Launching a new SaaS product is exhilarating and can completely change the lives of those involved, but oftentimes we get so caught up in the honeymoon phase of our product launch that we lose sight of the bigger picture.
What does it actually cost to get a new customer? This is a vital metric to master if you are looking to scale up your business in the near future.
If you are a SaaS startup looking to build a predictable customer acquisition engine, or a SaaS Company that is ready to scale, this article is for you.
· Delve into the What? and Why? of Customer Acquisition Costs (CAC)
· Consider Factors Associated with CAC Calculations
· Determine the Right Marketing Mix to Accelerate Growth
· Use CAC Insights to Profitably Scale Paid Acquisition
The What? and Why? of Customer Acquisition Costs (CAC)
What is Customer Acquisition Cost?
Customer Acquisition Costs, or CAC, is a metric used to determine the costs associated with acquiring a new customer into your business. This type of insight can help with resource allocation, allowing the sales team to focus on selling to the right customer. While used in many other industries, it’s one of the key metrics for SaaS companies looking to scale. The framework of the SaaS model is dependent on the lifetime value of the customer, rather than the short-term gains of acquiring them, so if this is your model you’ll want to listen up.
It’s important to note that CAC is best used for those SaaS companies that already have a handle on their ideal customer and their product. If you are still in these stages, the CAC metric is good to know about, but you’ll likely not use it until it is time to start scaling. The fact is, SaaS companies tend to have such explosive growth, that many companies don’t even realize how much it costs to acquire a customer – mainly because that isn’t the problem in the beginning. Later on, when you are fine-tuning your product or marketing fit, CAC analysis will help you determine if you are poised for future growth.
Why is Customer Acquisition Cost Important?
We touched on why CAC is an important metric for SaaS Companies already, especially for companies with a vetted product ready to scale, but what are some other reasons to pay attention to this metric?
CAC helps you delve into picking the right customer. You don’t want to waste valuable resources on chasing customers that have little or no value to your company. . It’s kind of like the prizes at a County Fair. You may be focused on that large prize so much, that you lose sight of how much money you’re spending to play. In the case of your SaaS company, you may want to sell that whale of a customer on your Enterprise platform, but you could be so focused on the prize, you forget what it costs to get you there. The other side of that scenario is just as futile. You don’t want to find yourself using cut-rate marketing techniques, only to acquire a cheap customer who really won’t do much for your bottom line.
The other part of the equation covers how long it takes for you to recover the costs associated with acquiring a new customer. The more your business grows, the more important it is to examine how many months of revenue it takes from a customer to recover acquisition costs. It isn’t out of the ordinary to find your company waiting months to years to generate enough cash flow to recover CAC, but that’s not a long-term success strategy. An ideal goal for recovering CAC is within a year. It may not be a viable benchmark for a SaaS startup, but it is a proven model for long-term strategizing.
How do I calculate CAC?
Now on to the nitty-gritty – how to calculate CAC. The straightforward formula is:
Divide the total sales and marketing expenses by the total number of customers acquired within a specific period, as the diagram below depicts.
In this formula, your total cost of sales and marketing should account for everything related to those disciplines, such as:
· monthly costs for paid advertising
· monthly costs for content marketing
· costs for SEO or other marketing automation tools
· salaries of sales/marketing team members
Seems pretty simple, right? Unfortunately, no, it’s a little more complicated than that.
With business accounting, we get the benefit of a reporting structure, thanks to GAAP financials, but that’s not the same for most SaaS metrics. There are no governing standards, protocols, or guidance on CAC, so it is a relatively gray area.
There are, however, some key metrics to observe, and there are some common pitfalls to avoid when handling your CAC calculations.
Let’s say, for example, your sales and marketing expenses for a month are $2,500 and over that month you acquired 10 new customers.
You’d calculate your CAC to be:
CAC = 2,500/10 - $250/customer
Let’s dig into a few more metrics worth calculating at the same time:
Calculating CAC Recovery
To figure out how long it will take to recover CAC, you divide the CAC by the difference between monthly recurring revenue (MRR) and the average cost of service (ACS). In the example above, and given an MRR of $100, and an ACS of $60, you would calculate CAC recovery as:
CAC payback time = 250/(100-60) = 6.25 months
Calculating Customer Lifetime Value (LTV)
To calculate the lifetime value of a customer, divide the average revenue per customer by the average churn rate.
For example, if your gross margin per customer is 30% and the average churn rate per month is 4%, your LTV will be calculated as:
LTV = (100*30)/4 = $750
Calculating LTV: CAC Ratio
Now to plug it into the final insight: your LTV: CAC ratio, which lets you know if you have the right mix. In this case, the ratio is calculated:
LTV: CAC = 750/250, or 3:1, which is right within the industry benchmark.
