I got an email the other day asking about Freemium Customer Acquisition Costs (CAC) and whether or not to include the cost of supporting and marketing to free users in the cost of acquiring paying customers.
Here’s my quick answer and some other resources for you to check out.
The Question about Freemium Customer Acquisition Costs
“Question for you – do you feel that all costs of supporting the free users should be included in the cost of acquisition of a customer? Further, when calculating the CAC should we consider the average lifetime of a free user and multiply that by the monthly cost of supporting a free user? An example would be support, hosting and banking integration fees (in our case).
“For example, the lifetime of a free user is 12 months. The monthly cost of supporting the free user is $2. Therefore the lifetime cost of supporting the average user is $24 – regardless of whether or not they convert to a customer.”
My Answer on calculating Freemium Customer Acquisition Costs
Generally, you would include all of the support and marketing costs for the free users in the CAC. I say generally because it depends on many factors, not the least of which are your CFO and investor’s points of view on this subject.
But generally, yes. That means if it costs $24 per free user per year to support them (assuming that is also inclusive of whatever marketing costs are required to get the free user to the site, get ’em signed-up and on-boarded, etc.), then it would cost $2,400/year to support 100 free users.
If you have a 3% conversion rate on an annual cohort of 100 users (that’s somewhere near the typical conversion rate for the BEST Freemium companies, BTW), that would be a total of $2400 to support them, and the CAC based on the 3 that become customers would be $800.
If the Life time Value (LTV) of a paying customer is < $800, that’s probably not good.
If the LTV of a paying customer is > $800, that’s at least heading in the right direction.
Now, there are obviously other things to consider here – this is hardly a well crafted financial model – but the idea is there.
And of course if you’re using other methods to monetize the free users – advertising, network effect data aggregation, etc. – then this becomes even more convoluted.
But – generally – you’re on the right track.