Unlocking the Formula for Lowering Customer Acquisition Cost and Improving Your Customer Experience
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- Product Metrics /
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As a product leader, managing customer acquisition cost is likely at the top of your list of high priority items to address. After all, your product and business won’t be successful or even viable if you don’t.
It can be challenging to dig into the complexity of the customer journey and what they must go through to find, assess, select, and adopt your product. Then to keep that customer you need to ensure that they continuously discover value in your product or service. That’s a tall order!
Lowering the cost of customer acquisition doesn’t have to be complicated. But it does require collaboration across different teams within your organization. And on the other hand, great customer conversion itself is meaningless if the product experience doesn’t help you retain that customer and build lifelong value.
While every function has its own goals and incentives, they need to ultimately align on a shared purpose and outcome.
Here are key tactics you can use to lower your customer acquisition costs and ultimately deliver an improved customer experience.
Customer Acquisition Costs & Lifetime Customer Value
If you want to design a business model that not only generates revenue but also retains profits, digital product leaders have to consider two major factors: customer value and value exchange.
- The first is understanding the ‘customer value’ of addressing the articulated or unarticulated need, the solution to the problem, or the access to a new opportunity.
- The second factor is understanding the ‘value exchange’ that defines what the core customer is willing to trade (i.e. money, time, access, etc…) in return for the product or service.
This is part of the essential foundation to a successful strategy and finding product-market fit. We can break this down even further by looking at customer acquisition costs (CAC) vs. the total lifetime value (LTV) of a customer. This accounts for what it takes to attract, convert, and retain customers. Let’s quickly break each one of these down.
Customer Acquisition Costs
Let’s start with the average customer acquisition costs. This is calculated by taking your total marketing and sales costs and dividing them by the number of newly acquired customers (users) within a given time period.
CAC = (Marketing + Sales Costs) / (Number of NET new customers)
A common best practice is to aim to recover your CAC in less than 12 months. This target is relative to your business, but you want to maximize your capital efficiency and reduce strain on resources that are needed to drive growth and continuous product improvement.
Lifetime Customer Value
Next, calculating LTV is a bit more complicated as it is dependent upon your revenue model (i.e. perpetual license, subscription, consumption, premium access, advertising, associated products or services, etc). To calculate LTV, let’s use the example of a subscription-based model. In this case, you would want to look at the annual subscription revenue multiplied by the estimated lifetime of that customer and then multiply the sum by the gross margin (i.e. sales revenue – the cost of goods sold, a.k.a. retained revenue).
LTV = (Annual Revenue x 3 years) x (Gross Margin)
A common best practice is to aim for your LTV to be at least 3X your CAC. Again, it is important to note that this is specific to every unique business model. LTV has to take customer buyer cycles, business velocity, the scale of growth, and the market landscape into consideration. With a firm understanding of your revenue and associated cost structures, you can now evaluate if your approach to customer acquisition is aligned with your goals. You’ll be able to identify where you can optimize and lower costs.
4 Customer-Centric Approaches to Lowering Acquisition Costs
1. Identify Your Ideal Core Customer
With your CAC and LTV numbers, evaluate (or re-evaluate) your target customer segments. Product leaders from every function of the organization need to be aligned and exceptionally clear about who the core customer is, and who it isn’t. When you establish this clarity, you eliminate the guesswork. You’ll be able to leverage data-driven insights to focus on the desired target customer segment that has the necessary volume and spending power. They will become identifiable, accessible, and exhibit similar behaviors when the need is recognized and is prioritized to be addressed. This unlocks access to realizing your goals in a highly competitive marketplace. Ask yourself:
- What is the customer value of your product or service to each segment?
- What is the value exchange for that particular customer segment?
- Based on this insight, which customer segments are the least expensive to acquire with the highest level of return on investment in the shortest period of time?
2. Re-evaluate the Role of Your Website
For many organizations, websites have evolved from marketing brochures into full-blown digital products without the organization ever being aware. When this happens, the approaches to strategy, design, development, and continuous improvement have to evolve as well. So what’s the difference?