Here are those formulas again:
SaaS CAC: Factors to Consider
Now, these calculations are all well and good, but there are nuances with using the formulas, as many businesses include or exclude certain details. Factors to keep an eye on include:
One key factor to consider is the costs associated with retaining customers. Activities like customer service while learning your software should not be included in your calculations for CAC, as these are related to retention, not acquisition.
Related Sales and Marketing Expenses
Another pitfall SaaS companies encounter when calculating CAC is not factoring in all the costs of acquiring a new customer. In fact, the portion of the CAC formula containing the “sales and marketing costs,” should really read “costs associated with acquiring a new customer,” as this is a more concise depiction of what needs to be included. A great example of costs commonly left out of these calculations include:
· cost of free trials
· server costs handling the free trial subscriptions
· implementation costs associated with offering the free trial
Leaving these calculations out paints a skewed picture of the actual CAC.
In smaller companies, there is a tendency to multi-task, as resources are usually tight. Let’s say, for example, your sales team is handling customer service for both existing and new customers. This activity is partially acquisition and partially retention, so a salesperson’s base salary of $80,000 would need to be split based on the time they spend on new clientele, vs. existing.
Most costs associated with CAC are pretty straightforward, but others, like amortization, need a little extra attention. A prime example of this is the costs spent sending sales personnel to trade shows.
Maybe you spent $1200 in April for a tradeshow, but the leads generated from that touchpoint are intended to attribute to customer acquisition throughout the year. If you applied that total amount to acquisition costs in April, your number will be skewed.
It makes more sense to take that cost and spread it out over the entire remainder of the year to better reflect the ROI of attending the trade show.
Marketing Spend: Getting the Right Mix
Just like the story of Goldilocks and the Three Bears, it’s all about getting it just right – so what does that look like for your SaaS company?
Too Hot – Spend is High, Return is Low
A 1:1 ratio is really too hot and means you are going to lose money the more you sell. It indicates you’re spending too much to acquire customers and the return is too low to show growth. It is not a sustainable model.
Too Cold – Spend is Low, Return is Limited
Ratios close to 5:1 indicate you aren’t spending enough to grow acquisition. This leads to stagnation and limits any long-term growth you would hope to have. This also is not a sustainable growth model.
Just Right: 3:1 Ratio
The industry standard for SaaS companies is 3:1, but even a 4:1 is good sustainable growth. As we mentioned above, however, the closer you get to a 5:1 ratio the more you’ll restrain growth.
Using CAC Insights to Scale Profitably
It’s not enough to know about CAC, you need to know what to do with those insights. Let’s take look at a few ways you can use this newfound insight to help profitably scale your SaaS.
Refresh Your Buyer Personas
CAC is all about zeroing in on specific value-added targets. If you find this difficult with your current model, take a new look at your buyer personas. When is the last time they were refreshed?
Spending time on refreshing and fine-tuning your buyer personas, based on insights you derive from CAC analysis can help you stay on a good growth path. Remember as you continue growing, it is likely you’ll need to go back a few more times to tweak your personas. Take time for this valuable exercise as it keeps you on a focused growth track.
Quantify Your Customer Personas
Another piece of the buyer persona puzzle includes quantifying your customers. This knowledge is vital, as it helps categorizes your better-valued customers. You want to quantify things like:
· how long it takes to convert your potential customers into actual customers
· how much is each customer willing to pay for your software
· what are your customers’ buying motivators
Remember this is a qualitative exercise – no guessing allowed.
Knowing these key, qualitative measures can be a real game-changer strategy you will want to revisit as often as you update your buyer profiles.
Repurpose Your Content
A great way to capitalize on CAC insights is to repurpose existing content. When you get a good handle on what your target audience motivators are, this kind of repurposing will give you a better bang for your buck and help limit new spending.
Another lucrative SaaS marketing strategy to begin, if you haven’t already, is adding video content to your brand. By going live, you can scale profitability by offering another look at your software. This is where live product reviews and product demos would be valuable offerings that could help with customer engagement.
A few social media options include:
· Facebook Live
· Instagram Live
· LinkedIn Live (it’s new, check it out!)
· YouTube Live
· Periscope (Twitter’s live)
Optimize Your Sales Funnel
This is a project worth doing every time you update your buyer personas as this can spur new growth without spending a dime. Once you have a strong sense of your ideal clients, tweaking the associated sales funnels should be no problem at all.
Remember, tweaking of this nature requires quantifying, not guessing.
Each step of the funnel needs to be analyzed for lead generation and quality of leads to ensure you retain long-term growth.
Any effective sales growth strategy will require testing, tweaking, and retesting to remain viable, so it’s important to know what you’re looking for.
And knowing where you land on the CAC metric, can help drive insights that can optimize your sales strategies and lead to sustainable growth for your SaaS business.