How To (Actually) Calculate CAC
CAC specifically measures the cost to acquire a customer. Conversely, CPA measures the cost to acquire something that is not a customer — for example, a registration, activated user, trial, or lead. The two are related because CPA is usually used to measure the cost of things that are leading indicators of CAC.
The basic calculation of CAC and why it’s wrong
If you google ‘how to calculate the cost of customer acquisition” you will get the basic formula below:
CAC = Total Marketing + Sales Expenses / # of New Customers Acquired
On the surface this is correct, but it is missing a lot of details and definitions around each variable in the equation to get it right. Start writing today. Use the button below to create your Substack and connect your publication with Top 10 PM Point
To adapt this spreadsheet for your own calculations, click here,
But what if I told you the following things:
It takes on average for most customers 60 days from lead to becoming a customer.
Not all customers are new customers, but some of them are returning.
This is a freemium product and there are costs to supporting users while they are free before they become paying users (customers).
How to really calculate CAC
There are three key questions we need to ask to define a more accurate calculation of CAC for a business. All of them dig a level deeper into the variables in the equation.
Question #1: How long between your marketing/sales touch points and when someone becomes a customer?
The first issue with the basic calculation is that it doesn’t take into account the time period between when you spend the marketing/sales money and when you actually acquire a customer.
Example 1: Freemium Product:
When you sign up for Dropbox you start using their free tier. You use Dropbox free for some time period until you hit your storage space limit, which you then might upgrade. For a lot of users that time period is months (and in some cases over a year). The story is the same with other freemium products such as Evernote, Buffer, etc.
Example 2: SaaS Company w/ Inside Sales
In most SaaS companies with inside sales models, someone might become a leader this month (due to our marketing efforts this month) but will take 60+ days before they become an actual customer because they need to go through the sales process.
If you don’t take these time periods into account, you could be overestimating or underestimating CAC and as a result, making some terrible operating decisions.
Here is an example of how you could overestimate. In the below example, CAC is calculated by taking the month’s marketing costs and dividing it by new customers in the same month.
In March we try some new channels which causes a large increase in marketing costs. Under the simple calculation, our CAC is $148. If our target CAC is $125, we would likely make the decision that March was unsuccessful and we would turn off those new channels.
But, let’s say it actually takes 2 months for someone to become a customer. Below is the same data but changing the calculation to account for this 2-month period.
This change tells a completely different story. In March we have a CAC of $84 and in April a CAC of $111. Instead of turning off the new channels we tried in March, we would probably make the decision to scale them.
The key question about the time between marketing/sales expenses and acquiring a customer does not matter if you fall into one of two scenarios:
1. The time between the marketing touch point and someone becoming a customer is very short. This is true for a lot of B2C companies that have very short decision funnels for users: Snapchat, Instagram, and others.
2. Your marketing/sales expenses are so consistent that it normalizes themselves out over time. But even in this case, it is best to be more accurate.
You need to figure out how the timing of the expenses correlates with the timing of someone actually becoming a customer. Marketing expenses could correlate differently than sales expenses.
The simplest way to account for this is to figure out your average marketing/sales cycle. In other words, what is the average amount of time from the first marketing touch point to acquiring the customer?
Here’s an example. Let’s say we are a SaaS company where the average time is 60 days from lead to customer and we believe the sales expenses are spread evenly over that two-month time period.
The CAC equation would be as follows:
CAC = (Marketing Expenses (n-60) + 1/2 Sales Expenses (n-30) + 1/2 Sales Expenses (n)) / New Customers (n)
n= Current Month
Here is an example model with that calculation built-in:
Question #2: What expenses do you include in the Marketing + Sales?
The second question you need to answer to get an accurate CAC calculation is what expenses do you include in the numerator (marketing/sales)? Before we look at some examples of the answer to this question differs, here are the three most common mistakes I see:
Not Include Salaries: You need to include the salaries of all people working on marketing and sales. A CAC number with salaries included is often referred to as a “Fully Loaded CAC.”
Not Including Overhead: Similar to the mistake of not including salaries, you need to include the overhead (rent, equipment, etc) allocated to those employees working on marketing sales.
Not Including Money Spent On Tools: The marketing and sales tool space has exploded. Most teams are using 10+ tools to operate their marketing and sales machine. These tools can add up in cost and need to be included in the expenses of your CAC calculation.
The Fully Loaded CAC equation would be as follows:
Marketing Expenses + Sales Expenses = Salaries + Overhead + Cost of Tools
If you include those main things, the answer to this question starts to get a little more complicated and ranges from company to company.
Case #1: Spotify and the Case of Freemium
Spotify is a freemium business. They have millions of users using the free version of their product which helps them acquire new users through sharing music and other viral channels.
In most companies, product, engineering, and support are not included in CAC (typically part of R&D). But if the free product is your primary method of customer acquisition, shouldn’t the expenses that support that free product is included in the expenses portion of your CAC calculation? There are different opinions to this question, but we fall on the side of yes.
If you had engineers, PMs, and other roles on the marketing or sales team for marketing/ops you would include those salaries and expenses in the CAC calculation. The engineers, PMs, or other roles might not technically be on the “marketing” or “sales” teams, but they are still expenses that are required to support new customer acquisition.
Case #2: Dollar Shave Club and the Case of Subscription E-commerce — Support, Shipping for Free Trial?
Dollar Shave Club is a subscription eCommerce business. They famously have a one-month trial for $1. That one-month trial has a number of expenses outside of marketing, including shipping costs for the initial package, support during the trial, and other costs. Should those costs be included in CAC? The answer to that depends on how you define a new customer.
In Dollar Shave Club’s case, we would make an argument that someone on a $1 trial is not a customer yet. A new customer is someone that extends beyond the trial. Therefore all of those costs associated with supporting the free trial should be included in CAC. Those costs are partially offset by the $1 trial payment, but not fully offset.
A customer is a customer, right? Not necessarily. When it comes to calculating CAC, we need to distinguish between new and returning customers. In most organizations, there are marketing and sales efforts focused on new customers, and there are marketing and sales efforts focused on retaining or getting customers back.
The mistake is only including marketing and sales expenses in the numerator for new customers, but including all customers (including returning customers) in the denominator. This will make your CAC look artificially low. You can solve this in one of two ways:
1. Include all marketing/sales expenses (including those focused on retention) and all customers.
2. Separate expenses for new customers from reactivating old customers and separate out new from reactivated customers in the denominator.
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