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When validating a SaaS concept in its early stages, teams often struggle to see past the utility of the product — overlooking the aspect of profitability. While there’s no doubt that acquiring customers is crucial, placing all your emphasis on net new logos alone is not a viable growth strategy in the long term.
Customer acquisition cost (CAC) plays an important role in determining the sustainability and scalability of SaaS businesses. It also helps identify areas of improvement and guide strategy.
This blog highlights everything you need to know about CAC.
Customer Acquisition Cost (or CAC) refers to the total amount of money a company spends on marketing, sales, and other GTM activities to acquire new customers.
The formula to calculate CAC is as follows:
Customer Acquisition Cost = (Sales expenditure + Marketing expenditure) / New Customers Acquired in a given period of time.
Here, sales expenditure includes employee salaries, sales tools & tech, etc. Marketing expenditure includes ad spend, content production costs, event expenses, etc.
Note that CAC excludes repeat customers. It only accounts for new customers, not new orders from existing accounts.
A lower CAC indicates that a company is acquiring customers at a more cost-effective rate. This generally implies a strong product-market fit and successful marketing and sales efforts. A higher CAC, however, suggests that the company might need to re-evaluate its GTM strategy.
Here are some of the ways in which CAC serves as a powerful barometer for profitability, product-market fit, and overall strategic direction.
CAC helps SaaS companies assess the balance between acquisition costs and revenue generated. A low (or lowering) CAC-to-CLV ratio helps galvanize the brand by signaling efficient, sustainable growth.
A high CAC often indicates misaligned PMF or efficient GTM efforts. This signal can then prompt course-correcting adjustments. Say, a company with a tiered pricing structure spends $1000 to acquire a new customer. However, 90% of its customers end up subscribing to the most basic plan, which is priced at only $150 per annum. At this rate, the company will need more than 6 years to recover the cost of the acquisition.
In this instance, it may be time to re-evaluate the product offerings, and customer requirements and make adjustments that make the company more profitable.
Insights from measuring CAC can help inform efficient resource allocation. With a detailed analysis of how each channel contributes to customer acquisition, teams can optimize marketing and sales budgets to maximize return on investment.
Say a company uses the following channels for customer acquisition:
In this case, although events bring in the maximum number of acquisitions, content marketing provides the lowest acquisition costs. Hence, the company may want to consider investing more in content marketing efforts going forward.
CAC should not be viewed in isolation. It's important for SaaS businesses to strike a balance between CAC and Customer Lifetime Value (CLV) as well as CAC payback period.
You can justify a high CAC with a high CLV or a short payback period. Say, a company spends $5000 to acquire a new customer. If the lifetime value of this customer is $18,000, or it takes only about a month to recover the $5,000 through subscription or in-app purchases, the CAC is certainly justified as compared to a company that spends $100 dollars to acquire a customer but has an average CLV of $50.
In other words, a company experiencing higher churn rates is bound to rely on low customer acquisition costs to become profitable.
Additionally, CAC also varies widely based on industry standards (Purchase Frequency, Purchase Value, Customer Lifespan, Company Maturity, Length of Sales Cycle, etc.)
Calculating CAC can be a nuanced task. Here is a step-by-step guide to help you through the process:
Make sure to only include expenses that directly contribute to customer acquisition.
Advertising Expenses
This includes the totality of ad spend across search ads, paid social, sponsored events, etc.
Technological Investments
Technological costs include spend on marketing and sales technology that supports go-to-market initiatives. This consists of automation platforms, intelligence solutions, outreach tools, etc.
Note: This category should not, however, include software or technology that does not directly affect the sales funnel: say your internal collaboration or task management tools - Slack, Asana, Notion, etc.
Employee Salaries
If you have a dedicated sales team working on outreach, their salaries should be factored in when it comes to CAC calculations.
TIP: Most companies exclude salaries of the entire marketing team when calculating CAC. This is not the right approach to follow as marketing costs can add up quickly. The right approach is to include salaries of employees who come in direct contact with customers or have a direct impact on sales and acquisition. For example, a PPC or SEM expert should be factored into the calculations. Still, SEO experts or website developers who do not contact the customers directly, should not be included.
Content Marketing Costs
Content marketing costs encompass all expenses associated with creating new content assets across blogs, media, and more. For example, when producing a video, this includes the cost of purchasing equipment, setting up a studio, acquiring backdrops, obtaining editing software, and other related expenses. Remember: even if you hire a third party content producer, these costs should be considered.
