So there you are, crouched in front your laptop, squinting at the screen as you crunch the numbers for your new business idea in an Excel spreadsheet. As you scour the Internet for information and talk to everyone you can about what’s required in a business plan, you hear the term cost per customer acquisition come up. Since Google can be a bit overwhelming for questions like these, we’ll go through what the term refers to, why it’s relevant and how to calculate it for your business.
Cost per customer acquisition (CPA) refers to the amount of money spent by a company to gain a new customer. Each company has its own business model and the characteristics of that model will determine how a company needs to proceed in order to bring a new customer into the business. Customers need to be reached (through marketing channels) and converted (through relationships), and the CPA is derived from the costs associated with reaching customers and establishing relationships with them.
A business needs to understand what its CPA is for numerous reasons:
- It aids a company in understanding whether or not a business is worth running, as the revenues generated from a customer must exceed the costs to get that customer;
- It helps businesses understand what types of cash they will need in order to meet any ambitious financial projections;
- It allows companies to aggregate marketing costs into a simple metric, showing them in clear terms how marketing dollars are being spent.
Many investors will want to see what a startup or cash-strapped venture thinks their CPA is for many of the reasons listed above.
In order to calculate the CPA, you need to think about what channels are utilized to reach a customer and what people need to be in place to establish relationships. Both the channels used and people needed cost money. The sum of the marketing costs and the marketing staff salary for a given period can be divided by the total number of customers acquired (or projected to be acquired) during that same period to determine the CPA.
Once a CPA has been established (even it is just an initial estimate), there are many ways to try and validate if the number is reasonable. The first way would be to compare the number to general industry standards. For example, tech companies who do a lot of online marketing may have a very low CPA, while cellphone companies, who need to use multiple medium and sales people to land a customer, will have a very high CPA. A second step to ensure that the number is reasonable is to compare it to the revenues produced by that customer over their lifetime (as your customer). If it is going to take years to reach a point where revenues exceed costs, or worse it never happens, then it might be time to rethink the business model or marketing strategy.
If you are running a business, or planning to in the near future, it is very important to get a good handle on what your CPA is. Great opportunities may be obscured simply because a company doesn’t understand its cost structure in relation to its customer base, or conversely, warning signs to shutdown a business may be missed by not analyzing important metrics such as this one. If you need help trying to piece together your CPA, give us a call.
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