Do you know what your actual CAC is? It is higher than you think.
How to acquire customers/users — the one question that keeps the head of marketing awake every night at every single business, new or old. Call it traction or name it anything else, this has always been and will continue to be the biggest challenge. And the cost to get every single foot through the door keeps on getting higher and higher.
THE INCREASING CAC
CAC = Customer Acquisition Cost
There may have been a time when ‘build and they would come’ would have been applicable to businesses. Today, it is no longer so. Businesses in every sector are struggling with ways to rope in new consumers, and that is why you see a flow of offers all around you:
- Real estate developers keep on coming up with more and more attractive payment plans for new home owners.
- Credit card companies offer zero annual fee cards, and waive off annual fee for first year (or two) on cards where an annual fee is applicable.
- Fashion retailers come up with newer schemes every season to increase footfall in their stores.
- Most of the online businesses offer attractive additional discounts to their new users. Grocery, home services, lifestyle products — you name it, and the new user is being wooed in the same way. Additional savings.
It would be important to note here that all these costs that businesses are subsidizing to incentivize consumers is in addition to the cost they are bearing to get this message out. Real estate developers take up ad space in newspapers, radio stations, billboards. Same for fashion retailers. Banks offering credit cards are promoting themselves everywhere — most prominently via affiliate networks. And whatever you do, you always come across ads by internet startups — on facebook, youtube, in the middle of your favorite game app. Everywhere.
There are so many businesses around us today that the race to grab the consumers’ attention has been consistently driving the costs up. Be it for a single click, or for generating a lead.
Those pennies and dollars just keep on adding up.
I KNOW ALL THIS! HOW IS THE CAC HIGHER?
Yes. I’m aware of the trivial nature of what we just talked about. The reason why I say the CAC is higher than what many of us think is based on a number of discussions I have had with fellow entrepreneurs, startup founders and marketeers in recent past.
Whenever I have put across the question — “What is your CAC?”, the answer I have received is the number they are being reported from their facebook or adwords campaigns. The thing is, that data is off — often by a factor of 5, at the very minimum.
First of all, let us remember that there is a percentage drop off at every step of your business process. It doesn’t matter how amazing a product or service you are offering, you will never be able to convert 100% of the traffic. Let us call that the
second law of startup thermodynamics.
Even if you were to offer iphones for $199, put up all disclaimers that the phones are 100% genuine etc etc, there will be a bulk of consumers who would ask that exact question — Is this fake? Will warranty be applicable?
And believe me, a deal doesn’t get sweeter than that, does it? After all,
if you don’t have an iphone, you don’t have an iphone.
So. You will have a percentage drop off. At every stage. Let’s take a scenario where you are paying your ad network for every single click.
We will also assume that whatever you are selling has been the next best thing since mankind has seen sliced bread, so you will not witness a massive drop off anywhere. Keeping things quite optimisic, let us assume a per-stage drop off of 40% before the big moment (when the consumer actually makes the transaction) and 20% at the final moment.
HOW MUCH IT REALLY COSTS WHEN YOU PAY $0.50 FOR A CLICK?
It costs you $0.50 for each click.
What happens next? Are you trying to generate leads, or getting the consumer to sign up?
There will be a drop off here, at 40%. Which means, you just paid $0.50 for 60% of a click. So your cost of each signup effectively becomes $(0.5/0.6) = $0.83 (67% higher)
Now, there will be a percentage of this base, who would leave after this step. They may or may not check out the product details, but they do not go all the way to adding the product to the cart. Once again 40%.
So, $ spent on getting things to the cart = $ 0.83/0.6 = $1.38
Now, there will be cart abandonment, people second guessing their decision, bookmarking this purchase for later, waiting for an approval from their spouses (Oh yes. That does happen), and countless other scenarios. Still. We decided, we will keep the drop off at this stage at 20% only.
So, cost for a successful transaction = $1.38/0.8 = $1.73
So, essentially, your CAC wasn’t 50 cents, it wasn’t even 83 cents, or dollar thirty-eight. It was $1.73, almost 3.5x what you paid for a click. And this was quite an optimistic approach, with all assumptions being in your favor — extremely.
Also. $0.50? Yeah, that’s never gonna happen. This is a more realistic portrayal of how the average CAC looks like.
THE WORST PART? THIS WILL GO HIGHER!
No. I am not talking about this going higher as your business grows; that’s a given. I am talking about this number getting higher right now. Our calculations aren’t done. Not by a long shot.
There are three metrics that you probably highlight in every single funding meeting you have — Churn rate, CAC, LTV.
Having a good LTV/CAC ratio is quite instrumental for the success of a business. Dropbox started the whole referral program primarily because the LTV/CAC ratio from their initial digital campaigns looked disastrous and unsustainable for the business.
But why will the CAC (that we computed earlier) go higher?
Because you will lose out on customers. A good portion of your customers will be lost right after that first transaction. What will you do then? You try to re-engage with them. Digital ads, emailers, text messages etc. You would try it all. Yet, somehow we don’t count these subsequent marketing expenses into computing our CAC. Why not? Ideally we should, isn’t it?
Even if we are losing out on just 40% of our initial base after the first transaction, and we are spending $1.38 — $1.73 again on having them transact for the second time, it should reflect in our acquisition cost.
SO. HOW TO CALCULATE THE REAL CAC?
Let us analyze data to come up with some definitive trends. If you are an ecommerce business, some examples of meaningful trends could be:
- 40% of customers who transact once more in the 30 days since signing up transact 5 times or more in the first 6 months, with minimal further marketing expense. (Emailers, text messages are cheap, so in the long scheme of things they don’t account to much.)
- 60% of customers who don’t visit the site/app again within 7 days of having signed up gets lost and need to be re-acquired in almost the same fashion as a new customer.
Remember Facebook’s “7 friends in 10 days” rule. What I am asking for here isn’t much different. The more you look at things this way — different points where your funnel is leaky — the better your computations will get.
IS IT REALLY NECESSARY?
If you want to build a business that’s sustainable, you need to get in touch with this number as closely as possible. SaaS companies have been known to spend even 12–18 months of ARR on acquiring a new paying customer and yet be profitable. How?
- Better average lifecycle. Despite drop offs and churns, the average years worth of billing incurred off of each paying customer is better than most businesses.
- Lower CAC on multiple channels — Word of mouth, referral, PR pieces etc have much lower CAC. Helps in offsetting the expensive acquisition on digital channels.
- Strong content marketing — You would notice most SaaS products to have a pretty robust content marketing plan. Why? Lower CAC, and better rate of return on drip.
- Upsell — This happens on two fronts. While existing paying customers upgrade to more expensive plans as they expand, customers on free plans upgrade to a paid plan once they see value in the services being offered.
All in all, the LTV of a customer is much better and there exist a number of ways to try driving the CAC a bit down. You can’t make those calls unless you know what your LTV is, what your churn looks like and how much can you afford to spend on acquiring a customer.
So. What are you waiting for. Fire up that spreadsheet and get cracking.
That’s it for today; see you tomorrow.
I am Abhishek. I am here... there.... Everywhere...