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How Much Should your Startup Spend to Acquire a Customer?

One of the first questions our team asks when on-boarding a client is “what’s a customer worth?”. It seems like an obvious question, because without knowing how much money your business makes from a typical customer, it’s impossible to know how much you can invest in acquiring them. Many startups have a hard time answering this question, because often, they don’t have enough data on existing customers to help them understand their expected lifetime value (LTV), the average total revenue earned from each customer.

But, what they are able to do, is help us define how much they can expect to earn from the best and worst imaginable customers. For example, they can say that a great customer is someone that makes a certain number of purchases or pays for a subscription for a specific period of time. A great customer can also be counted on to recommend your company to other people and bring you new referrals. On the other hand, a bad customer is someone that signs up for a free account, but never buys; or someone that only buys products that you sell at promotional prices with no margins.

Outlining what these two customers look like is an important exercise that can help you really think about who you want to target and how you need to brand yourself in order to acquire them. Once you’ve done that and have adjusted your branding so that it’s relatable to” great” customers, count up how much money you can expect to make from such a customer and subtract the cost of providing the products and services needed to retain them. Then, multiply that number by 1 minus your target profit margin (don’t be greedy if you’re a new startup trying to gain market share). The result of this calculation is your target Cost Per Acquisition (CPA) for this segment. If your data or industry experience tells you that only a certain percentage of new customers become “great”, multiply your CPA by that percentage. Now do the same for “mediocre” as well as “terrible” customers. Add them all up, and you’ll get your general target CPA.

Clearly this somewhat oversimplifies a calculation that has tremendous long-term significance. But when you’re just starting out, you need a good “ballpark” CPA number to help you evaluate your various sales channels.

What if the lifetime of a customer is several years? In that case, if you acquire them at a specific cost based on the calculation above, it could take years to realize your profits. This would be a good time to bring your CFO or other finance professional into the conversation to help determine how much you can afford to spend on growing your customer base. Often you’ll need to limit the revenue count to a specific period of time. For example, you may only want to count revenue generated during the first 6 months of the customer’s lifetime.

Once you’ve established your customer Lifetime Value and target Cost Per Acquisition, you’re ready to build out a marketing plan with a budget that’s directed at reaching your target CPA within that budget. Good luck!

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