CAC IS THE UNKNOWN KILLER FOR BUSINESSES.

Businesses exist and grow only because they have customers. Whether it is a D2C brand, a B2B business, a SaaS enterprise or a fitness brand – everyone needs customers. Then why is it so difficult to predict how will a brand or a company acquire customers? Let us discuss in detail what is CAC in various types of setups.

What is CAC or Customer Acquisition Cost?

Before we start getting into elements of CAC, let us understand what exactly is CAC. As the name suggests, it is the average cost of acquiring one customer. Lets take a simple example wherein an organisation spends Rs. 50 in marketing and gets 10 customers from the campaign. In this case, the customer acquisition cost or CAC is Rs. 5/- (Rs. 50 / 10 customers). 

Mathematically, all spends on marketing divided by the number of new customers for a given period gives the CAC.

How does one calculate customer acquisition cost for a D2C brand?

A D2C brand or direct to consumer typically would have an online setup. Lets assume they have their own website where they are selling from and have created social media presence on Instagram. They want to start off by using Instagram as a platform to promote their products and brand and sell on their website. After the initial few months, the brand realised that the traction is not as high as they wanted it to be. So they decide to run some discounts to take advantage of the festive season around the corner. They offer a 20% discount on all orders. Let’s assume their average order value or AOV on the website of Rs. 1,000/-. The customer acquisition cost in this case becomes Rs. 200/- (20% of Rs. 1000).

To grow their business further, they decide to run Meta ads to get new customers into their fold. In the first month, since there was very little brand awareness, they spent Rs. 10,000/- in ads and managed to get only 100 customers. In the next month, a larger set of people were aware of the brand. The customers who bought in the previous month also advocated for the product and got in newer customers. During the month, with the same Rs. 10,000/- of ad spend, the number of new customers went upto 150. This snowballing effect continued and in the 3rd month, the number of new customers went upto 250 for the same ad spend. This means that during the 3 month period, they spend Rs. 30,000/- to acquire 500 customers, giving them a CAC of Rs. 60/customer.  If the 20% discount continued, that would add another Rs. 200/- as a part of customer acquisition cost for an average order value of Rs. 1,000/-.

Whether this good or bad? What about repurchases? We will discuss these questions once we have discussed a few more scenarios.

What happens to the CAC for marketplaces like Amazon?

Lets take the D2C example ahead. Now after running ads on Meta, they think they have well established processes to take the sales higher. So, they list their product on marketplaces, say Amazon. Is there a customer acquisition cost there? Typically, most of the marketplaces like Amazon, Flipkart, Meesho, etc. have a free listing of products and charge a commission basis the product category and the price of the product. It could vary from single digits to as high as 30%+. Some platforms like Etsy also have a listing fee. Even on Amazon, once a business wants to list for sale in different geographies (they started with Amazon India and then want to move to Amazon US or Canada), there is a fixed monthly charge that they need to pay irrespective of the number of items they sell. 

For simplicity, lets assume the business is selling on Amazon in India and the commission on the sale of the product is 25%. This 25% then becomes the customer acquisition cost or CAC. Further, to enhance the sales and growth on Amazon, the business decides to advertise the product on Amazon. Similar to the example of Meta ads, lets say here the CAC comes out to be Rs. 50/customer. Now assuming the price of the product to be Rs. 1000/-, the total CAC in this example would be Rs. 300/- (Rs. 250/- As amazon commission and Rs, 50 for the advertising). Further with a big Amazon sale around the corner, they decide to give an additional 10% discount on the products. In this case, the customer acquisition cost becomes Rs. 400/- (10% of Rs. 1,000/- getting added to the existing Rs. 300/-).

 What is the CAC in case of offline sales?

Now, after a few months of stabilising the only model, the brand decides to go to offline sales channel. They start off by contacting a local store to place their product. Typically, the store owner is going to ask for a margin of anywhere between 20-30% for a new brand. In addition, there may also be a cost or rent for the shelf space he is providing. So the customer acquisition cost is going to be a combination of fixed and variable expenses. Lets say he charges Rs. 2,000/- per month as the rent for the shelf space and agrees for a margin of 20%. Again, let the average order value be Rs. 1,000/-. If he is able to generate 10 such orders, the customer acquisition cost would be Rs. 400/- (Rs. 200/- as margin, 20% of Rs. 1,000 + Rs. 200/order, rent of Rs. 2,000/10 orders). In addition, you might run some introductory offers / discounts for the customers, hire some promoters over the weekends to promote the brand and so on. All these costs will get added while calculating the CAC for the offline store. Even with all these efforts, the products do not move as expected, there might be some offers that are needed to be run, further adding to the cost of customer acquisition.