The tracking period is the timeframe over which you'll calculate your CAC. It's essential to choose a period that aligns with your sales cycle. For SaaS businesses, this could be monthly, quarterly, or annually, depending on how long it typically takes to convert a lead into a paying customer.
Count the number of new customers you've acquired during the chosen tracking period. This should include all paying customers during that time frame.
Note: The more accurate way to analyze customer acquisition cost is to track the costs and acquisitions over the length of a sales cycle in the industry. Say enterprise sales in the healthcare sector take about 10 months to close a deal and get a paying customer, then the CAC should be tracked for that period of time.
The formula for calculating CAC is straightforward: CAC = Total Acquisition Costs / Number of Customers Acquired. Plug in the numbers: Divide the total acquisition costs (step 3) by the number of customers acquired during the tracking period (step 2).
Here's an example to illustrate these steps:
Suppose a SaaS company spends $50,000 on marketing and sales efforts in a given quarter. During the same quarter, they acquired 500 new customers.
CAC = $50,000 / 500 = $100 per customer.
Determine your total marketing and sales expenditure within a specific time frame. This time frame can be a month, quarter, year, or any other relevant period. Next, calculate the number of new customers acquired during that same time frame.
Utilize the customer acquisition cost formula to ascertain the average cost per customer, providing insight into your gross margin and how much you potentially earn per new customer.
There isn't a one-size-fits-all benchmark for CAC, as it can vary significantly depending on factors like your industry, target market, business model, and growth stage. What might be considered a good CAC for one SaaS company might not be the same for another. That said, here are some general guidelines and benchmarks to use as reference:
OpenView’s report on SaaS Benchmarks shows CAC Payback periods based on company size or annual revenue, with a focus on different customer segments:
Source: SaaS benchmark report 2022 by Openview
The findings in the report are summarized as follows:
The CLV:CAC ratio is a more reliable metric when at least 1-2 agreement renewal cycles have occurred to establish a more consistent churn rate across renewal periods. It helps to gauge the return on investment when it comes to customer acquisition.
According to a report by RevOps Squared, over the last three years, the benchmark for CLV: CAC ratio has varied between 3.6 times and 4.2 times, regardless of the company’s size, ARR, or any other revenue metrics.
The report implies that for every $1 spent on customer acquisition, the business should ideally generate revenue of $3.6 or $4.2.
NOTE: Both metrics should not be viewed in isolation. A company can have a high CLV:CAC ratio, but if the CAC payback period is much longer, say 24 months, the business does recover its initial cost of acquisition but it takes them 2 years just to break even.
Calculating customer acquisition cost is simple in theory, but easier said than done. There are several nuances to account for and businesses face common challenges in calculating CAC.
"Days to close" can significantly impact Customer Acquisition Cost (CAC). Typically, businesses opt to provide reports on a weekly and monthly basis. However, a challenge arises when attempting to make monthly reports, especially when the "days to close" metric stands at just 14 days. This situation implies that any new visitor acquired during the latter half of a month will only become a customer in the first half of the subsequent month.
In such a situation, you’ll be incorporating the costs incurred in Month 1 and revenue generated in Month 2, which can throw you off track. The best way to tackle this situation is detailed user journey mapping. Tracking a customer’s interactions from the very first touchpoint to the final is a great way to understand the sales cycle and determine the tracking period for CAC calculations.
What campaigns and content actually contribute to conversions and pipeline? Without understanding the impact of marketing and sales touchpoints on bottom line metrics, it’s difficult to attribute CAC accurately.
The main challenge with revenue attribution is the nonlinear nature of customer journeys. When a visitor becomes a paying customer, it's rarely because of a single touchpoint. It's likely a result of many touchpoints: channels, campaigns, content, and people — working together to convince the buyer.
Without the right attribution tools, it's hard to understand and appreciate how each channel (whether it is organic or paid) contributes to revenue generation.
Another challenge when calculating CAC is siloed data across various sales and marketing channels. It’s a tedious, time-consuming process to manually monitor KPIs and stay on top of channel-level performance. Again, without the right tools, the team’s focus may be redirected towards operational tasks such as reporting, and away from strategic decision making.
Teams should spend more time making sense of their CAC and less time actually measuring it.
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