The past 18 months have thrown retail into turmoil. If we rewind two years, I don’t think anyone could have envisaged the turbulence to the FMCG market that we’ve experienced.
Full lockdown on the high street channelled footfall to mouse clicks. As such, FMCG e-commerce sales skyrocketed by 45.5% in 2020 as more households pivoted towards online grocery shopping. Quite frankly, the level of growth experienced in 2020 was an anomaly and will certainly be marked in the history books. However, it appears consumer behaviours continue to favour online shopping; e-commerce now accounts for 6.5% of grocery sales globally.
What’s the current situation?
Quarter three of 2021 has presented retailers with even more challenges. Supply chain issues continue to be exacerbated by COVID-19, as the virus effects workforces and production capabilities. This, coupled with delivery delays due to a shortage of lorry drivers, and heightened by Brexit, have played havoc with availability of stock both in store and online.
These obstacles, when combined with increasingly impatient shoppers, have more than impacted customer loyalty. Previously, shoppers would return to their favourite brands, either by habit, or via incentives and promotions. Now, shoppers are influenced more by stock availability than traditional tactics designed to nurture customer loyalty. As such, we’ve seen a big surge in shoppers making one-time purchases from competing brands, both through choice and necessity.
Today’s online shoppers want faster deliveries, cost effectiveness and timeliness.
Fierce competition within the FMCG sector has forced brand owners to thoroughly analyse the changing needs of the consumer. Today’s marketplace is not simply about customisation and tailor-made products, nor is it about reaching out to more and more customers. Rather, it is about innovation, faster deliveries, cost effectiveness and timeliness, alongside quality and unmatched features.
This shift in consumer behaviour means e-commerce storeowners are now more aggressively leveraging their biggest asset, customer data, to achieve a more competitive edge. Two critical metrics you need to be aware of to help generate revenue and improve your bottom line are customer acquisition cost (CAC) and customer lifetime value (CLV). By doggedly tracking these metrics, you will be able to build a more informed marketing strategy and ensure maximum profitability.
Do you know your CACs from your CLVs? Below are the definitions and calculations you need to know, plus the tactics and strategies you can implement to lower the cost of acquiring those all-important new customers.
What is Customer Acquisition Cost (CAC)?
E-commerce Customer Acquisition Cost (CAC) measures the cost of converting a potential lead into a customer. The CAC is the total sales and marketing cost required to earn a new customer over a specific period. Knowing this number provides a business with the budget needed to secure a new customer, and by working to drive this number down efficiently, deploy their marketing power. Continual analysis of how adjustments to the sales and marketing strategy is affecting your CAC is then crucial to ensure efficient spending and greater profits.
How to calculate CAC?
All of these acronyms can seem a little confusing, so let’s break it down. The first step is to determine the time period that you’re evaluating (month, quarter, year). This will help you narrow down the scope of your data. Then, add together your total marketing and sales expenses and divide that total by the number of new customers acquired during the time period.
You can calculate CAC by using this formula:
Customer Acquisition Cost = Cost of Sales and Marketing divided by the Number of New Customers Acquired
However, other factors can effect this number. For instance, if a customer makes recurring purchases throughout their lifetime, this is where customer lifetime value (CLV) comes in and provides more context so you can better understand the customer acquisition cost. More on that later.
Calculating the cost of sales and marketing
The total sales and marketing cost includes all marketing spend, salaries, commissions, bonuses and overheads associated with attracting new leads and converting them into customers. Let us take a look at each expenditure individually.
- Ad spend
The money you’re spending on advertisements to release your marketing campaign to the public. This should be a multi-channel strategy to ensure you’re not reliant on one channel. Examples include: paid social media ads, PPC, TV airtime or magazine advertorials.
- Technical costs
This refers to the technology and software that your marketing and sales team uses.
- Production costs
Whether you’re creating video content in-house or using an agency, it all adds up and needs to be added into the equation.
- Inventory upkeep
Another factor to consider is product maintenance – the costs of holding stock, storage and the cost of having cash tied up in stock.
- Fulfilment costs
A crucial factor to consider and often a make-or-break for online retailers. Controlling and improving this cost is critical to success. Don’t forget to account for the cost to your business of returns as well as orders being shipped.
- Referral fees
Referral fees are commissions that you must pay online marketplaces for each sale. Fees to marketplaces and affiliates range from 6% to 20%, while most Amazon sellers pay 15%.
- Employee salaries
Here, you’ll need to factor in staff salaries associated with order fulfilment.
Defining customer lifetime value (CLV)
As briefly mentioned, another crucial metric for e-commerce storeowners to calculate and monitor is the customer lifetime value (CLV) – the value customers bring to your business over their lifetimes.
The methodology is simple yet effective. If you attract customers who only buy what you’re selling once or twice, your CLV may be low. However, if customers buy repeatedly, CLV is likely to be high.
Why you need to calculate customer lifetime value (CLV)
One of the most profitable things you can do is to retain customers. Acquiring a new customer can be anywhere from 5 to 25 times more expensive than retaining one you already have. Furthermore, increasing customer retention by a mere 5% can increase business profits by 25%. To help improve your customer retention rate, you must determine what makes buyers happy and what drives them away.