As we see in the scenarios above, every sales channel comes with its own CAC associated with the sales. Once the business understands the costs and the benefits / sales, it is upto the business to decide whether the CAC for a particular channel makes sense to pay for for the sales it generates. Whether discontinuing a channel makes more business sense to ensure lower revenues at better profits or is it worth continuing for the contribution it has to the top line and brand visibility – a strategical call every business has to take for their own business.

Before we move on other business models, lets answer the questions we raised earlier.

How are returning customers treated?

Customer acquisition cost or CAC can be looked at in different ways depending on the purpose. If one is evaluating a particular campaign, the returning customers are not accounted for. If a slightly longer term view of marketing efficiencies is to be looked at, the returning customers are also taken into account and the customer acquisition cost is known as blended CAC.

In case the company is not running any ads and selling products on the website and promoting it organically on social media, is there no customer acquisition cost? Most companies would say no. But ideally, the payments being done to the agency or the individual posting on social media is a cost that the company is bearing to acquire new customers. Similarly, any other cost that can be attributed to marketing should ideally form a part of CAC.

How does one calculate the CAC for a service brand?

Let us take an example of a SaaS company to understand how one can calculate the customer acquisition cost of a service brand in the B2B space. Lets say a company offers solutions for other businesses on a monthly subscription. Also, there is very little online presence and marketing for the brand (since we already understood how to calculate the CAC from online channels). Typically, they will have tele-calling and sales agents gathering qualified leads who will then be given a demonstration of the product, the commercials will get discussed and the sale is closed. 

What are the various cost heads involved? Firstly, of course the salary of the agents, although not a direct marketing expense, should be considered as a part of CAC. Over the course for the first few months of business, they realised that the best way to convert a customer is to offer a free trial for a month. So, this free month of subscription also gets added to the cost of customer acquisition. 

Lets say the subscription is Rs. 1,000/- per month. There is only one agent with a salary of Rs. 20,000/- and he converts 10 customers in a month. In such a scenario, the customer acquisition cost is Rs. 3,000/- (Rs. 20,000/- salary for the agent + Rs. 10,000/- as free subscription to 10 customers @ Rs. 1,000/- per customer per month). Looking at this calculation, it seems like the company is spending way more than they are earning. Is this a good business model?

Let us introduce another concept to understand whether this is a good business model – customer lifecycle value or CLV. Typically, if one decides to start using a software for their business, they are not going to stop using in a month or two even if the subscription is charged monthly. Hence, they are going to keep giving revenue to the company over a longer period known as lifecycle of the customer and the revenue thus generated is known as customer lifecycle value. So, going back to the B2B SaaS company example, lets say on an average the customer stays with the company for one year, the CLV of the customer is Rs. 12,000/- on a CAC of Rs. 3,000/-. Now the business starts to look better. In the D2C context also, the customer lifecycle value can be determined by how many times does a customer come back to the brand for purchases.

What are some benchmarks for CAC and CLV?

All these numbers, whether it is CAC or CLV vary drastically from one business sector to another, one geography to another, one customer segment to another. Broadly, in India, a “stable” CAC of 35%-40% is something that one should account for while working on the pricing for a D2C brand. Stable means that initially the CAC is going to be way higher (depending on a lot of other factors) and slowly will keep reducing and probably after 6-9 months hit these levels. 

Similarly, in the B2B space, where CLVs are more relevant, one would want the CLV to be at least 3-5 times the CAC. 

Here are some global figures for e-commerce players from SHOPIFY, arguably the leading e-commerce website platofrm. Again, these are very broad numbers and every business needs to look at their own niche and understand better what should be a benchmark CAC.

Why is CAC the silent killer for a startup?

Most of the costs for a startup are known and calculated. Whether it is material cost, distribution or shipment cost, rents and so on. But what one does not know is the customer acquisition cost. It is always calculated basis certain assumptions. In most cases, these assumptions are not very well known – like a benchmark mentioned, one wouldn’t know how soon can they reach the benchmark if at all. 

While the digital marketing spends are easier to attribute and the parameters are easily available, it still is a fixed cost and doesn’t ensure that the CAC targets will be hit. Hence, If a business starts, say with a glide path of CAC going for 200% to 35% (spending Rs. 2,000/- to generate Rs. 1,000/- of revenue at the beginning to Rs. 350 for the same revenue) in 6 months time, only time will determine whether these assumptions are correct. In most cases, even after 6 months, the business might end up with a way higher CAC than the targeted 35% eating away into the profit margins rendering the business bankrupt. 

Similarly, for a B2B scenario also, there would be some customer connects and conversion ratio targets for a sales agent. Again, one cannot be sure of how this pans out. Only once a business has been operational for sometime and has tried different sales channel will they be in a position to create a more accurate business case. For many businesses, it is too late by then.

As overwhelming as it is, it is critical to understand these concepts in detail. If you would like to know more or want us to assess your overall business for free, please fill in the details here.

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