How COVID-19 has affected Customer Acquisition Cost Calculations
A good business practice every year is to review your KPI calculations and adjust for any changes. Right now, this is especially true because of all the changes every company undertook due to the pandemic, especially moving to remote work and contactless selling to customers. This post focuses on Customer Acquisition Cost (CAC) calculations: what should be in it and what should NOT be in it, and how the pandemic may have changed your calculation.
Items to Review for Customer Acquisition Cost Calculation
Most vendors during the pandemic shifted resources to ensure customer retention. You should assess how that may have changed any of your tracking systems to separate CAC expenses from customer retention expenses. Here’s a brief list of items to review:
- Changes to the definition of a Paid Customer. Did you extend freemium offers to potential customers to acquire them during the pandemic? This affects both the denominator and numerator of the CAC equation, as the denominator should be the number of new paid customers (not freemium customers). Expenses associated with freemium acquisition are part of the numerator as a lead gen expense. Were there other expenses that went into providing new freemium services to prospects or maybe to keep lapsing customers warm?
- Changes to the time period between Lead Generation and Customer Acquisition. This may have extended (or shortened) in 2020.
- New systems or tools used for contactless sales should be added to CAC, such as sales usage of Zoom or any other sales tools for contactless sales, such as investments in videos for prospecting, etc.
- All sales and marketing systems and tools associated with new customer acquisition should be reviewed. If it isn’t possible to segment between new customer acquisition and existing customer tools, then a portion of the total can be allocated to CAC. This is often done based on the percentage difference between new customer revenue and renewal/expansion revenue.
- Any new marketing content production and creative costs aimed at acquiring leads and new customers? Did you revise marketing pitches and tools to deal with the new environment?
- Fully loaded salaries and benefits for sales and marketing personnel associated with new customer acquisition. Make sure you include the cost of overhead: Did you provide additional dollars for sales and marketing people working from home and not in the office anymore? If Sales, for example, has responsibility for both new customers AND renewals and up-sells (often the case in smaller companies), then a percentage of the expense can be allocated to new customer acquisition, typically based on the percentage difference between new customers revenue and renewal/expansion revenue.
- Large irregular expenses relating to one-time events or events that happen once every few years, e.g., large trade shows or marketing events that will spike CAC in a particular year can be normalized based on the time frame that they benefit.
10 Items NOT to Include in SaaS Customer Acquisition Cost Calculations:
Here’s a brief list of items that should not be included in your CAC (but could already be), and you may need to set up accounts to handle these items separately.
- Fully loaded personnel costs for salespeople who are focused on existing account management and renewals of existing customers.
- Sales tools and analytics for anyone NOT selling to new customers (CRM and any tools associated with the salespeople selling to new customers SHOULD be included in CAC.
- User events, and all associated expenses.
- Credit card and payment processing fees.
- Customer marketing campaigns.
- Marketing expenses such as corporate branding, logos, general awareness PR, if not focused directly on prospects, etc.
- Any current customer contests, recognition, giveaways, holiday gifts, etc.
- Travel to visit or service current customers.
- User guides and customer knowledge base.
- Customer training.
The pandemic changed a lot of the ways that we are doing business, and that may have affected your CAC. Make sure your customer acquisition cost calculation is up to date and will be accurate through 2021.
Lauren, this is incredibly insightful and helpful advice. As companies mature, one of the most common enhancements for KPI calculations for CAC Ratio and CAC Payback Period calculation is exactly what you highlighted – expense allocation
We often find all Customer Success expenses are lumped into “Sales” thus making CAC and thus New CAC Ratio artificially high – flip side sometimes all into COGS
Another common omission we find is splitting out how much sales and/or marketing expense is allocated to New Name Customer Acquisition versus existing Customer Expansion
One other topic I would like your insight on is the importance of factoring Gross Margin adjustments (versus just ARR) into any CAC Ratio calculation
Glad you found it helpful! You correctly highlight confusing two areas – Customer Success and Sales & Marketing allocations between new customer acquisition and existing customer expansion – which I think are hard because not all companies do it the same way. For some companies, Customer Success is really a customer renewals (and often upsell) team, and for others, Customer Success is a customer satisfaction organization, which falls more into Cost of Revenue. The point, though, is that Customer Success, even if it sits in Sales, is dealing with existing customers and shouldn’t be part of CAC at all. On the question of Gross Margin, I might not be understanding your question since Gross Margin is determined by the Cost of Revenue, so wouldn’t be included in the CAC calculation. Happy to follow up further. Thanks for your comments!
Ray, I’m so sorry that I missed your question and comment earlier! Glad you are finding this helpful – I know you are helping loads of Finance folks deal with these questions. Your point about Customer Success and whether it is sales or COGs is exactly right. It really depends on the company and how they are managing Customer Success. Some view it as a renewal sales team, and some manage Customer Success more as a customer engagement, customer satisfaction organization, with a soft emphasis on selling renewals. We see CS sitting in all sorts of places in a company: Sales, Services, even G&A under the CFO. Some companies have a completely separate “Customer” organization, reporting directly to the CEO, which is really fun for Finance to account for the expenses between OPEX and COGS.
On your second topic about factoring Gross Margin versus just ARR into a CAC ratio, that seems to be a hot topic right now. I think it makes it a different metric, which doesn’t make it less valuable, just tells you something slightly different. When you look at CAC ratios without factoring in gross margin, you really are looking at your velocity to acquire new customers and the straight cost. And given that gross margins in SaaS generally have been improving over the past 10 years, mostly due to competition in hosting offerings, what’s more important – your cost of new growth or gross margin? But you can also factor in gross margin, which especially for slower growth companies, gives you a fuller picture of your CAC payback. So I think both ways of doing it are valuable, just gives you slightly different information. And you might lean more towards one way or another depending on whether you are analyzing fast growth or modeling slower growth and more profitability. Does that make sense? Happy to discuss further and hear your thoughts. Thanks for asking!
Lauren, I have read your posts extensively, and I find them to be incredibly helpful.
One thing that I couldn’t find a definitive answer for (Or perhaps I missed it) – should costs of obtaining expansions/upsells be considered as part of CAC (My logic tells me that it shouldn’t)? What most companies do in your experience, and what would be the reasoning to include this in CAC?
If this isn’t counted as part of CAC, should it be part of CRC?
I would be thrilled to get your thoughts on this.
Michael, Really glad you find our posts helpful – that’s why we do it! You ask a great question that many companies consider. My opinion is that it depends on your expansion model. If you sell a small contract and then have to work and invest to get the desired large contract with an enterprise, especially where the expansion revenue is significantly greater than the original contract, then the cost of acquiring the expansion revenue should be included in CAC. If the expansion revenue is just 10% or maybe 20% on top of the original contract, is handled by your renewal managers or customer success, then I wouldn’t include it in CAC. Some companies base it on how they handle it from a sales perspective, ie., if you have a policy whereby account executives (the hunters) get to continue selling for some period after the initial contract, 6 to 12 months, then maybe that expansion revenue should also be considered part of CAC, whereas once it is handed off to customer success or a renewals team, then it is no longer part of CAC. You really have to look at the goal of the metric which is to measure your cost to acquire new recurring revenue, versus your cost to renew and maintain a customer relationship and contract. Does that make sense? Thanks for asking, it is one of those questions where it depends.