CAC can be difficult to calculate. If you have 1000 customers paying $1,000/year plus 100 customers paying $10,000/year, is it good, bad or indifferent if your average CAC is $5,000/customer? In the B2B SaaS world, most companies have different customer segments who pay somewhat or very different prices based on a variety of different licensing options.
The CFO of a successful SaaS company recently said,
“I don’t really care about CAC, I know I should but frankly, what does it tell me about the business? It varies too much among our customers to mean much.”
Here’s another view from an experienced SaaS CFO.
“If you track CLTV/CAC in a consistent manner over time you can gain tremendous insight into multiple drivers of your business model – pricing effectiveness, churn, COGs cost structure, customer success, etc. To have a viable business you have to be able to sustain an average of 3-5x CLTV over your cost of acquisition. If you’re able to capture value in excess of 5x, you should spend more on sales and marketing. If you’re under 3x you need to rationalize your sales and marketing costs to get back to equilibrium.” James Orsillo, CFO/O at UnderscoreVC.
At the highest level, the calculation of CAC is an approximation of the expenses involved in acquiring a new customer. It is usually calculated by dividing sales and marketing expense by the number of new customers.
There are several issues here:
- Defining the sales and marketing expense to apply to the calculation,
- Counting the number of “new” customers if one account can represent many sales efforts, and
- What to do if Customer Lifetime Value (CLTV) varies among customers segments
For a $100M SaaS company, with $100M in existing customer subscriptions, some Sales & Marketing expense goes toward other activities and not just towards new customer acquisition. Customer success, for example, may be part of Sales expense, and in retaining and renewing customers, they shouldn’t be part of CAC.
In the case where portions of Sales and Marketing expense are not dedicated to new customer acquisition, CAC expense can by tracked by cost centers and only costs associated with customer acquisition used for the CAC calculation.
What’s a “New” Customer?
Defining your number of new customers can be hard and you should establish a good policy about it. If you follow a Land & Expand model where you sell a small contract, followed by quite large contracts with the same customer, at what point is the customer “new” or no longer a new customer? Are each of these sales to the same customer counted as one or several? Many companies with this sales scenario will define a time period during which all sales to the customer are counted as one for the purposes of the “new” customer count. Usually, this is a six or even twelve-month period, but we have seen longer terms for companies where the contracts are so large that the targeted “first” real sale takes more than a year. Usually, you can look at the pattern of your sales and define a relatively standard approach which will capture most situations.
Similarly, large enterprises can consist of many “new” customers, if you sell to various business units, franchises, etc. New customers for the purposes of CAC should be defined by new entities that require new sales efforts and new decision-making processes on the part of the customer. Again, if you look at the individual enterprises, or at the pattern, you’ll usually see what makes sense. Start with the goal of the CAC analysis and work backwards to get the calculation. If one large enterprise required 10 major sales efforts to close different parts of the company, it should probably be considered 10 customers instead of just one.
Often, large enterprises have a single procurement system, almost like an outsourced service for the entire enterprise or even series of companies. You may have 10 different customers served by the same purchasing system, so it usually is not advisable to count customers from your billing system, since it will look like one very large customer. By the same token, if you sell to the SMB market with a pure transactional model using credit card purchases, you can over count your customer number if you take the customer count from the number of individual credit cards processed. Companies often use several different credit cards, doubling or tripling your customer number.
Customer Lifetime Value to CAC ratio
Is a CAC of $5,000 good, great or average? You have to look at CAC in relation to Customer Lifetime Value (CLTV). CLTV is defined as the value of a customer over the expected lifetime of a subscription customer and incorporates the cost of doing business by including Gross Margin. CLTV is also called LTV (Lifetime Value of a Customer) – they are the same metric.
If your CAC is $5000 and your CLTV is $15,000, you have a profitable model. The rule of thumb is to target 3 or better for the CLTV/CAC ratio.
Now you can look at segmenting your customers into cohorts and look at the CAC and CLTV for each segment to isolate unprofitable customer segments and profitable ones.
Is It Worth Tracking CAC?
If your growth rate is good, and the market is strong, how important is it to calculate what it costs to acquire a customer? CAC matters because it is hard to scale if you don’t know what it costs to acquire a customer and how it relates to the value of the subscription. You probably are pouring resources and investments into acquiring some group of unprofitable customers – every company does it. You might be growing faster with the same investment if you had better guidance about where to focus your sales efforts. CAC matters as a way to improve your business model and company value.
And finally, it is worth tracking CAC in relation to CLV because the market may not always be hot. Inefficiency combined with a market slow-down is not a good combination for any company. It is always better to do the analysis and set up well-understood processes to support the analysis, ie., have clear process for counting customers, and defining a “new” customer, before you run into problems.