Customer acquisition cost (CAC) for ecommerce: what it is, and how loyalty marketing can lower it

Customer acquisition cost (CAC) measures how much you spend, on average, to bring in a new customer.

In theory, it’s simple to calculate. The formula is this: cost of sales and marketing divided by new customers.

But behind that simple formula is a complex process of data gathering, analysis and decision-making.

CAC includes all your sales and marketing costs

Most CAC calculations are oversimplified. When a business owner wants to figure out if, say, a pay-per-click (PPC) campaign is working, they might divide the $2,000 they spent on ads by the 50 new customers who arrived through that channel — a $40 CAC.

But although this is a handy way to compare marketing channels, it’s not a true reflection of costs. This is because there are many other expenses involved in acquiring a new customer in ecommerce, such as:

• buying stock
• raw materials
• manufacturing
• storing and shipping products
• salaries, if you have employees

These costs make the calculation more difficult, but they’re necessary for a precise CAC.

(You may comes across other ways of calculating CAC, such as:

• “Blended CAC”, which involves dividing marketing costs by the total number of customers in that time period, new and existing
• “CAC payback period”, which focuses on the time it takes to generate enough revenue from a customer to “pay back” the cost of acquiring them

Both of these metrics are best suited to brands with subscription business models, which generate predictable revenue from each customer over time. For ecommerce brands, it’s best to focus on the standard formula.)

CAC vs. CLV: A “good CAC” is one that’s lower than your average customer lifetime value

Even a precise CAC doesn’t tell you much on its own. To know if you have a “good” or “bad” CAC, you need to know how much revenue you get from each customer acquired. This metric is called “Customer Lifetime Value”, or CLV.

To calculate CLV, you need to multiply “average order value” — total customer spend divided by total purchases in a given timeframe — by “average purchase frequency” — number of purchases divided by number of customers.

This is your “average customer value”. You can then multiply this by the average customer lifespan — the amount of time, on average, a customer purchases from you — and you have a CLV figure.

So, if your average customer spends $20 per purchase, and makes an average of four purchases per year, your average customer value is $80. If your average customer buys from you for five years in a row, your CLV is $400.

If your average CLV is higher than your CAC, your customers are profitable. Congratulations.

But for serious growth in ecommerce, your CLV/CAC ratio should be around 3:1. That means for every dollar you spend bringing in a new customer, you make 3.

Unfortunately, acquisition costs are increasing each year — especially in ecommerce

According to data from Statista, customer acquisition costs have risen by 60% in the past five years. Essentially, you’re paying more to acquire the same number of customers. And this isn’t going to change any time soon.

Here’s why: digital advertising spend is forecast to grow to $836 billion by 2026. And the more companies want a piece of the pie, the more the cost of advertising increases for everyone. 

Paid search and social are currently the dominant forms of digital advertising in ecommerce, which means that more brands than ever are fighting for visibility on the same platforms and (hopefully) gaining customers as a result. The upshot: increasing demand for a static supply.

There are many ways to reduce CAC — but focusing on CLV can be a more effective way to increase profits

If you’re spending too much acquiring new customers, you can:

• optimize advertising campaigns
• test out new marketing channels
• source products at lower cost
• reduce operational and logistical costs, such as warehousing or shipping

All of these things can help you bring in new customers more cost-effectively. But many businesses would benefit more from increasing revenue per customer (or, in other words, increasing their CLV). 

After all, it’s the ratio that matters. As long as your CLV is three times greater, it doesn’t really matter how much you spend.

But the CLV side of the equation is often neglected. Accenture found that 80% of brands spend less than 30% of their time on retention marketing.

Prioritizing customer retention increases CLV — and therefore offsets high acquisition costs

Of all the customer retention statistics we’re fond of — and there are many — our favorite might be this: improving customer retention by 5% can increase profits by up to 95%.

And so, in a world of increasingly expensive acquisition, you might better increase profits by focusing on retention. Ask yourself: how can you make your existing customers spend more money with you, more often, over a longer period of time?

Get retention right, and you’ll increase your revenue without having to spend your hard-earned dollars on increasingly challenging acquisition campaigns. There are several reasons for this:

• Your existing customers already have some affinity for your brand. Think about it: are you more likely to open an email or click a display ad? It’s much easier to engage with people who have already bought from you than it is to convince a brand new audience.

• You have access to low-cost, high-converting marketing channels. Even the best-optimized Facebook ad campaign has an imperfect signal-to-noise ratio. Many of the people who see your ad simply won’t be in the market, and that means wasted money. Channels like email and SMS, on the other hand, have no “marginal cost”.

• Happy customers tell their friends about you. One of the most cost-effective acquisition channels is the humble referral. Keep your existing customers happy, and they’re likely to send new customers your way. And in turn, these referred customers tend to have a higher CLV.

Loyalty marketing is one of the most effective ways to lower CAC and improve CLV

Customer loyalty is the key to lowering your CAC and improving your CLV, but it doesn’t happen by magic. Without a defined, deliberate retention strategy, just 32% of customers place a second order in their first year as a customer.

A more structured, strategic approach is needed, and we call this “loyalty marketing”.

To develop your own loyalty marketing strategy, you need to do three things.

First, analyze your audience

For most brands, a small cohort of customers provide the majority of revenue. In many cases, it follows the 80/20 rule.

But only 13% of brands know which customers these are. If you’re not one of them, you’re missing out. By figuring out your most profitable customers, you can:

• cross-sell to those most likely to buy
• tailor your acquisition to people with a similar profile
• find existing customers with a similar profile who are less profitable, and focus your marketing on them

Next, define your rewards program

At the heart of any loyalty marketing strategy is a loyalty program, and a loyalty program is only as good as the rewards it offers.

So choose those rewards carefully. They should be sufficiently attractive that your audience wants to engage with your loyalty program, but not so generous that they compromise profit margins and lower your return on investment.

Think carefully about the structure of your loyalty program, too. Broadly speaking, there are four kinds — points-based, value-based, tiered and subscription — and each has its own pros and cons.

Finally, figure out how you’re going to measure success

There are many metrics you can track to assess the effectiveness of loyalty marketing.

Average order value = total revenue / number of orders

Purchase frequency = total number of purchases / number of unique customers

Word of mouth revenue = Number of referred customers x average purchase value of referred customers

Loyalty reward redemption rate (%) = (number of rewards redeemed / number of rewards earned) x 100

Loyalty program engagement (%) = (number of active customers enrolled in loyalty program / total number of customers) x 100

Customer churn rate (%) = (number of customers at start of period – number of customers at end of period) / number of customers at start of period x 100

Ready to get started with loyalty marketing?

Loyalty marketing is crucial to developing long-term relationships with customers who spend more with you. 

With loyalty program members generating between 12 and 18% more revenue per year than the average guest shopper, it’s no wonder so many brands are investigating how to leverage loyalty to their advantage. If you want to do the same, book a demo with one of our specialists.