You’ve probably heard this saying before…
“You’ve got to spend money to make money”
It’s not true 100% of the time. But if you’re looking to scale a business fast, it’s pretty much the only way.
In an ideal world, you spend $1 and make $3. That’s a business right there.
But the challenging part for most online business owners is figuring out how much you can spend upfront and still be profitable.
Get this right, and you’ll be growing profitably.
Get this wrong, and you’ll find yourself quickly running out of cash.
Before we get into how to calculate the optimum amount for your business, let’s start with a basic understanding of how it works…
Understanding Cost of Customer Acquisition (CAC)
In simple terms, your Cost of Customer Acquisition (CAC) is the amount you can spend to acquire a new customer.
It includes the costs of any marketing or sales expenses like ad-spend or commissions.
To calculate your current CAC:
CAC = Cost of marketing + sales / Number of customers acquired
For example, you spend $2K on ads and an additional $1K in sales commissions which makes $3K. If you get 50 customers from that, your CAC is $60.
Even if you’re not spending on ads, your marketing expenses can contain things like content creation, video editing, and app subscriptions.
Straight forward so far? Well, this is where it can start to get challenging…
What this tells you is you’re currently spending $60 to acquire each customer.
What this doesn’t tell you is how much more you can spend to acquire customers and still be profitable.
And in order to do that, we need to look at another leverage point in your online business – customer lifetime value.
Customer Lifetime Value (CLV) – Understanding how much customers are worth to you in their lifetime
If you’re like lots of online business owners then you have multiple products (at different price points) that you’re selling.
I breakdown how this works in this Deep Funnels essay but in simple terms, a typical product lineup looks like this:
- Front-end offer – normally < $99
- Middle offer – normally > $250
- High-end/continuity offer – could be anywhere from $500-$3K per month
There are two important metrics for you to think about…
1. Average purchase value
This is for online businesses that sell one-off products (no subscriptions or memberships) and do not typically see repeat buyers.
Average purchase value = Revenue / # of purchases (across all products)
For example, if your revenue for the year is $500K, and you sold 350 products across your funnel, then your average purchase value is $500K / 350 = $1,429.
2. Customer lifetime value
This is for online businesses where there is a subscription/membership element. Since people will be paying multiple times for months/years, we need to calculate their ‘lifetime value’.
Customer lifetime value = Customer value x Average customer lifespan
This image breaks down the various components involved in this calculation.
So why bother calculating your Average Purchase Value or Customer Lifetime Value at all? Seems like a lot of hard work for nothing, right?
Understanding these numbers can allow you to scale your revenue much faster than your competitors. Here’s why…
“The business that can spend the most to acquire a customer—wins”
This famous quote from legendary marketer Dan Kennedy summarizes the relationship between your Cost of Acquisition and your Customer Lifetime Value.
If you’re able to increase your ACV or Customer Lifetime Value by selling more to your existing customers (again, check this Deep Funnels essay for a breakdown of how to do this) then you’re able to increase the amount you spend to acquire them in the first place.
But why would you do this? Surely you should focus on keeping your CAC as low as possible to make more profit?
Let’s imagine all businesses spent as little as possible to acquire customers. Can you imagine how competitive that would be?
Everybody fighting over the same pool of customers with shoestring budgets to spend. You think it’s hard to stand out now? That would be an entirely different ball game.
And that’s why the business that can spend the most to acquire a customer wins.
By spending more you can cut through the noise, target your focus on a more specific segment of customers, and sell to them over their lifetime. And because these customers cost more to acquire, your competition won’t be anywhere near them… because they probably can’t afford to reach them.
The same logic applies if you use affiliate partnerships to acquire customers. If you can offer an affiliate 100% (or more) of the revenue you make on an initial sale, because you know you’ll make it back later then you’re an incredibly attractive partner.
Running the numbers – How can Cost of Acquisition impact your revenue and profit growth?
Let’s see how this plays out in reality…
Example 1- You keep Cost of Acquisition low
- Revenue – $300K
- Customers – 350
- Cost of acquisition – $50 ($17.5K total)
- Other costs – $50K
- Profit – $232,5000
- Profit % = 77%
Example 2 – You add more back-end products to increase your Average Customer Value, which allows you to double your Cost of Acquisition. The increased CAC also means you acquire more customers.
- Revenue – $500K
- Customers – 400
- Cost of acquisition – $100 ($40K total)
- Other costs – $50K
- Profit – $410,000
- Profit % = 82%
See in this example, by increasing your ACV and therefore spending double to acquire customers, your revenue increases and you’re more profitable as a result.
But it only works when you can boost your lifetime values.
Understanding how to increase your CAC is the key to 7-figure growth
Knowing how to increase your CAC while still being profitable allows you to scale from 6 to 7 figures in less time.
The businesses already doing 7-figures+ have a clear understanding of their CAC and how much more they can pay to acquire customers than their 6-figure competitors.
Figuring these numbers out isn’t always easy, which is why it’s one of the things we work with our clients to do at Clear Accounting to understand the story behind your numbers.
Taking care of your bookkeeping & taxes is just the first part of knowing your numbers.
Once we’ve got that running smoothly, the next thing we look at is your ‘leverage points’ like CAC and Conversion rates – and how we can help you to use these to scale your revenue to 7 figures faster.
If this is something you’re current bookkeeper or CPA isn’t helping you with, then get in touch.
Until next time.
Dan Steinhart, CPA
P.S. Cost of Acquisition is one of a few key leverage points that can unlock revenue growth in your business.