When starting an advertising campaign, a business should begin with a clear objective. If any part of the long-range plan is to increase revenue, then every business must know these two metrics: Customer Acquisition Cost (CAC) and Lifetime Value of a Customer (LVC). Without knowing Customer Acquisition Cost it is almost impossible to accurately optimize an advertising campaign. Without having the Lifetime Value of a Customer, it is very hard to intelligently calculate an advertising budget. Every business must know these two metrics.
What is CAC
For businesses working with a Lead Generation Advertising Agency, these metrics should be discussed before any advertising campaign begins. To clarify, Customer Acquisition Cost is the amount of money spent on marketing divided by the number of new customers acquired in the period the money was spent. A local restaurant that spends one thousand dollars in advertising over a month and gains 20 new customers will have a CAC of $50.
Customer Acquisition Cost should also take into consideration other factors. If the restaurant just began an SEO program and does not expect to see any returns on that for six to nine months that must be factored in.
CAC By Channel
Calculating your Customer Acquisition Cost by marketing channel is the next step in the optimization process. Understanding how each marketing channel performed is what most advertisers want to know. With some businesses it is easier. E-commerce of physical products allows for direct attribution for Pay-per-Click. But here is where we get into attribution models and that can generate serious debate. If we just work off of Last Click Attribution credit is easy to assign. We credit Pay-per-Click 100% because that drove the sale. But what if the customer saw a TV ad first, then visited the site organically and bought after a paid search click? Every business needs to decide on its’ own Attribution Model. And that is a whole ‘nother blog.
With the CAC in hand we can now look at the Lifetime Value of a Customer. LVC is the amount of money received from the average customer over the lifetime of their patronage. In the restaurant example above if the average customer spends $100 per meal, and the profit on the meal is $50 the restaurant owner only breaks even on the first meal ($50 CAC + $50 Expenses = $100) However, the average customer visits the restaurant three times per year and has a life cycle of five years before they move to a new favorite restaurant. In year one, the restaurant profits $100 from the new customer. In years two through five the profit margin is $150 per year or $600 for an average customer, for an overall LVC of $700.
Many business owners would not undertake a marketing campaign that would at best break even on the first sale, unless they knew the long-term yield. Many e-commerce businesses understand they will lose money on the initial sale. But, through quality products, excellent customer service and inexpensive email follow-up campaigns expect to keep customers returning for years of profits.
LVC can be calculated on an historical basis, which is relatively easy and accurate. Or, it can be done on a predictive basis, anticipating future revenue. It is easier to calculate predictively if your business works on a subscription basis as opposed to product or service basis.
Benefits of Knowing LVC
Knowing your LVC has many benefits. First, it is a testament to your initial product or service. If your service is truly white-glove, then people will want to return multiple times. LVC also speaks to the relationship with each client. Poor LVC may indicate that relationships need to be nurtured. A business can use LVC to determine their most loyal customers. Then, learn why and replicate. Most businesses find that lengthening their LVC is not about discounts, but about customer loyalty. And of course, knowing the Lifetime Value of a Customer will aid in determining budgets. Not just an acquisition budget but a retention budget.
Business owners love to look at all the details of how advertising campaigns are performing. How many impressions, clicks, phone calls and new revenue. But success will ultimately be determined by the Cost of a New Customer and the Lifetime Value of a Customer. That is why every business must know these two metrics.