Step-by-Step: How to Calculate Customer Acquisition Cost (Episode #016)

Conversations with a Digital Strategist

Hey y’all and welcome to episode 16 of Conversations with a Digital Strategist podcast. Thank you so much for tuning in again this week. I’m super excited at how much my podcast is growing. The feedback has been so positive and I’m really thankful for all the support. On this week’s episode I’m going to talk to you about the customer acquisition cost KPI. If you’re new to analytics this may not be a KPI you’ve heard of before. Or you may have heard of it, but never really understood what it was or how to calculate it. Well, today we’re going to get into detail about this interesting and valuable key performance indicator. Ready? Let’s go.

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First, What is a KPI Again?

Before we jump into customer acquisition cost, I want to take a moment to remind you of the definition of a KPI. Customer acquisition cost is a type of KPI, or key performance indicator. A KPI is a way to measure goals. KPIs are indicators of your performance. You can have KPIs for your website, individual departments, processes, or business in general. Think of a KPI as the gas gauge on your car. When the gauge light comes on, it is an indication of a problem. Well, KPIs work the same way. You will set a target for you KPIs and aim to reach that target.

Usually a KPI is a calculated ratio, but that’s not always the case. A KPI can really be anything you want it to be, as long as it is THE indicator that identifies your performance. Here’s a simple example. Let’s say your goal is to bring in $10,000 per month in revenue from your website. You may decide to setup two indicators. The first is average transactions per month. The target for this could be 200. The second KPI would be average revenue per transaction. The target for this would be $50. So your target for each month is to get 200 transactions that total $50 or more. This will get you to your goal of $10,000 per month.

Throughout the month, you should keep a close eye on both of these KPIs. A decrease in one, means you will have to increase the other somehow, to compensate. Otherwise, you won’t make your target of $10,000 for the month. See how this works? That’s a fairly simple example, but still drives home the importance of KPIs and how they can help you keep a finger on the pulse of your business.

What is Customer Acquisition Cost?

Now’s let’s talk about customer acquisition cost. Customer acquisition cost is how much it costs you to acquire a new customer. Yup, that’s it. A big long term for something so simple, yet so important. This KPI is normally stated in monetary terms, however for those of us out there bootstrapping it, it can also be stated in terms of time. The question this KPI answers is, what am I sacrificing to get a new or repeat customer.

If you’re running paid advertisements, banner ads, paid social media videos, sponsored content, or any other advertising that requires you to pay, you must know what your average customer acquisition cost is. You should also know what your target is. The same goes if you’re like me, and you are going the route of bootstrap marketing, where you depend heavily on amazing content pushing visitors to your website and less on spending money on ads. You must know how much of your time is being spent creating and editing content. This is a sacrifice in that it’s time away from doing other things, like running your business or servicing your customers.

How Do I Calculate Customer Acquisition Cost?

So, why should you care about customer acquisition cost? Because it tells you if you’re profitable or not. You want your cost to be as low as humanly possible. The ratio should read: I spent $500 on advertising this month and I brought in $1,000 in revenue from my new customer segment (remember segmentation). This is a good thing. First it means you brought in more than you spent. But it also means your customer acquisition cost is $2. I calculated this by dividing how much came in by how much went out. Let’s look at this the other way around. Let’s say you spent $1,000 on advertising, but brought in $500 in revenue from your new customer segment. Is this a good thing? No! You spent more than you brought in! That’s going out of the world backwards.

Let’s look at time now. This calculation is a bit more tricky, but equally as important. Again, you want your number to be low. Let’s look at an example. Frank here, is an accountant. To bring in new customers he write blog posts and articles for online publications. Frank charges his clients $80 per hour to manage their books. On average, it takes him 4 hours to write blog posts and articles each week. In return, on average he acquires 3 new customers.

Let’s do the math. He’s spending $320 worth of time writing blog posts and articles each week, which equals out to $1,280 per month. But, he works for his three new customers for 2 hours per week, which brings in $1,920 per month. That’s netting him $640 per month. Nice! But if he spends 8 hours per week writing blog posts and articles, well, now he’s spending more time than the customers are paying for. That’s no bueno!

Rules to the Game

So, now you know what customer acquisition cost is and how to calculate it for both time and money. But how do you avoid the bad scenarios? Follow the rules. And the rules are simple.

1. Segment your customers – Segment your customers so you know what your numbers look like for both new customers and existing customers. You may even want to add a third segment that looks at customers who haven’t purchased in a while. Especially if you’re running retargeting ads. Always know your metrics for customers as a whole, and in their respective segments.
2. Weigh cost over position – When running ads, always weigh cost over position. Remember you’re trying to keep your numbers low. If that means you’ll sit at position number four instead of number one on Google, that may be a good trade off, if it keeps your costs low. You will need to play with the numbers to find the best spot for you, taking into consideration your ultimate goal. Which takes me to number 3.
3. Watch your numbers like a hawk – Keep a close eye on this KPI. Like your gas gauge, you don’t want to get stuck in the middle of the road with no gas. You don’t want to get stuck in the middle of the month, already in the negative with your spend. Start the month out slow and whatever you do, keep your eye on those KPIs. They will tell you where you are at any given moment. The numbers fluctuate with each new ad spend and each new transaction.
4. Always set targets – Never start a month without targets. Your targets are like your monthly household budget. Targets help you stay within sight of your objectives.

In Conclusion

Customer acquisition cost is a fun one to watch, because it does fluctuate. If you’re working with a marketing firm, ask them to go over the math with you on how they are calculating customer acquisition cost. Be sure they are including any incidental costs (like their fees), so you know the true cost of acquiring a new customer or capturing a return customer.

Thank You!

Thank you for listening. I hope you enjoyed this week’s episode of Conversations with a Digital Strategist. If you have questions about anything I covered, feel free to email me at [e-mail]. If you’d like more information about me, visit my website at Level360.co. I’m also social, you know. Follow me on Twitter at Level_360. Or on Facebook at Facebook.com/Level360LLC. Until next time, live true, work smart, and in the words of one of the greatest strategists to ever live, think different! Bye!

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