Customer Acquisition Cost: Why You May Be Spending Way Too Much
Determining how much to spend to acquire a new customer is critically important. Almost all companies want to add new customers, growing top-line revenue, but only should do so if they're growing in a smart way. Bad growth, where the unit economics don't make sense, is not worth pursuing and can kill a company in the long-run.
That said, the analysis behind determining how much to spend to acquire a new customer should generally be conducted as it would be when acquiring any other asset – with a detailed review of the asset's cash flows.
It's surprising then that some industry commentators (i.e. the blogosphere) seem to take such a basic view of the relationship between Customer Lifetime Value ("LTV") and Customer Acquisition Cost ("CAC"), particularly when discussing software-as-a-service ("SaaS") companies. When it comes to analyzing SaaS companies' unit economics, the discussion is typically centered on the ratio of LTV to CAC (the "Ratio"), and often in nominal terms – i.e. without explicit reference to why the length of a customer's lifetime is so important in determining the appropriate value of the Ratio.
Of course logic suggests a customer's value to a company should exceed the cost to acquire that customer, but analyzing this relationship between LTV and CAC as a simple ratio doesn't tell the full story. The concept of time value of money is ignored, and it shouldn't be, or you may spend way too much for each new customer acquired.
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