New customers are the lifeblood of a business. But entrepreneurs need to be sure they can absorb the full bottom line impact of acquiring them
San Francisco, CA (PRWEB) February 10, 2014
The customer acquisition cost (CAC) is one of the most important (and misunderstood) challenges that new companies face. Convincing consumers or businesses to change buying habits can take a tremendous amount of time and effort. Entrepreneurs and new business owners are typically passionate about the benefits of their company’s product or service. When creating a business plan, CEOs tend to under estimate how much time and money will be required to win the first set of customers.
The time to acquire customers--and the resulting delay in starting to get revenue--is as important a component of a cash flow forecast as sales and marketing costs. A company may have a great product or service, but if venture funding will only support a burn rate for 12 months, there is no margin for error.
Other drivers of customer acquisition cost come from further afield. As more businesses have moved manufacturing 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 a company missed the “open to buy” window, there may be little left in the retailer’s budget for new inventory. In building cash flow forecasts, CEOs need to do homework on industry norms and their targeted customers’ buying practices.
If customers require modifications to company products, this can increase CAC significantly. Something that seems as simple as unique packaging and labeling can increase complexity and drive up labor costs. Customers may want shipping and billing data in electronic formats that may require investments in new software and training. Grocery chains may charge “slotting fees” to put product on the shelf. In some categories, Home Depot or Lowes may require a seller to provide staff to visit individual stores to train sales staff and replenish merchandise.
While getting new products and services into the market may be complex, the traditional calculation of CAC is simple. Add up all of the costs of sales and marketing over a given period and divide by the number of new customers. This assumes a product is fully developed and ready for sale. The key measurements are: the full cost per lead, conversion rates at each stage of the sales process and the level of touch required. The company business plan should aim to recover the entire CAC in 12 months.
In computing CAC, build a detailed scenario for acquiring new customers, including:
- Checking the credit worthiness of the prospective customer and their its track record of paying vendors.
- Considering whether you will have to cut price or relax payment terms just to have a chance to get the proverbial “foot in the door.”
- Travel costs for repeated visits to the prospective customer to get them familiar with you and comfortable with the level of post-sale service.
- Overcoming the response of the incumbent suppliers. Current suppliers will fight hard to keep the account and won’t hesitate to spread FUD (fear, uncertainty and doubt) about a newcomer’s capabilities, reliability and staying power. Overcoming these objections will take time.
- Delay—approvals needed from higher ups to try a new vendor.
In new business ventures, CEOs need to go beyond the traditional CAC measurement and make sure that the total costs of all activities and processes required to land new customers are considered. These go well beyond sales and marketing. Development and servicing costs can be significant and should be used to create a total cost of client acquisition. New customers are the lifeblood of a business. But entrepreneurs need to be sure they can absorb the full bottom line impact of acquiring them.
John Farrall is a partner in the Carolinas office of Newport Board Group