- Marketing-focused websites are trying to persuade someone to do something.
- Product-focused websites are trying to empower someone to do something.
While this distinction may seem subtle, it is profoundly important. Once the website becomes an intricate component to how the business delivers its products or services, the impact on customer acquisition costs, and improving the customer experience and lifetime customer value, it has to be treated differently. Ask yourself what jobs your website needs to perform:
- Attract new customers?
- Covert, nurture, and engage prospective buyers at each stage of their journey?
- Guide users through specific tasks?
- Educate and inform new and recurring visitors?
- Self-service customer support?
What moments in the customer experience are inhibiting someone from addressing their needs? To support today’s B2C and B2B buyers, we need to support every stage of the customer journey. Not only to manage costs but to support customer success and retention. This understanding will help to improve multi-channel marketing, content development, campaigns and retargeting, marketing automation, conversion funnel creation and optimization, and performance testing.
3. Improve Your Product Experience to Increase Customer Retention
While acquiring new customers is extremely important, ensuring your existing customers are happy, satisfied, and engaged with your product or service is also essential to your success. Minimizing your churn rate directly impacts LTV and CAC. Your churn rate is the percentage of customers that cancel or fail to renew over a given period of time. Increasing customer retention generates new growth and development. Improving the customer experience is key to mapping the moments and user flows that yield the sum of the customer experience. The most common challenges to addressing these issues are not having a complete picture of how customers use your product or service, fragmented data, and misalignment of the value exchange. Ask yourself:
- Do you know how people use our product or service? How effective is it at addressing their needs?
- Do you have a clear picture of what motivates the customers’ behavior? What are their goals, perceptions, needs, influences, and constraints?
- Do you have a clear map of the product flows, and the intended user and necessary business outcomes? What do you have in place to measure those outcomes?
In multiple cross-industry studies, it has been found that the first 90 days of a customer’s experience are the most critical to increasing retention and capturing LTV. One example of this you can see at scale is in the mobile app space, where the average churn rate after the first three months can be as high as 94%. One of the common reasons for this is poor onboarding. In customer experience terms, we want to reduce the level of effort required from the customer, providing a guided experience that takes them from a novice first-time user, through product adoption, and ultimately product mastery. If you look at companies like Box or Slack and their business models this is even more critical. They have taken on a bottom-up customer acquisition cost model that is dependent upon the user quickly recognizing value and inviting others to participate. Without increased user participation customer value declines and the value exchange becomes inequitable.
4. Test Often, Optimize, and Iterate
Co-create with your customers and users. It’s important to capture the voice of the customer throughout the product development lifecycle. To achieve your shared purpose and objectives, this insight is essential to an integrated cross-functional team (marketing, sales, product, customer success, etc.) at every level. It is also fundamental to each team building and maintaining alignment as they work to achieve their individual metrics.
One of the most common types of testing sighted when it comes to lowering customer acquisition costs is A/B testing. While this is important, it doesn’t capture the vast scope of testing. It also does not identify all the opportunities to lower costs while improving the customer experience.
When you look at integrating the voice of the customer into your work there are two approaches to highlight:
The first approach focuses on the voice of the customer by identifying and visualizing the gap between customer expectations and their actual experience with the product/business, putting the emphasis on customer value.
The second approach focuses on the voice of the customer, where you look to move into a new market, create a new feature, or acquire feedback from your target customer to increase and put emphasis on the value exchange with your product/business.
If you want to truly move the needle in lowering customer acquisition costs, the only pathway that leads to predictive results is engaging prospective and existing customers, experimentation, testing, and optimization. In addition to A/B testing, this includes first impression analysis, usability testing, and competitor comparison analysis to name a few. This mindset is prevalent in most high-performance product teams around the world today.
Take the next step!
The number of tactics is potentially endless when it comes to lowering customer acquisition costs, and how you can integrate the practices into your product and business. Rapid growth and scale come from managing both sides of the equation. It drives the most successful products, teams, and organizations to incredible heights. You now have a foundation, a series of questions to ponder to propel results on both sides of your equation.