In the customer lifetime value calculation, average customer acquisition costs are deducted from the customer’s profit contribution over time to determine the customer’s “net” profit contribution for the entire period of the customer relationship. As well, the acquisition cost as compared to the total customer lifetime value enables the calculation of a marketing ROI.
Definition of customer acquisition cost in the customer lifetime value calculation
Customer acquisition costs are all the expenses incurred by the company (or brand) in order to generate (and fulfill) a purchase from a non-customer.
Key points to note from the above definition of customer acquisition costs are:
- Acquisition costs are broader than just promotional expenses,
- They also include the cost to “fulfill” the purchase, perhaps including supply, installation, clerical processing, and so on, and
- The purchase is coming from a non-customer to the firm – which may include former customers (see the article discussing non-customers and lapsed customers).
The customer acquisition cost formula
The formula for average customer acquisition cost (AC) to be used in the CLV calculation is:
- Total costs attributable to attracting non-customers (in a time period)
- Divided by
- The number of customers acquired (during that time period)
- That is, Acquisition Costs = Total costs/total non-customers gained
An example of the customer acquisition cost formula
As a simple example of the customer acquisition cost formula, if the company spends $1 million on an advertising campaign designed to attract new customers and they successfully attract 10,000 new customers – then the average acquisition costs to attract each of these customers is:
- $1 million / 10,000 customers = $100 per customer
As with the standard CLV formula, we are calculating acquisition costs on a per customer basis. This may be calculated on an individual customer, or a particular customer segment, or for the total customer database.
Another example of the customer acquisition cost formula (with broader acquisition costs)
For another example, let’s now consider the following firm that attracted 1,000 new customers in the last year. In the same time period, they were able to isolate the various costs that were used to target first-time customers, as listed below.
- Advertising targeted at first-time customers = $1 million
- Proportion of sales promotion costs, targeting first-time customers = $2 million
- Proportion of sales staff costs spent on new customers = $1 million
- Direct mail expenditure, targeting new customers = $1 million
- TOTAL expenses = $5 million
In this case we will include all the above costs – including staff costs – to determine that total acquisition costs are $5 million. And because the number of new customers attracted in the period, we can calculate the average customer acquisition cost as:
Acquisition Costs (AC) = $5m / 1,000 = $5,000 (average per new customer).