When you’re starting your SaaS company it can be tempting to get customers any way you can--regardless of the cost, time, and energy. However, if you plan on running a successful and profitable company you will need to balance the total cost of sales and marketing efforts that is required to acquire a customer or your Customer Acquisition Cost (CAC).
If you’re too cautious about your CAC, you will likely be missing out on customers and future revenue. Yet, if you spend too freely, you won’t be profitable and will likely end up in the Deadpool.
The challenge of CAC is: Spending the right amount to drive new customers to your service without jeopardizing the Lifetime Value (LTV) and revenue from that customer. This is known as the LTV/CAC ratio, and it's the "god metric" of many successful SaaS companies.
Successful SaaS businesses calculate CAC correctly and use that information to quantify and optimize their marketing funnel. As well as understanding and mastering the balanced relationship that CAC has with LTV. Let's take a look at why CAC is important, how to calculate it, and ways you can make your acquisition cost work efficiently to ensure that your SaaS business is among the successful elite.
What is CAC and Why Should You Care
To put it simply - CAC is the total cost of sales and marketing efforts that are needed to acquire a customer. It is one of the defining factors in whether your SaaS company has a viable business model that can yield profits by keeping acquisition costs low as you scale.
"Customers Are Costly - Not managing CAC is like descending from the face of Yosemite without a harness"
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If you have a successful business model your CAC will be sufficiently lower than LTV. If your CAC is higher than LTV right now don’t panic. As seen in the image above - CAC is a seesaw that may experience some ups and downs. With the information and steps we are about to show you, you can surely get your SaaS business on the right end of the seesaw.
Why understanding your CAC is so important?
Customer acquisition cost is a direct reflection of the future success of your SaaS business. Most SaaS companies put forth a lot of time and money before they ever see a return on that investment. This metric will begin to matter more and more as time passes and you begin to add up the months it takes to recover from CAC and actually turn a profit.
The graph above depicts the early period of the acquisition process (highlighted in red) where your SaaS business is spending time and money. Then as time passes your customer starts to pay monthly for your subscription service and you eventually break even and make your money back on the initial investment. From then on is a magical period (highlighted in green) where you’re rolling in the dough and netting a profit from that customer until they decide to cancel (which is hopefully never).
More specifically (and bluntly), understanding your CAC is important for three key reasons:
Helps optimize your LTV/CAC ratio to 3 or higher: Every quarter you should be managing your LTV/CAC ratio by optimizing Sales and Marketing output. You constantly need to be optimizing your channels and tactics to ensure you're optimizing this ratio and making that green triangle as large as humanly possible. For a benchmark, you want this number to net out to at least 3, meaning for every dollar you put in your SaaS machine you're getting 3 out.
Determining and optimizing your payback period: As soon as you acquire a new customer you instantly have lost money. This means the first thing on the agenda moving forward should be getting that upfront money back as soon as humanly possible. Think of payback period as the next layer of CAC in the fact that it reveals a much more dense look at how your channels and business as a whole are doing from an acquisition front, especially if you're employing a freemium model. Check out this post from HubSpot on how their product team thinks about the payback period.
Tracking and optimizing your CAC ratio: Oh yes, CAC goes deeper than simply the CAC to what's known as the CAC ratio. The reason this number is so important (and will be written about in the future) is that the purpose of a business is to generate a margin, not just revenue. As such, the CAC ratio takes gross margin over the costs of customer acquisition and tracks it over time.
What do you include in CAC - Users you acquire and the costs that brought them in
Going a bit deeper into the heart of CAC, it is comprised of two main factors:
Sales and Marketing expenses: This includes three critical parts - salaries, tools, and spend. Everything in those respective verticals should be included. Think of it this way - anything on your P&L that is contributing to the acquisition of new customers should be included. Remember you're trying to optimize your profitability, so you don't want to disclude things that would be hiding flaws in your acquisition strategy or include things that well mask how profitable you truly may be in your acquisition.
New customers acquired: Only include new customers that you have acquired. This is a bit more hotly contested, because of the inclusion of "Customer Success" in SaaS businesses. Yet, CS focuses on retention, which should be ever expanding in terms of MRR/ARR. CAC focuses in on the acquisition piece of SaaS.
What you should not include in CAC
There's a heated debate in SaaS around whether you should include Customer Success costs in CAC (as alluded to above), as well. In our experience chatting with and sitting in on SaaS boardrooms, we typically see that customer success is not included in CAC. This isn't necessarily a reason not to include it, but when you think about customer success costs, their main purpose centers around your expansionary revenue, not your new customers.
Sure, customer success can be looked at as part of sales, but you should be treating each part of your SaaS foundation as an individual axis to make sure you're optimizing each piece of the SaaS equation. As such, customer success makes much more sense to include in your CAC ratio, not in pure CAC, because you'll want to measure the efficiency of your acquisition teams independently.
Ok, so how do I calculate CAC?
Calculating CAC is fairly easy to equate. All you need are the right components to plug in. Here is a breakdown of the formula to help.
CAC: Here you take the sum of all your sales and marketing expenses over a given period of time (Salaries, tools, spend) and divide by the number of new customers acquired in that same time period.
What Are Four Ways You Can Reduce CAC?
Customer acquisition cost is designed to measure and maintain the profitability of your acquisition teams. If your costs to get the customer through the door are higher than your Customer Lifetime Value (CLTV, LTV) than the business cannot be viable. The best rule of thumb is to be spending 33% or less of your customers lifetime value.
With that being said lets put this knowledge into action today. Here are some ways you can reduce your CAC and optimize for profit.
Optimize your funnel: Quantify each step of the process, and understand how many visits lead to leads, how many leads lead to opportunities, and how many opportunities lead to customers. The best way to do this is to apply the Balfour Method of growth process to your funnel, which ensures proper mechanics in your channels.
Optimize your pricing: Remember a huge portion of CAC feeds into the recovery period, as well as your CAC ratio. As such, if you optimize your pricing to gain cash up front to recover your CAC, in the form of mandatory training, integration costs, etc., you can ensure you start making a profit as soon as possible. Check out more on value based pricing strategy here on our Price Intelligently blog.
Strengthen the effectiveness of Sales and Marketing spend: Take a lean approach to marketing and sales expenses. Put money into channels that have proven returns so that you aren’t wasting any more dollars.
Quickly engage new customers and prospects: Cut down the time it takes to get new customers engaged with your product. The quicker product engagement happens per customer the cheaper acquisition cost becomes per customer
Inbound Marketing: Using real deal sweat equity to produce content that provides value for your audience is a great way to bring leads through your funnel at minimal cost to your business.