In my last article, I discussed the cost of acquiring new customers, emphasizing that you must understand the cost in cash and time of pursuing new customers and convincing them to take a chance on you.
Other drivers of customer acquisition cost come from further afield. As more businesses have moved their sourcing offshore, lead times have become longer and purchasing commitments are made earlier. Many seasonal retail decisions for Christmas 2014 were locked down by mid November 2013, 13 months in advance. If you missed the “open to buy” window, there may be little left in the retailer’s budget for your product. In building your cash flow forecasts, do your homework on industry norms and specific practices of your targeted customers.
Other Drivers of the Cost of Customer Acquisition
If the customers you are trying to acquire require modifications to your products, this can increase your costs significantly. Something that seems as simple as unique packaging and labeling can increase complexity and drive up labor costs.
Customers may want you to transmit shipping and billing data in electronic formats that require you to invest in new software and training. Grocery chains may charge “slotting fees” to get your product on the shelf. In some categories, Home Depot or Lowes may require you to provide staff to visit individual stores to train their sales staff and replenish merchandise. Make sure you know the full range of channel expectations before you quote prices.
The traditional calculation to create your CAC (customer acquisition cost) is simple. Add up all your costs of sales and marketing over a given period and divide by the number of new customers. This assumes your product is fully developed and ready for sale.
The key measurements are:
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Full cost per lead
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Conversion rates at each stage of the sales process
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Level of touch required
Your business plan should aim to recover your entire CAC in 12 months.
You can learn more about customer acquisition costs in a blog by David Skok, “Startup Killer: The Cost of Customer Acquisition." In this interesting blog, Skok discusses the importance of business model, the entrepreneur’s “Achilles Heel” (i.e. optimism). He also presents specific examples of CAC calculations. He explains practical ways to reduce customer acquisition costs, such as use of a free offer of your product or service to attract web visitors--to try to make your product go viral, as early adopters tell their friends about you.
Recommendations for the Cost of Customer Acquisition
My recommendation, especially in new business ventures, is to go beyond the traditional measurement and make sure you are researching and forecasting the total costs of all activities and processes required to land new customers. These go well beyond sales and marketing. These development and servicing costs can be significant and should be used to create a total cost of client acquisition. That is the number that will impact your bottom line.
In the long term, what really matters is the lifetime value of a customer (LTV). This is a measurement that can significantly affect the valuation of your business.
An example: the long term contract you sign with a cell service provider is worth a lot more to them than if you were paying month to month with no contract. Investors and acquirers like the security of consistent, recurring revenue. It takes away much of the risk from your business.
When thinking of a good example of LTV, you could do worse than envision your local pizza restaurant. They have low startup costs, good margins, and lots of repeat business. Will your customers be as loyal as you are to your favorite pizza place? What do you need to do to avoid customer “churn” and ensure that the account you sell today will produce revenue for years to come? How “sticky” is your relationship with your customers? The more difficult it is for them to leave you for another supplier, the more stable the revenue stream from them.
Integrating your product or service into your customer’s operations means that they in effect invest time and money making you part of their own processes. Here is an analogy to customer stickiness: the stickiness of enterprise software platforms (ERP). Installing an ERP from a company like SAP can cost up to $100 Million and take 3-5 years for a large company to complete. It is expensive, painful, and extremely time consuming. It forces you to change the way you do business. Once you have finally integrated all your company’s records, cost systems and processes, you will be very unlikely to make that transition again anytime soon. It is too disruptive and costly.
While it is unlikely that you can make your product or service as sticky as a SAP system, the same principle applies: create LTV by driving value deep your customer’s performance system - so it is hard for them to envision doing business without you.
I will address some specific examples of customer stickiness in the next article in this series.
Customer aquisition costs is just one of the barriers a CEO will face while trying to grow. Explore this insightful whitipaper, "Helping CEOs Navigate Barriers to Growth," to get around these hurdles.
About the Author
John Farrall is a leader in growing businesses, with a track record of growing both the top and bottom line. During his 30+ year career at Milliken, he had profit and loss responsibility for business units in the commercial office furniture, retail home furnishings and hospitality markets. Time and time again, John improved profitability by growing the business while driving down costs and improving customer satisfaction. Contact or learn more about John here.
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