When validating a SaaS concept in its early stages, teams often have a one-track mind and focus on product over profitability. While acquiring customers is critical, you must also be mindful of this metric: Customer acquisition cost.
Customer acquisition cost (CAC) plays an important role in determining the sustainability and scalability of SaaS businesses.
This blog highlights everything you need to know about CAC.
What is Customer Acquisition Cost (CAC) in SaaS?
Customer Acquisition Cost (or CAC) is 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:
Customer Acquisition Cost = (Sales expenditure + Marketing expenditure) / New Customers Acquired in a given period.
Here, sales expenditures include employee salaries, sales tools and tech, and the like etc. Marketing expenditures include 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 more cost-effectively. This generally implies solid 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.
Why is Customer Acquisition Cost Important In SaaS?
Here are some ways CAC is a powerful barometer for profitability, product-market fit, and overall strategic direction.
1. Gauge Profitability
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.
2. Evaluate Product-market Fit
A high CAC often indicates misaligned PMF or inefficient 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 acquisition cost.
In this instance, it may help to re-evaluate the product offerings and customer requirements and make adjustments that make the company more profitable.
3. Optimize Resource Allocation
Insights from measuring CAC can help inform efficient resource allocation. By analyzing 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:
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.
Should you view CAC in isolation?
You should not CAC in isolation. SaaS businesses need to strike a balance between CAC, Customer Lifetime Value (CLV), and the 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 justified compared to a company that spends $100 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, such as:
- Purchase Frequency
- Purchase Value
- Customer Lifespan
- Company Maturity
- Length of Sales Cycle
- Research and development
Step-by-Step Guide to Calculating CAC for SaaS
Calculating CAC can be a nuanced task. Here is a step-by-step guide to help you through the process:
1. Identify all costs related to customer acquisition
Make sure only to include expenses that directly contribute to customer acquisition.
Advertising Expenses: This includes the total 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.
You should also consider infrastructure costs, such as those for data storage platforms like SingleStore, Google Cloud, Azure, etc. The CAC is relatively higher than the costs for other SaaS platforms.
Note: This category should not include software or technology that does not directly affect the sales funnel, such as your internal collaboration or task management tools, such as Slack, Asana, Notion, etc.
Employee Salaries: If you have a dedicated sales team working on outreach, their salaries should be considered when calculating CAC.
💡TIP: Most companies exclude the salaries of the entire marketing team when calculating CAC. This is not the right approach, as marketing costs can add up quickly. The right approach is to include the salaries of employees who come in direct contact with customers or directly impact sales. For example, a PPC or SEM expert should be factored into the calculations. Still, SEO experts or website developers who do not contact 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: these costs should be considered even if you hire a third-party content producer.
Research and Development
PLG companies invest in R&D as part of their customer acquisition mix (free sidecar products, freemium, growth teams, self-service purchasing, etc.). Atlassian, for instance, spends $2.43 on R&D for every $1 on sales and marketing.
However, R&D investment is usually not factored into the CAC payback period calculation, blurring the picture of the growth model.
If you’re investing in PLG, plan to stay below the “normal” CAC payback benchmarks.
2. Decide on a tracking period
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. This could be monthly, quarterly, or annually for SaaS businesses, depending on how long it typically takes to convert a lead into a paying customer.
3. Calculate the number of customers acquired in your tracking period
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 an industry's sales cycle. For example, if 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.
4. Divide your acquisition costs by the number of customers
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 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. This will provide insight into your gross margin and how much you potentially earn per new customer.
CAC benchmark: “What’s a good customer acquisition cost?”
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:
CAC Payback Period
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:
CAC Payback Period
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 2023 by Openview
As you can see, the payback period has gotten worse as companies grow in revenue. This holds especially true for companies that grow upward of $20M ARR. There could be 3 main mistakes here:
- Not focusing on Net Dollar Retention (NDR)
- Believing that sales and marketing are the sole costs of acquisition
- Looking at CAC payback on a revenue basis instead of a cash basis
Andrew Allsop, Senior Demand Gen Manager at Bryter put it best when he said that marketers must focus on new sources of acquisition instead of over-optimizing an existing channel:
"If you’re able to acquire customers that fit within your financial model then do so until you can anymore, and then find other ways to do the same thing.
New sources of acquisition = greater growth potential than spending 100s of hours squeezing an extra few cents out of an existing channel."
CLV: CAC Ratio
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 gauge the return on investment regarding customer acquisition.
According to a report by Benchmarkit, over the last three years, the benchmark for the CLV: CAC ratio has varied between 2.1 and 6, 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 $2.1 or $6.
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 two years just to break even.
Challenges with calculating CAC
Calculating customer acquisition costs is simple in theory but can get complicated really quickly. There are several nuances to account for, and businesses typically face these challenges in calculating CAC:
1. Inconsistent tracking period
"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.
2. Unreliable attribution
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 difficult to understand and appreciate how each channel contributes to revenue generation.
3. Fragmentary data and analytics
Another challenge when calculating CAC is siloed data across various sales and marketing channels. Manually monitoring KPIs and staying on top of channel-level performance is tedious and time-consuming. Again, without the right tools, the team’s focus may be redirected towards operational tasks such as reporting and away from strategic decision-making.
Wrapping up
Teams should spend more time making sense of their CAC and less time actually measuring it. When you track relevant metrics such as NDR and CLV, you get a holistic view of how much you spend in acquiring customers and how you can save costs accordingly.
