12/11/2019

What Does It Really Cost To Acquire A New Customer?

Introduction

Revenue is the lifeline of every kind of business or organization. All businesses need loyal customers, both for the immediate purchases they make month by month, but also to recommend new customers to the business. Without satisfied and loyal customers, profitable success will elude business owners in the long term.

One of the numbers-you-need-to-know, in our series of the same name, is the customer acquisition cost, often shortened to CAC.

Why Care About The Cost of Acquiring Customers.

Businesses exist to make and keep customers. And the process of acquiring new customers, is anything but automatic, unless of course you run a monopoly business. 

“The true purpose of a business is to create and keep a customer, not to make you money.”
Theodore Levitt

It is very possible however, to lose money and or run into significant cash flow perils, growing a business with expanding customer numbers, if the ratio of the cost of acquiring customers, is not in a good proportional relationship to the revenue generated by those acquired customers, and the costs to serve them.

Customers however, are not all equal, and certainly not all equally valuable to the business. The marketing professor and guru, Theodore Levitt went as far as to say ‘there is no such thing as an average customer’. There are multiple different customer segments, and some customers are worth more than others to attract. 

If have too few customers, your business will starve given the fixed costs (staff especially), that drain your cash each month. If on the other hand you spend too much attracting new customers, you can end up with a larger business that requires more staff to run, and is more of a headache at a larger scale, but is less profitable in the end for the business owners.  

Business’s need to be especially careful about customer acquisition costs when they are embarking on new marketing efforts/programs either defensively in response to new competition in the business area, or proactively to support business growth aspirations. It is relatively easy to end up with a larger but less profitable business if there is not real clarity about the average customer acquisition cost, and subsequent customer value realised.

Definition

The customer acquisition cost (CAC) is defined as the average cost to the business of acquiring one additional customer. This is calculated from the sum of all customer acquisition expenses, divided by the number of new customers acquired per year – see below.

 

A common mistake in assessing CAC, is to undercount the complete set of expenses that are directed to bringing in new customers. If CAC is underestimated, poorly informed decisions will be made as to with regard to acquiring new revenue sources. Sometimes therefore a more demanding but explicit listing of costs is useful to drive a more rigorous assessment of customer acquisition cost data.

 

Contributors

Some of the acquisition costs are obvious – annual marketing spend, consultants fees, advertising, paid search etc. Most businesses using their accounting tools (Xero, MYOB etc) can fairly quickly find the direct marketing & consultant costs, and advertising expenditure. Using the practice management application (Exact, Dentrix, Genie, Medical Director etc), numbers of new patients, and non-active or lost patients may also be derived.

There are also non-obvious costs that should be considered such as:

– An estimate of reception staff time (and therefore annual staff cost) dedicated to handling new customer enquiries,
– Internal staff costs associated with team and administration activities associated with new customer enquiries and records,
– IT costs relating to digital assets (website hosting, design, content generation etc) that primarily relate to attracting new customers. 

These costs are harder to acquire, although not impossible, and estimates based on sampling is a good start towards a more formal activity based costing approach. These latter costs are real, and are a part of the customer acquisition cost, so to enable informed decision making, real effort should be expended to at least intelligently estimating these non-obvious costs, rather than putting them in the too-hard basket, and deriving an under-estimate of true cost. 

What businesses can and can’t influence 

The levers that businesses can move to positively influence the customer acquisition cost include:

– Increasing the referral rate [RR] (# new customers referred / yr /customer) by increasing customer satisfaction.
– Reducing churn rate [CR] by working on customer satisfaction,
– Increasing average longevity [AL] by increasing customer satisfaction

All of these require the business to be systematically sampling customer satisfaction and being able to locate this feedback to an individual customer record so dissatisfaction can be acted on, and promoters recognized and valued. The Net Promoter score system1 is perhaps the most established way of doing this currently, and there exists an extensive body of industry comparative data to compare results with.

Trailing vs leading metrics

Data must be first assembled to assess current levels or churn, the number of new patients acquired per year, as well as current customer satisfaction. If the business does not have these to hand, the business is essentially flying blind from a management perspective. They can only look at trailing results (financial – P&L, B/S, CF), as they turn up in the rear view mirror. By the time these are noticed, it is too late to do anything to impact them per se. This is why building a tool set of leading indicators is so important to enable steering the business into the market conditions ahead. 

Of all the leading indicators, ongoing customer satisfaction trends sampling using a tool such as Net Promoter Score, are probably the single most important metric. 

The main factors that businesses really can’t do a lot to influence are 

– The amount of competitive advertising for customer attention that exists over time
– Competitor customer satisfaction rates
– The customer churn (annual loss rate as %) that relates to non-satisfaction factors, e.g. relocations, illness, job changes etc.  

Customer acquisition cost also has a strong and highly interrelated relationship to other key numbers-you-need-to-know factors – Lifetime value, churn, treatment plan acceptance rate, and customer satisfaction per customer segment.

Summary 

In summary, the average (or even better – segmented) customer acquisition cost (CAC) is one of the key numbers-you-need-to-know to profitably grow a business. Business profitability & cash flow profile in the mid to long term is strongly influenced by the dynamic relationship between the cost of acquiring customers, and the value to the business of those acquired customers over the lifespan of their time as customers. 

Undercounting CAC is far more common than over estimating. Underestimation will lead to poor financial and marketing choices in terms of efforts to acquire new customers, and less insight as to which customer types are most (and least) desirable to acquire and serve.

Businesses can influence CAC by reducing churn rate by working on customer satisfaction, increasing average longevity by increasing customer satisfaction, and increasing the referral rate (# new customers referred / yr /customer), or by increasing customer satisfaction. All of these improvements, will all else being equal, reduce the customer acquisition cost, and therefore improve the CAC:LTV ratio, assuming LTV is stable. If LTV is improved, the ratio will improve even further. 

Building data sources to automate the tracking of customer acquisition cost as much as possible, is key to be able to make informed financial and marketing decisions about what growth is worthwhile, which customers to attract, and at what cost it is worthwhile to do so. CAC is strongly interrelated to the other numbers-you-need-to-know, i.e. LTV, percentage annual customer churn (loss), as well as the treatment plan acceptance rate (%), and customer satisfaction scores, (e.g. Net Promoter Score).  

Average (and segmented) customer acquisition costs are highly calculable, and a critical number to track for businesses needing to defend their current revenue against competitor market share threat, or those wanting to grow their customer base. 

References

  1. Net Promoter Score http://netpromotersystem.com/about/index.aspx 

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