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What Is 'Allowable Acquisition Cost (AAC)'?

Allowable Acquisition Cost (AAC) is the marketing component of the Lifetime Value. The higher the Lifetime Value of your customers, the more you can spend to attract new customers.

To calculate your AAC follow these steps:

1. Start with your average customer's Lifetime Value.
2. Subtract your Value Stream costs.
3. Finally, subtract your Overhead divided by your customer base (which represents your Fixed Costs).

The higher the Lifetime Value, the higher the AAC. The more each new customer is worth, the more you can spend to attract them and keep them happy.

Josh Kaufman Explains 'Allowable Acquisition Cost'

Think back to the lemonade stand: how much could you spend to attract a single paying customer? Not much-you're only earning $1 per cup of lemonade, so you can't afford to spend much on marketing to individuals.

Contrast that with the insurance agency: if the Lifetime Value of a customer is $24,000, how much could you spend to attract a new customer? Much more.

Getting people's attention and acquiring new prospects typically costs time and resources.

Once you understand the lifetime value of a prospect, you can calculate the maximum amount of time and resources you're willing to spend to acquire a new prospect. Allowable Acquisition Cost is the marketing component of lifetime value.

The higher the average customer's lifetime value, the more you can spend to attract a new customer, making it possible to spread the word about your offer in new ways. Having a high lifetime value even allows you to lose money on the first sale.

Guthy-Renker sells a topical acne treatment called Proactiv using long-form television infomercials, which are expensive-they're spending millions to produce and air those commercials, hiring celebrity endorsers like Jessica Simpson.

At first glance, it doesn't make any sense: the first sale is for the "low, low price" of $20. How on Earth are they not losing money hand over fist? The answer is Subscription.

When a customer purchases Proactiv, they aren't just buying a single bottle of face goo-they're signing up to receive a bottle every month in exchange for a recurring payment.

The lifetime value of each new Proactiv customer is so high that it doesn't matter that Guthy-Renker "goes negative" on the initial sale-the company makes a ton of money using expensive advertising, even if it loses money on a few customers who don't continue with the program.

The first sale is sometimes called a “loss leader”—an enticing offer intended to establish a relationship with a new customer. Banks and financial services firms will often encourage qualified prospects to open an account by giving them hundreds of dollars in free waivers, gifts, or—in some cases—cash.

To calculate your market’s Allowable Acquisition Cost, you’ll need to know your desired Profit Margin. Start with your average customer’s Lifetime Value, then subtract your Value Stream costs—the Variable Costs required to create and deliver the value promised to each customer over your entire relationship with them. Then subtract your Overhead divided by your total customer base, which represents the Fixed Costs required to stay in business over that period of time: that’s your net income before marketing expenses. Multiply the Lifetime Value by your desired Profit Margin, then subtract that result from your net income before marketing expenses. That’s your maximum Allowable Acquisition Cost.

Here’s an example: if your average Lifetime Value is $2,000 over a five-year period, and the cost of value creation and value delivery is $500, that leaves you with $1,500 in revenue per customer served. Assuming your Overhead expenses are $500,000 over the same five-year period and you have 500 customers, your Fixed Costs are $1,000 per customer, which leaves you with $500 in net income before marketing expenses. If you’re shooting for a minimum 15 percent Profit Margin, you can afford to spend up to $200 per customer on marketing expenses. ($500 – 0.15*$2,000 = $200) If your assumptions are correct, any customer you can attract for $200 or less will be worth the investment, giving you a clear budget for future marketing campaigns.

Knowing that, you can test various forms of marketing to see if they work - if your assumptions are correct, any customer you can attract for $200 or less will be worth the investment.

The higher the Lifetime Value of your customers, the higher the Allowable Acquisition Cost.

The more each new customer is worth to your business, the more you can spend to attract a new customer and keep them happy.

Questions About 'Allowable Acquisition Cost (AAC'

• How much can you reasonably spend to attract a new customer?
• Could you use a 'loss leader' to establish a new relationship with a high lifetime value customer?

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"Any business can buy incremental unit sales at a negative profit margin, but it's simpler to stand on the corner handing out $20 bills until you go broke."

Morris Rosenthal, author of Print-on-Demand Book Publishing and blogger at fonerbooks.com

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