Earning a sale—and hearing the cha-ching from your Shopify app—feels great. But how much did you spend to acquire that customer? Was the transaction profitable? If you can’t answer these questions, you may not have a grasp on your customer acquisition cost (CAC).
Spending the right amount to acquire a customer can be a tricky prospect. Spend too little and you miss out on sales, spend too much and your business is unprofitable.
While finding the right balance might sound daunting, there are a few simple formulas you can use to calculate your CAC—and get it on track. Ahead, learn why customer acquisition cost is important, find out how to calculate it for your store, and get advice for reducing it.
What is customer acquisition cost (CAC)?
Customer acquisition cost is the total cost of acquiring a single customer. This includes sales team costs, ad spend, marketing costs, and any other expenses that contribute to getting your product into a customer’s hands.
It’s important to understand your CAC because it directly informs profitability. Your CAC tells you how much you need to earn from each customer in order to have a profitable business. Put simply, if you’re spending more on business costs to acquire customers than customers are spending on your products or services, your business model is not viable.
📝 Note: The basic formula for CAC doesn’t include all your costs like cost of goods sold (COGS) and other operation costs. It focuses on marketing efforts and the costs associated with those only (marketing staff or agency, ad fees, etc.). Later, dive into several formulas for gaining a true snapshot of your profitability.
What is the difference between CAC and CPA?
CAC and CPA (cost per acquisition) are similar terms in that they calculate the cost of achieving a single business goal. While CAC measures how much it costs to acquire a paying customer, CPA measures the cost of acquiring a lead. For ecommerce businesses, a lead may be as simple as email capture from a newsletter signup.
What’s included in CAC?
CAC takes into account a number of costs associated with acquiring new customers. This includes both the direct and indirect costs of your marketing and sales efforts. When you calculate CAC, don’t forget to include:
- Ad spend (Facebook Ads, Google Ads, traditional advertising)
- Sales and marketing team wages
- Marketing software company fees
- Agency fees
- Creative costs (hiring designers or photographers to execute creative or design software subscriptions)
- Publishing and PR costs
- Production costs (videographer fees or production equipment)
- Influencer partnerships (as part of a social media marketing budget)
- Inventory maintenance
📝 Note: As a rule of thumb, you shouldn’t spend more than 5% to 8% of your business budget on marketing.
Why is customer acquisition cost important?
Ultimately, CAC is a key metric for determining a business’s viability and profitability. But understanding CAC for your business offers other benefits:
- CAC determines the effectiveness of each marketing channel or campaign. Which marketing efforts are the most effective and which aren’t performing? You can use CAC calculations to measure all marketing channels as a whole or at the specific channel and campaign level.
- It’s the first step to reducing costs. Knowing your CAC is the first step in evaluating how you can reduce it—and boost ROI.
- CAC helps find roadblocks in your sales funnel. Examining your CAC will uncover areas where you may be spending too much to get a customer to the next stage of the funnel. This allows you to focus on the specific areas where inefficiencies are happening.
📝 Note: CAC is always higher for acquiring new customers (versus retaining existing ones). While reducing your CAC is important, it’s equally critical to invest in customer retention strategies.
How to calculate customer acquisition cost
Marketing for a small business can sometimes feel like throwing spaghetti at a wall. Understanding the effectiveness of your marketing efforts can help you keep costs low and invest more in performant channels and campaigns.
CAC is only one piece of the puzzle, however, so this guide also covers how to consider other factors and calculate CAC as part of a larger formula to determine your true profitability.
1. Use the basic CAC formula
The basic formula assumes that your only costs are marketing costs. It’s an effective calculation for early stage businesses and those struggling with marketing costs in particular.
In this example, a business spent $500 on Google Ads and those ads resulted in 10 customers. The customer acquisition cost would be $50.
🪄 Formula: Total Marketing Spend ($500) / New Customers (10) = CAC ($50 per customer)
2. Factor in COGS
Marketing accounts for only some of a business’s costs. These include day-to-day operations and cost of goods sold (COGS). COGS includes costs and expenses directly related to the production of your products, from raw materials to manufacturing labor. It excludes indirect costs, such as marketing and sales. Adding COGS into the calculation gives you a more accurate CAC.
🪄 Formula: (Total Marketing Spend + COGS) / New Customers = True CAC
3. Consider average order value
Average order value (AOV) tracks the dollar amount spent for each customer order on your website or in your store, and determines an average across all customers. To calculate your business’s average order value, divide total revenue by the number of orders.
🪄 Formula: Total Revenue / Number of Order = AOV
4. Determine your gross margin
To get the calculation of your profit, you need one more figure: gross margin. Gross margin represents the total sales revenue your company retains after the direct costs associated with producing your goods. Gross margin may be calculated as a dollar value or as a percentage.
🪄 Formula (dollar): Net Revenue – COGS = Gross Margin
🪄 Formula (percentage): Net Revenue – COGS / Net Sales x 100
5. Calculate your profit
Now you’ve determined your CAC, COGS, and gross margin, you can put it all together to get a true picture of your profitability.
