sales where you get a discount when you buy more than one course. They have a “often purchased together” prompt, they do retargeting, and send out discounts if they haven’t seen you for awhile.
How can you improve the frequency of purchases in your business?
Final Words on How to Calculate Customer Acquisition Cost
The goal of this article was to show you how to calculate customer acquisition cost. If you’ve calculated it, and you’re off balance, don’t worry, just take note. Focus on increasing the lifetime customer value by getting more customers (either thru increasing retention or using a proven marketing method), increasing the frequency of purchase, or increasing the value of each sale.
If you have questions or concerns about this, don’t hesitate to leave them in the comments section. I’d love to help you out!
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Now, it’s Your Turn…
Have you had problems balancing customer acquisition costs with lifetime customer value? Were you able to fix that? How did you fix it? Leave your comments, questions, concerns, and feedback below.