The 5 Essential Steps To Determine Your nCAC (Net Cost To Acquire A Customer)

Every business owner dreams of growth, but how do you ensure that growth is sustainable and profitable? The answer lies in understanding one of the most critical marketing performance indicators (MPIs): your nCAC, or net Cost to Acquire a Customer. This isn’t just a number; it’s your guiding light, determining how much you can truly afford to spend to bring a new customer through your doors, whether through paid media, content marketing, or SEO.

As the saying goes, “He or she who is most willing and able to pay more to acquire a customer wins”. But to know how much you can pay, you need a precise calculation. While there are three fundamental ways to grow a business: getting new customers, getting them to buy more when they’re buying, and getting them to buy more often, acquiring new customers is often the most challenging. That’s where the 5-step formula comes in.

Let’s break down this crucial calculation using an example of a $10 million beauty and wellness e-commerce company.

Step 1: Determine Your Customer Lifetime Value (CLTV/LTV)

The first step is to figure out how much a customer is worth to your business over a specific “Y” time period. This period can vary greatly depending on your industry and product. For instance, a supplement company might look at a 6-month or 12-month period, while a baseball glove manufacturer might need a 2-year look-back, as purchases are less frequent.

For our beauty and wellness example, after analysing their Shopify data over 12 months, they identified 20,000 unique customers for their $10 million in revenue.

Calculation: $10,000,000 (Revenue) / 20,000 (Unique Customers) = $500 CLTV.

Pro Tip: For Shopify store owners, the “Buy The Numbers” app can greatly assist in calculating CLTV and other metrics. There’s even a hack to use its 30-day free trial for initial calculations.

Step 2: Subtract Chargebacks and Refunds

Not every sale is final. Customers will return items for various reasons, and these chargebacks and refunds directly impact your customer’s actual value. This percentage can also serve as a “canary in the coal mine,” signalling potential issues with your product, shopping cart, or customer satisfaction if it’s too high.

Industry standards for chargeback and refund rates typically range between 5% and 10%. Our example beauty company boasts a healthy 5% rate.

Calculation: $500 (CLTV) – (5% of $500 = $25) = $475 Net Lifetime Value (NLTV).

Step 3: Subtract Cost of Goods Sold (COGS)

Next, you need to account for your Cost of Goods Sold (COGS), which are the direct costs associated with producing and delivering your products. It’s crucial not to confuse this with general operating expenses like rent or payroll unrelated to manufacturing.

Typical COGS components include:

Raw materials/wholesale costs.
Storage costs (a portion of warehouse expenses).
Shipping costs (from manufacturer to plant).
Packaging materials (boxes, tape).
Pick and pack labour.

For our beauty company, their COGS broke down as: $100 for wholesale costs, $25 for shipping, $10 for packaging, and $15 for pick and pack, totalling $150.

Calculation: $475 (NLTV) – $150 (COGS) = $325 Gross Profit (GP).

Note: COGS can vary significantly by industry. Digital products often have much lower COGS, while service-based industries or retail can have higher ones.

Step 4: Subtract Desired Net Profit Margin

After accounting for COGS, you need to decide what net profit margin you desire for your business. This is the percentage of profit you want to retain before taxes and interest are applied, serving as a hybrid model of EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortisation).

E-commerce profit margins generally fall between 10-15%, with premium beauty and wellness brands often seeing 10 to 30% due to higher-priced products. Our example business targets a 10% net profit margin.

Calculation: While your gross profit is $325, this 10% is typically taken from your original CLTV. So, 10% of $500 (CLTV) = $50 desired net profit.

Sub-total: $325 (Gross Profit) – $50 (Desired Net Profit) = $275.

This $275 represents the highest end of your nCAC range. If you only factored in these costs, you might believe you could pay $275 to acquire a customer. However, there’s one more crucial step.

Step 5: Subtract Operating Expenses (OpEx/SG&A)

This is often the most overlooked and debated step. Many financial professionals might argue against including operating expenses (OpEx), also known as Selling, General, and Administrative (SG&A), in nCAC calculations. However, for a realistic and sustainable nCAC, you absolutely must factor these in.

Operating expenses are fixed costs essential for running your business, regardless of sales volume. These include:

Payroll (non-marketing/non-pick-and-pack specific).
Software expenses.
Accounting and legal fees.
Rent (for office or general warehouse space).
Travel and general expenses.
Insurance.
Sales expenses (salespeople).
Marketing staff (non-agency, internal).
Web hosting and e-commerce platform costs.
CRM and email provider fees.
IT and support.
Training, licenses, and permits.

For our $10 million beauty company, their OpEx is substantial, typically around 25% of their revenue.

Calculation: 25% of $500 (CLTV) = $125 (per customer’s share of operating expenses).

Final nCAC Calculation: $275 (from Step 4) – $125 (OpEx) = $150.

Your nCAC Range: The Key to Scaling

So, for our example beauty and wellness company, their nCAC range is between $150 and $275.

$275 represents the higher end, which you might aim for if you’re taking on more risk or have a larger cash reserve.

$150 is the “scale number”. This is the target you give your marketing team, telling them: “If you can acquire a customer for $150, scale to the moon! Keep it there!”.

Knowing this range is essential for making informed marketing decisions, allowing you to confidently increase ad spend, invest more in content marketing and SEO, and even plan for staffing and additional warehouse space when you’re growing profitably. Without this critical number, you’re essentially flying blind in your quest for business growth.

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Original Source: https://www.sfdigital.co.uk/blog/net-cost-to-acquire-a-customer-ncac/

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