Whether you’re trying to work out how efficient your sales and marketing strategies are, or determine how profitable your current customers are, it’s vital to keep a pulse on the health of your SaaS business. Thankfully, there’s a simple performance metric that does both.
Today we’re taking a deep-dive into one of the most crucial SaaS metrics around: customer acquisition cost (CAC).
HOW TO CALCULATE CUSTOMER ACQUISITION COST
Customer acquisition cost is designed to tell you how much you need to spend to acquire a single new customer.
For most B2B SaaS businesses, the costs of acquiring a new customer are determined by two factors:
- The costs of generating a lead (usually determined by marketing expenses).
- The costs of converting that lead into a customer (normally a result of sales costs, or touch costs – the salaries of sales development reps or field sales people).
Typically, the easiest way to work out the cost of securing a single new customer is to bundle together the total sales and marketing expenditure in a given time period (period t), and divide it by the total number of new customers.
CACt = Sales & Marketing Costt / # New Customerst
For example, if you spent $5,000 apiece on sales and marketing in a given month, and closed 10 new customers over that same time period, that month’s Customer Acquisition Cost would be $1,000.
($5,000 + $5,000) / 10 = $1,000
CAC AND CUSTOMER SUCCESS
Most CAC calculations intentionally exclude the costs and revenue associated with customer success strategies.
Although customer success teams generate (often significant) revenue, through up-selling, cross-selling and encouraging renewals, CAC is designed to measure your ability to generate new revenue from sales and marketing expenditure.
Adding customer success into the calculation distorts that measurement, so it’s best to track separately.
This type of CAC calculation isn’t useful in isolation: after all, you can’t work out whether your CAC is good or bad if you have no idea of how much revenue those customers bring in.
Its real value lies in comparing your customer acquisition cost with the average lifetime value of your customers (referred to as LTV, CLV or CLTV): the total amount of revenue they’re expected to generate over the entire course of their relationship with your company.
LTV : CAC
For example, if your customer’s lifetime value was $3,000, and it cost $1,000 to acquire that customer, that’s an LTV:CAC ratio of 3:1.
$3,000 : $1,000
3 : 1
It makes sense that your LTV should always be greater than your CAC: few businesses want to lose money on every customer they acquire.
Beyond this, past performance suggests that LTV needs to be about 3x CAC for a SaaS business to survive. Best-in-class performers (like Salesforce and Constant Contact) do even better, with multiples closer to 5x.
A DIFFERENT APPROACH TO CAC
Dave Kellog proposes a different version of the CAC formula:
CACt = S&Mt-1 / New ARRt
Instead of generating an abstract dollar value that only makes sense when compared to CLTV, Dave’s calculation compares your sales and marketing expenditure in the previous period (S&Mt-1) to the new revenue generated in the current period (New ARRt).
In other words, this version of the CAC formula tells you how effective you are at turning last period’s sales and marketing expenditure into this period’s new revenue: or how much you’re spending to generate a single dollar of new customer revenue.
For example, if you spent a combined total of $10,000 on sales and marketing last month, and generated $12,000 in new revenue this month, that means that for every $1 of new revenue, you had to spend $0.83 to attain it.
($5,000 + $5,000) / ($12,000) = $0.83
CAC PAYBACK PERIOD
Customers will only become profitable when they’ve generated enough revenue to cover their acquisition cost, and it can be extremely helpful to work out how long this “payback period” will be.
The formula for this is straightforward: just divide the cost of acquiring a customer by the monthly revenue they generate, to work out how many months’ revenue it requires to break-even.
Payback Period = CAC / (MRR per customer)
For example, with a customer acquisition cost of $200, and an average monthly revenue per customer of $15, it’ll take just over a year for each customer to become profitable.
$200 / ($15) ≈ 13 months
GROSS MARGIN ADJUSTED PAYBACK PERIOD
But although your MRR is going towards paying back your acquisition cost, it’s also contributing to the extra costs associated with providing your service.
These costs are usually referred to as COGS: Cost of Goods Sold. In a SaaS company, these are usually expenses like hosting and customer support.
The company’s sales revenue minus these costs, divided by sales revenue, is known as the Gross Margin. By factoring this into our formula, we can calculate a more accurate payback period.
Gross Margin Adjusted Payback Period = CAC / (MRR per customer * Gross Margin)
For example, with a CAC of $200, MRR per customer of $15, and a gross margin of 70%, we generate a CAC payback period of 19 months: 6-months longer than previously estimated, as a result of the COGS your MRR needs to cover.
$200 / ($15 * 0.7) ≈ 19 months
This article originally appeared on CoBloom.