🪄 Formula: (Average Order Value x Gross Margin) – Customer Acquisition Cost = Profit
How customer lifetime value (LTV) affects CAC
Customer lifetime value (LTV) is important to the overall picture of profit because it measures the potential revenue you can earn from a customer through the lifetime of the relationship.
The link between CAC and customer lifetime value is determined through the LTV:CAC ratio. This ratio is important in determining the profitability of your business. The metric can confirm whether the value of the customer is higher, lower, or the same as the cost to acquire a customer.
A healthy LTV:CAC ratio for ecommerce businesses is around 3:1. Any lower than that and your business is at risk. A higher ratio is good news but it could be a signal that you’re ready to scale up. As such, this is a useful calculation when you’re revamping your overall business strategy and marketing strategy.
🪄 LTV:CAC ratio: (Customer Lifetime Value) / (Customer Acquisition Cost)
5 ways to reduce customer acquisition cost
- Prioritize organic marketing
- Focus on your AOV
- Lower your cost of goods sold
- Improve retention
- Tap into the power of AI
If your LTV:CAC ratio is less than 3:1, your business isn’t operating efficiently and you’ll eventually run out of money. The good news is that there are tried and true ways to reduce your CAC to improve this ratio and start down the path to profitability.
1. Prioritize organic marketing
Organic marketing ideas including email marketing, SEO, and referral marketing are effective at driving customers to your website without costs associated with other types of paid marketing. Many of these ideas are more resource-intensive than other methods. Therefore, don’t forget to factor in the cost of marketing teams’ wages and other indirect costs associated with organic marketing.
2. Focus on your AOV
CAC and pricing go hand in hand. CAC can be an indicator that you’re spending too much on marketing but it can also signal that your prices are too low. If your marketing budget looks good, take a closer look at your prices—they may need an increase. Doing so will increase your average order value (AOV) and help offset your CAC.
Aside from raising prices, you can increase average order value in different ways:
3. Lower your cost of goods sold
So you’ve rid your marketing strategy of any inefficiencies and your pricing strategy is sound. Now what? Lowering the cost to produce your products is another way to lower CAC. Ask yourself:
- If you’re purchasing raw materials, is your supplier competitive on price? Are there cheaper materials you can substitute that won’t impact your brand? Can you comparison shop with competitors?
- Can you lower manufacturing costs through negotiation with your manufacturer or by switching producers?
- Is there any way to streamline the production process and lower labor costs?
- Have you negotiated your shipping costs? Can you consolidate shipping or increase order quantity to reduce these costs?
4. Improve retention
As outlined earlier in this article, it’s more expensive to gain a new customer than it is to retain an existing one. Implementing retention strategies like loyalty programs, repeat purchase discounts, referral incentives, and customer perks can help to offset a high CAC.
5. Tap into the power of AI
Reducing your CAC may mean reducing some of the human costs associated with marketing. Automate some of your marketing efforts to free up more of your time to explore other marketing ideas and grow your business. AI chatbots, automated email campaigns, and smart recommendation tools can all deliver personalized marketing experiences to customers while you focus elsewhere.
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Keep customer acquisition costs low—and profits high
Acquiring customers shouldn’t cost more than the value they bring to your business. If it does, it’s time to evaluate your marketing expenses, business practices, and pricing strategies. To improve customer acquisition cost, you need to look at it within the larger picture of your business. Once you understand how these calculations can help you run your business, you’re on track to keeping it profitable.
Remember customers acquired offer more value over time when you can retain them, as your acquisition costs are much lower. As you look to reduce your CAC, focus at the same time on customer loyalty through experiences and incentives.
Customer acquisition cost FAQ
What is a good customer acquisition cost (CAC)?
A good customer acquisition cost depends on the industry you’re in and the type of business you’re running. According to a 2021 Shopify/Angus Reid survey of businesses with less than four employees, the average customer acquisition cost for a small ecommerce business is $58.64. It’s worth noting that the bigger your company gets and the more employees and overhead you have, the higher your customer acquisition cost will be. The CAC alone, however, doesn’t represent the whole picture.
A good CAC should be roughly three times lower than your customer lifetime value (LTV). This means that the ratio between the value of paying customers over time and your marketing costs should be 3:1 or higher.
How do I lower customer acquisition costs?
You can lower your customer acquisition costs in a number of ways, including increasing your average order value, lowering your cost of goods sold, focusing on less competitive markets or niches, prioritizing customer retention over new customers, investing in a customer relationship management (CRM) strategy, and trying organic marketing (including SEO, organic social, and referral marketing).
What is a good LTV to CAC ratio?
As a rule of thumb, a good LTV:CAC ratio is 3:1 or greater. You always want your LTV to be greater than your CAC because it means you’re recouping your investment faster. When your CAC is higher than your LTV, it means your business model is not viable, because you’re not able to recoup the money you invested to acquire the new customers in the first place.