Knowing your CLV can help you identify the customers who generate the most profit. It’s an important metric to have to hand because your CLV may not cover the CAC if the customer only buys once. The CLV is there to set the budget/value of the CAC, based on how much you can spend to acquire a customer, and what level of return you get back from their lifetime of purchases.
How to calculate CLV
Similarly to determining your CAC, there are a few factors you’ll need to consider to calculate this metric accurately. Here’s the data you’ll need to hand:
- Average purchase value
Calculate this number by dividing your total revenue (usually one year) by the number of purchases over the course of that same time period. E.g. (total annual revenue/number of purchases over that year).
- Average purchase frequency
Calculate this number by dividing the number of purchases over the course of the time period by the number of unique customers who made purchases during that time period. E.g. (number of purchases over the year/number of unique customers who bought something during that year).
- Customer value
Calculate this number by multiplying the average purchase value by the average purchase frequency.
- Average customer lifespan
Calculate this number by averaging out the number of years a customer continues purchasing from your company.
Once you have gathered these figures, you can go ahead and accurately calculate the customer lifetime value by using the following formula:
CLV = customer value x average customer lifespan
The CLV will give you an estimate of how much revenue you can reasonably expect an average customer to generate for your company over the course of their relationship with you.
CLV to CAC Ratio
You can use the CLV to CAC ratio (CLV:CAC) to guide spending habits for marketing, sales, and customer service. CLV:CAC shows a brief snapshot of how much customers are worth compared to how much the business is spending to attain them.
The value of your customers should be three times the cost of acquiring them.
So, what does a good ratio look like? Ideally, you should look to recoup the cost to acquire a customer in the same year they were acquired; this helps maintain a positive cashflow and gives you more firepower to go out and attract more customers. You should also aim to maintain your CLV:CAC ratio at 3:1; in other words, the value of your customers should be three times the cost of acquiring them.
If it’s closer to 1:1, that means you’re spending just as much money on attaining customers as they’re spending on your products; in essence, ‘running to stand still’. If it’s higher than 3:1, like 5:1 for example, that means you’re not spending enough on sales and marketing and could be missing out on opportunities to attract new customers.
Average e-commerce CAC within FMCG
So far, we’ve discussed a lot of data points required in determining your CAC. But what does a good CAC look like within FMCG?
Research shows the CAC for consumer goods, as estimated by a few different publications, is £16. To give context, Amazon is said to spend approximately £116 per new customer acquired, while eBay pays around £130, and Facebook spends roughly £43. The big difference being that in FMCG, the likelihood of repeat purchases is far greater, and they are also likely to be more regular.
However, a small business using pay-per-click advertising might only need to spend around £14.50 per customer if they choose their keywords well and operate in a less competitive market.
How to improve your Customer Acquisition Cost
And now, how to make your profit margins healthier. There are a few different ways to improve your cost of customer acquisition to bring that CLV:CAC ratio closer to 3:1. Here are a few strategies to work towards:
Implementing the Super Six
Having a handle on the input and output of all areas of your business is crucial in building a strategy which delivers continuous improvement. At Evolution, we help e-commerce brands review the following Super Six areas: data; audience; engage; sales; value; loyalty. Being able to identify major areas of concern within these six key groups enables storeowners to re-focus, giving them the knowledge and confidence to implement a new roadmap for success.
Optimise your site for mobile form submissions and shopping, test website copy to make sure it’s as clear as possible, and try to create a touchless sales process so your visitors can buy from you 24/7 with no hassle. This will make sure it’s simple and straightforward for visitors to convert into leads, or for leads to convert into customers and make purchases on your site.
Increase customer value by giving customers what’s valuable to them. Collect customer feedback, and whether it’s a product fix, a new feature, or a complementary product offering, do your best to give customers what they’re asking for. Post-pandemic, the demand for Click and Collect continues to grow. Do you have the infrastructure to offer this service?
Adopting review platforms such as Yotpo or Trustpilot helps build trust with new viewers, drives revenue, and makes it easy for shoppers to find the information they need. The platforms also enable you to build tailored and data-driven loyalty programmes to help engage existing customers and increase customer lifetime value.
Customer referral programme
Consider implementing a referral scheme to reward customers for recommending their friends and family. New customers acquired on the back of referrals significantly reduces your CAC, so build a customer referral programme your customers want to participate in.
Online shoppers are demanding; research shows many customers stop buying from a brand after a single bad experience. As such, there’s an emphasis on implementing on-demand customer service such as AI-powered chatbots to take the strain of your team and automate a series of FAQs on ordering, shipping and after sales care.
Implementing a subscription-based service is an excellent way to ensure a steady stream of customers, and we’ve seen a dramatic rise in FMCG e-commerce stores adopting this model. Plus, don’t forget the upsell capability; incentivise your customers to buy more by offering free express shipping and discounts if they spend a certain amount. We worked with Mighty Pea to implement a subscription service for their plant-based m.ilks. In just six months, we helped increase their number of subscribers by +300%. Read the Mighty Pea case study here.
Need help building a customer acquisition strategy?
Whether you need help in determining the true costs of your CAC or CLV or are looking to build a strategy to lower your customer acquisition cost, our team of strategists can offer advice and expertise. Contact us today for an initial chat to find out how we’ve helped other FMCG e-commerce stores and how we can help you. ■
Author // Holly Hughes