The median startup spends approximately 92% of its first average contract value (ACV) on the sale, which translates into a payback period of 11 months..!
So what does that mean for your SaaS startup? How much should you be spending in Customer Acquisition Costs (CAC)?
In this article we will answer a few questions includingL: what is CAC? How to calculate it? What is a good CAC for SaaS? Let’s dive in!
What is CAC for SaaS companies?
CAC is a common metric for any business and has been around for a long time to assess a business’ sales & marketing efficiency. Yet, CAC has been increasingly used recently with the rise of SaaS and all types of subscription businesses.
Indeed, subscription businesses’ profitability and success relies on maximising Customer Lifetime Value (CLV or LTV). LTV is the total net margin (usually Gross Margin) you generate per each customer over their lifetime, in average. For more information on how to calculate it, see this. Because of the recurring nature of SaaS revenue, LTV is relatively easy to calculate for subscription businesses and, as such, is a very important metric to track.
In short, CAC is the sum of all your acquisition costs: sales & marketing. The expenses can be, among other things:
- Paid marketing campaigns (GAds, Instagram, etc.)
- Offline marketing campaigns
- Content marketing expenses
- Sales team salaries and commissions
- Marketing team salaries
In order to know whether your acquisition strategy is profitable, we therefore compare LTV to CAC.
Assume a $100 monthly subscription Enterprise SaaS with 20% annual churn.
Therefore LTV is $6,000. Theoretically, you could spend up to $6,000 to acquire one customer for your LTV:CAC ratio to be < 1, and your sales & marketing strategy to be profitable.
Let’s see together why this is not 100% correct, and how to assess a good CAC for such business.
How to calculate CAC for SaaS?
a) the simple CAC formula
If you google how to calculate CAC, the simple formula you will likely find right away is the following:
CAC = Sales & marketing expenses / New customers
For example, if your sales and marketing expenses for this month is $5,000 and you acquired 25 new customers, CAC will be:
CAC = $5,000 / 25 = $200 per customer
Unfortunately, whilst the formula is not per se incorrect, it is an oversimplification of reality and can be inaccurate.
b) Calculating SaaS CAC: a case study
What if a lead takes in average 60 days to convert, by the time he becomes a lead (a newsletter signup for instance) until he becomes a paying customer? What if this lead incurs different expenses (SEO, paid ads, sales team)?
Let’s consider the example of lead to conversion journey below:
|0||Lead clicks on company’s blog article||SEO|
|5||Lead clicks on a paid ad|
Lead signs up to newsletter
|30||Lead returns to landing page after receiving newsletter email||–|
|30||Lead interacts with Sales team via the chatbox||Sales team|
|55||Lead engages with Sales team for a 1-1 phone call||Sales team|
|60||Lead becomes paying customer (conversion)||–|
The problem we face with our simple formula above is that a lead to conversion can take more than 30 days, and some costs can occur earlier.
So if we were to calculate CAC for the last 30 days in this example, we would include costs (e.g. paid ads and SEO) that actually relate to customer that will be acquired next month.
That’s why CAC is more accurate when taken over a long period of time (a quarter of a year even).
What is a good CAC for SaaS?
CAC vary significantly from one business to another. And that makes sense: the more revenue you make per customer, the more you (should) spend to acquire that customer.
Instead we need, as we explained above, to compare LTV to CAC.
Indeed, LTV is generally calculated using Gross Profit per Customer. That is why comparing it against CAC is useful: Sales & Marketing costs are below Gross Profit. We therefore compare gross margin per customer (LTV) to how much sales & marketing expenses are needed to generate LTV.
Yet, profitability of a business naturally includes other expenses below Gross Profit (tech costs, customer success, general & admin, etc.). That is why the LTV:CAC ratio you should be aiming for is higher than 1. Actually an optimal LTV:CAC ratio is around 3:1.
|1:1||There won’t be enough cash to cover for other operating expenses|
|2:1||There might be just enough cash to be profitable. |
You should focus on decreasing CAC and/or increase LTV
|3:1||Optimal ratio. The business invests in customer acquisition (growth) whilst being profitable|
|4:1||Either you have reached maturity and your sales & marketing department is really efficient, or you could be investing more to grow faster|
|5:1||You are probably missing on opportunities to acquire more customers, and should be investing more in sales & marketing|
LTV:CAC also depends very much on the stage your business is. Typically early stage startups will have a 1:1 or 2:1 as they invest heavily into acquisition to test their product and find product market fit with specific audiences.
In general, the higher revenue growth, the lower your LTV:CAC can be. In comparison, a mature SaaS business growing at <10% year-on-year should be focusing on optimising its sales & marketing strategy and aim for a 3:1 to 4:1 ratio instead.
Note: If you want to estimate an accurate CAC for your business, read our article here.
CAC is a common metric for any business measuring the efficiency of its customer acquisition strategy. It is all the more important for SaaS businesses as, along with LTV, dictates how much you should be spending in acquisition expenses.
Whilst CAC can be estimated with a simple formula, accurately measuring CAC should be calculated taking into account the conversion funnel. How long does it take for an average customer to convert? What are the different steps a typical lead goes through before converting?
Early stage, high-growth startups tend to have low LTV:CAC ratios as invest in product market fit and gain in scale. In comparison, mature SaaS businesses will focus on sales & marketing optimisation to maximise profitability.
For more information on the 12 most important metrics you should track for your SaaS business, read our article here.
Do you need a template to forecast CAC, LTV and build rock solid financial projections for your SaaS business? Check out our expert-built financial model template below:
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