One of the best ways to grow your business is by acquiring more customers. If you solely grow through extending the value you get from your few customers, you run the risk of becoming a captured company. We see this at a micro level where independent contractors with one golden goose client forcing them to convert to W2 employees.
If you know how much it costs to acquire a customer, and you know your customer lifetime value, you can then make the rational decision to invest in acquiring customers because you’re going to make the money back over the lifetime of your business relationship.
Of course, the formula is a bit more complex than “if LTV > CAC, invest heaps in customer acquisition!”.
For example, there is also the cost to deliver the service to the customer. And there is the cost of capital to acquire the customer. So therefore, VC firms have the golden ratio of 3+ as LTV/CAC ratio. But VCs target 30%+ IRR on their portfolios. If you are working with a bank having cost of capital around 10% – 20%, you may be able to get away with a lower LTV/CAC ratio.
So how do you calculate Cost of Customer Acquisition?
You take the amount you spent on marketing during a given month and divide it by the number of new customers in that month.
Let’s take this business, Code For Cash, as an example. In August 2017 we had 17 new customers. What were our marketing expenses?
Facebook ads – ($390)
Reddit ads – ($112)
Amazon marketing services for our ebooks Software Engineer’s Guide to Freelance Consulting and 30 Days To Your First Freelance Programming Client– ($2000) with $1260 in ebook royalties so ($740)
Freelance blog content – ($600)
$1842/17 customers = $108 to acquire a customer. According to this analysis, $108 is our CCA.
Unfortunately, this is too superficial an analysis to have any value. The truth is, marketing programs pay off in months. You would also have to look at my marketing spend for July, June, May, April, March – and the customer signups – to get greater accuracy. Not only that, but I am probably forgetting lots of other relevant costs: SaaS programs used to automate the marketing, freelancers hired here and there for miscellaneous tasks, etc.
So, let’s get more accurate data:
Looking at the preliminary report from our bookkeeper Jamel Salter our marketing spend for the past few months is:
Sep Aug Jul Jun
2,419 3,641 3,680 5,661
If we credit the revenue from Amazon royalties, approximately $4500, that’s $10,901 in marketing spend. We added 31 customers over that time period: customer acquisition cost is actually higher than our preliminary estimate, at around $350.
Strategy for lowering customer acquisition cost
What does it take for someone to become a customer?
They have to:
A) Learn about our business (visit our webpage)
B) Sign up for a free trial
C) Convert their free trial into a paid subscription (establishing themselves as a customer)
Note: for the purposes of calculating CCA, only people who make it to stage “C” count. However, people in B and A should be treated as customers – prospective customers, that is.
So in order for us to lower our customer acquisition cost, we need to: educate people on our business for a lower cost; improve our webpage so that more people sign up for the free trial; and do a great job during the free trial so that more people become paying customers.
What are some concrete example tactics?
Educate people on our business for a lower cost
- Rely more heavily on content marketing, posting it on social media without promotional fees. This article is an example.
Improve our webpage so that more people sign up for the free trial
- Improve the design of the page so that it signals high quality
- Remove the credit card requirement from the trial signup
Convert more trials into paid subscriptions
- Aim for a 0% defect rate – 0 errors raised per customer
- Measure # of gig opportunities available for user immediately: add additional markets to the database; write content that is also aimed at acquiring business customers (who will submit original gigs to the network)
My hypothesis is the highest impact things we could do would be to remove the credit card requirement from the trial signup, aim for a 0% defect rate through automated testing of key customer workflows, and adding new markets. So that’s what’s coming up on the product roadmap!