Knowing the terminology around startup investing is an important part of mastering startup investing, and customer acquisition cost (CAC) is a crucial metric for startup investors to consider when evaluating a company's potential for success and scalability.
What Is Customer Acquisition Cost?
CAC is the cost of acquiring a new customer for a business and typically includes marketing expenses to get a customer to complete a purchase for your product. These costs might not always be inherently clear because startups often have drastically different business models. Some might be very high from the need to sell expensive items or hard to calculate because they might be sporadic or labor-intensive.
For example, if the startup is a consumer focused product selling something simple like t-shirts, they would need a very low CAC. This is because it’s unlikely they will be a repeat customer, so your CAC must be lower than, likely, the one time cart value of that customer. But if you’re an insurance company where the lifetime value of a customer is several thousands of dollars over potentially year, you can have a higher CAC. On the other hand, it might be harder to determine the CAC for an insurance company because some customers might leave immediately, while others might stay for life.
Why Is Customer Acquisition Cost Important?
Businesses, and their investors, pay close attention to CAC because it helps them understand how much a company is spending to acquire new customers and whether or not those customers are profitable. This metric is important because startups need to generate revenue to sustain their operations and fund growth. If a startup has a high CAC, it may be a red flag for investors as it indicates that the company is spending a lot of money to acquire new customers and may not be generating enough revenue to make up for those costs. It might also be an indicator of a lack of demand for the product or service or a generally unsustainable business model.
On the other hand, a low CAC may indicate that the company has found an effective and efficient way to acquire new customers and is likely generating profitable revenue. This indication could be positive because a low CAC means that the company is able to acquire new customers at a reasonable cost, which allows it to generate more revenue and fund future growth. It also means that the company has a sustainable business model and is able to generate a return on its investment in acquiring new customers. These businesses can be good startup investments because a low CAC pipeline is much easier to scale when startups receive money to grow.
It might not always be this simple, because in some industries a customer can be a customer for years, if not decades. Many people might not change their insurance provider for a decade. Similarly, someone might never use their insurance then one day they use $100,000 worth of insurance. If insurance pays $100 to acquire a customer, then makes $10,000 a year off that customer, but after 9 years the customer undergoes major surgery costing the insurance providers $100,000, then they ultimately lost money. This is just one example showing how investors need to take all of the factors into account before making an investment.
Customer Acquisition Cost Formula
Here's how to calculate customer acquisition cost: To calculate CAC, you need to know the total marketing costs spent on acquiring new customers, as well as the number of new customers acquired during a specific time period. For example, if a company spent $10,000 on marketing and sales efforts in a month and acquired 100 new customers, its CAC would be $100 ($10,000 / 100 customers).
What Is A Good Customer Acquisition Cost?
A good CAC is one that is low enough to allow a company to generate profitable revenue from its customers. In general, a CAC that is lower than the lifetime value (LTV) of a customer is considered good, as it indicates that the company is able to generate more revenue from the customer than it is spending to acquire them. For example, if a company has a CAC of $100 and an LTV of $150, its CAC is considered good because the company is generating $50 in profit from each customer. That profit can then be rolled forward to invest in other aspects of the company or continued to acquire more customers.
A promising marketing and customer pipeline is important because it’s a good indicator of demand for a startup's product and the general scalability of a startup if it receives your investment.