Calculating customer acquisition cost
Whenever you are wondering whether you should
continue to run an advertisement or whether your last mailer
was worth the cost, you need to consider customer acquisition
Customer acquisition cost is not hard to
understand, but few businesses do the math required to evaluate
their advertising efforts.
I first learned about calculating customer
acquisition costs while serving on the board of an Internet games
company. At this firm, revenue per employee was fairly low, but
the cost of acquiring a customer from certain kinds of promotional
efforts was very high.
The calculations go like this. If you mail
out 1,000 advertising fliers at a cost of 50 cents apiece, you
will spend $500. If you get 20 responses, it cost you $25 per
response. But you can’t spend responses; you can only spend sales/profits.
Now, if you were able to convince 100 percent of the people who
responded to become customers, your customer acquisition cost
would be $25. But no one closes all their prospects.
In most businesses, closing 25 percent would
be a reasonable rate. So, from the 20 responses, with a 25 percent
close rate, you can expect to add 5 customers. Now your customer
acquisition cost is $125. WOW. That could still be great if your
average sale were $1,500, with a 50 percent gross margin. Simply
put, it would cost you $125 to bring in one customer that produces
$750 of gross margin.
Now, if your cost to mail those brochures
were $1.00 each, then your customer acquisition cost just doubled,
Without considering the numbers and the lifetime
value of the customer in the case of repeat business, it’s impossible
to make an intelligent decision about whether your advertising
In my small business consulting, I frequently
find businesses that run $1,000 print ads without ever doing
the customer acquisition math. Even if the advertisement only
resulted in one new customer per time it ran, it still could
be a good investment if the new customer contributes enough to
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Ron Sturgeon is past owner of AAA
Small Car World. In 1999, he sold his six Texas locations, with
140 employees, to Greenleaf. In 2001, he founded North Texas
Insurance Auction, which he sold to Copart in 2002. In 2002,
his book “Salvaging Millions” was published to help
small business owners achieve significant success, and was recently
reprinted. In June 2003, he joined the new ownership and management
team of GreenLeaf. He also manages his real estate holdings and
investments. You can learn more about him at WWW.autosalvageconsultant.com
He can be reached at 5940 Eden, Haltom City, TX 76117, email@example.com or
817-834-3625 ext 6#.