Defining SaaS Customer Acquisition Cost – The Devil’s in the Details

August 23, 2018

SaaS customer acquisition cost (CAC) is one of the key indicators to define a profitable SaaS business model.  The difference between customer acquisition cost and the lifetime value of a customer defines the value of the business.

CAC is defined as the cost involved in acquiring one new customer.  The easiest way to determine customer acquisition cost is to divide total sales and marketing expense by the number of new customers.  This calculation is often used because it is easy, and because it is possible to calculate in the same way for most companies, even if they don’t publish or release customer acquisition cost directly; public SaaS vendors typically release total sales and marketing expense and customer numbers.

The simple division of sales and marketing expense by new customers is meaningful for start-ups and early stage companies because all of their go-to-market investment is focused on acquiring customers.  Some companies may take a previous year’s sales and marketing and divide by the current year’s new customers, but in general, the calculation is the same.However, if a company is a growth SaaS business, with new customer acquisition on top of existing customer renewals and expansion business, it becomes trickier to accurately calculate CAC.  Often times, this stage of company growth involves changes in the sales organization that muddy the picture in terms of what expense to associate with customer acquisition cost.  Your account reps may sell to new customers, expand business with existing customers and even do renewals.   Your marketing organization may focus on digital marketing to prospects as well as to customers to encourage customer engagement and retention.Let’s look at the Customer Acquisition Cost calculation again.  Basically, you are taking $s of expense and dividing it by number of new customers.

Acquisition Expense $ / # of New Customers = CAC

Defining Acquisition Expense

Take the example of a SaaS B-2-B vendor spending $10M in total sales and marketing expense.  The sales organization has 50 people, with an account rep group focused on new customer acquisition but also large account reps focused on expansion of sales within large accounts.  The sales organization also includes a renewals team.  Both the new account reps and the renewals team reports into the territory managers who report up to the head of sales.  Sales management is responsible for total revenues, from both new and existing customers.

Next take the example of a $100M SaaS vendor spending 30% of revenue on the sales organization, with different territory structures and additional sales roles.  This organization will most likely have evolved to much greater complexity, including Market Development Reps (MDRs), Sales Development Reps (SDRs), Account Executives (AEs), Onboarders to help new customers get started, Customer Success Managers, and Account Managers, who are looking for additional sales into existing customers, as well as a partner sales group.   In addition, the sales organization includes SalesOps and other support staff to help the overall organization.  Further, the company is spending another 20% of revenue on an active Marketing organization to build the pipeline and brand.  What portion of this approximately 50% of revenue should be associated with new customer acquisition?

Most companies use one of two methods.  One method is to take the percentage of new ARR from total ARR and apply that to total sales and marketing expense for a rough estimate the expense side of the customer acquisition cost calculation.   In this example, $40M of the $100M ARR is new ARR.  This includes both new customers, and new expansion revenue.  Most companies using this method argue that new expansion revenue can be as difficult and as important as acquiring a totally new customer, and therefore should be included in CAC.  Other companies exclude Expansion ARR from customer acquisition cost.The second method is a more bottoms up calculation by headcount of quota carrying reps.  The number of reps selling to both new and existing customers would be divided by an estimate of their new versus expansion ARR (for example, 70% new ARR versus 30% expansion, so divide that group by 70/30). Sales management and support would be divided the same way.  This method becomes difficult if the organization is complicated with many different roles and territory structures.  In those cases, companies usually use the first method above to define customer acquisition cost expense.

Defining “New Customers”

As SaaS companies grow, the definition of New Customers becomes more complicated.  Do you include freemium customers in customer acquisition cost?  How about free trial customers?  Or customers that churn in the first 90 days?   And for SaaS vendors selling into large enterprises, is a Fortune 500 customer one customer, or do you count the many different divisions and groups that you sell into?  How about international offices of your US customers?

Some companies, with a user license subscription, keep it simple and simply count the number of users as total customers.  Others count the number of businesses with separate contracts as customers.  In this case, if you have one contract with General Electric, then that is one customer.  But if you have a contract with 5 GE divisions, then that is 5 customers. Key is to come up with one consistent customer definition for the company.   Typically, Finance does this, as Sales may define customers based on sales territory definitions, which is valid for sales, but not for the company to understand its customer acquisition.SaaS companies should not use freemium customer numbers, free trial customers or any kind of limited trial customers in their customer acquisition cost calculation.  Freemium and free trial customers should be considered as pure sales and marketing expense – it is prospecting and not closed business.

Take Away

Calculating customer acquisition cost becomes more complicated as a SaaS vendor grows its sales and marketing support for new customers.  The first step is to separate sales and marketing expense to new customers from existing customers.  The second step is to define “new customers” out of total customers, excluding freemium and free trial customers.  The third step is to benchmark customer acquisition cost against peers at a similar stage of growth and selling into similar markets, either SMB or enterprise, or a mix of both.  In addition, SaaS vendors selling into horizontal markets (like CRM, ERP, etc.) versus selling into a vertical market (like education, finance, energy, etc.) will have different CAC depending on the type of market, so it is important to get the benchmark comparison right, once you have the calculation right.