Have you ever heard the phrase spend money to make money? It’s totally true, and it’s been demonstrated over the decades that companies need to invest in marketing, product development, salaries, and much more to keep growing.
However, managing all these investments and knowing how much money a company needs to expand can be much more challenging than you think. Here’s where customer acquisition cost (CAC) comes into play.
Understanding the CAC payback period is crucial to a company’s long-term success. You can identify ineffective marketing channels and invest your advertising efforts more efficiently. But what is CAC? How do you calculate it? How can you calculate the CAC payback period? What are some industry benchmarks?
Today, we’ll explore all these questions and more, including:
- What is CAC?
- How to calculate CAC
- What is the CAC Payback Period?
- Why measuring CAC is important
- How to decrease your CAC Payback Period
- CAC vs. LTV
- CAC Industry Benchmarks
- The CAC Payback Period
Let’s get started!
What is CAC?
The customer acquisition cost (CAC) is a SaaS metric that measures how much a company spends to acquire new customers. It refers to the total cost of sales and marketing efforts needed to convince the customers to buy. Often, CAC is measured together with the Lifetime Value or Monthly Recurring Revenue.
To quickly refresh your memory about these metrics, check out our blog post, Top 5 SaaS metrics, and tips to improve them.
So, how do you calculate this metric? Let’s find out in the next section!
How to calculate CAC
Measuring the CAC of your SaaS company is easy! Simply divide the total cost of acquiring customers (cost of sales and marketing) over a given period by the total number of customers acquired during the same period. Here is the exact formula:
CAC = (total cost of sales + marketing in X period) / (Number of customers acquired in X period)
For instance, let’s say last month, you spent $20,000 trying to acquire new customers through marketing and sales campaigns, and you’ve gained 500 new customers. Your CAC will be $40 per customer acquired. This means that a SaaS company’s costs of acquiring each new customer are $40 per user based on all the economic efforts they have made.
What is the CAC Payback Period?
The customer acquisition cost payback period (CAC payback) is a SaaS metric that shows the period of time (number of months) it takes to earn back the money invested in acquiring new customers. Often, CAC is measured together with Time to Recover CAC or Months to Recover CAC.
In other words, and according to Tom Tunguz – a managing director and venture capitalist at Redpoint Ventures – the CAC payback period determines how much cash the company needs to grow.
To measure the CAC payback period, you need to divide the sales and marketing expenses by the monthly recurring revenue (MRR) acquired and the gross margin percent. Here is the correct formula:
CAC Payback = CAC / (Net New MRR Acquired in Period x Gross Margin)
This will give us data about how much time our company takes to recover the investment in marketing and sales made to gain new customers. Using this CAC payback period formula, you will be able to measure the effectiveness of any marketing strategy changes and the progress of your customer retention programs. Churning customers before breakeven is a strong indicator that things aren’t going well.
Why measuring CAC is important
Measuring the CAC of your SaaS company is extremely important because of the following reasons:
- To calculate the overall value of a customer to the organization
- To calculate the resulting ROI of an acquisition
- To calculate and define your pricing strategy right
- To help you find where you are overspending
- To spot issues with retention and churn
Understanding your SaaS organization’s CAC is crucial. Think about it; the lower the CAC, the better. Once you’ve measured your company’s CAC, you should look for ways to reduce the payback period. Keep reading to discover the best ones!
How to decrease your CAC Payback Period
Did you know that according to the Financial & Operating Benchmarks Report, you must have a payback period of fewer than 15 months to qualify for seed funding?
As mentioned before, the lower your CAC payback, the better your business is doing. So, if your SaaS model comes in under these numbers, it means you’re doing something right. If not, don’t worry; there are many ways to reduce the CAC payback result and increase the revenue of your business. Here are the most common ones:
1. Expand into higher-value markets
Expanding your business into higher-value markets, such as enterprise customers, can directly reduce your CAC payback period. That’s because these types of companies are more likely to require yearly contracts and to pay large amounts of money, which means you’ll be able to recover your CAC upfront. Also, even if they need monthly contracts, the high monthly cost allows you to cover any marketing costs and profit quickly.
2. Try out different pricing strategies
When a company is developing a pricing strategy, many factors come into play: the perceived value of your product, the customer’s willingness to pay, and the profit margin. Implementing the right pricing strategy implies different trying strategies, and the CAC payback period can be a great indicator of how well your pricing strategy is working.
For example, if your CAC payback period is too long, it can indicate two things:
- The product is priced too low, or
- The product is priced too high and it won’t get as many conversions to increase the period.
To fight against this, you can raise or lower your prices or introduce premium or enterprise tiers to see if it reduces the payback period.
3. Invest in marketing channels that drive higher deal values
As we all know, marketing campaigns have a lot of possibilities, such as different techniques, channels, messages, and more. Additionally, campaigns must be constantly evaluated and optimized.
To reduce your CAC payback period, start by trying different marketing channels and testing how they affect your metrics. See if your product fits well in higher deal value markets. We recommend using an analytics platform or CRM to do so.
Remember that every company and product is different, and they all need different marketing strategies, channels, or messages. Investing in deciding which one is the best for your SaaS business is worthwhile.
4. Focus on upselling and cross-selling
Selling to an existing customer is easier than to a new customer, and customers who expand their subscriptions through upselling and cross-selling achieve payback faster. Investing in marketing and sales strategies to increase upsell and cross-sell can dramatically improve your CAC payback period.
5. Invest in decreasing the churn rate
One of the most common factors negatively influencing the CAC payback is customer churn. The more churn your company has, the longer your CAC payback period will have.
Keeping customers happy and ensuring they don’t want to leave is the best way to reduce churn. Try offering them incentives to retain them and reinforce the benefits of your product or service. At FROGED, we’re experts in customer retention and satisfaction, so if you’re looking for relevant information about reducing churn, check out our latest article How Product Marketers can improve SaaS Churn rate.
CAC vs. LTV
There are other metrics that are important to consider when talking about the expansion and growth of your company. The lifetime value (LTV) of a customer is one of them. To refresh your memory, the LTV, or lifetime value, measures the average revenue that a customer will generate over time.
However, nowadays, many SaaS companies have started to combine CAC with LTV because it gives companies a more detailed calculation of the return on their investment, and through it, organizations can see if their marketing is profitable or not. To do so, you must apply the following formula:
LTV: CAC = Lifetime value of a customer/customer acquisition cost
In an ideal world, the LTV: CAC ratio should be 3:1, meaning that you should make three times what you spend on acquiring customers.
The CAC Payback Period
It might sound obvious, but companies need to invest money to make more money. The CAC payback strategy may help you avoid wasting money on ineffective marketing campaigns or customers who leave within a few months of signing up. It will also give you an overall image of how your marketing and sales efforts are working, if they’re effective or not, or if you need to apply changes to succeed.
To conclude, measuring the CAC of your SaaS organization is crucial. It will help you calculate the overall value of a customer to the organization, and the ROI of an acquisition, define your pricing strategy, help you find where you’re overspending, and spot issues with retention and churn. Afterward, you must constantly learn and adjust your tactics to ensure you get the most from your customers.
Would you like to know more? Book a demo to learn more about how FROGED’s Product Success Platform can help improve your main SaaS metrics or discover our proactive customer support features that will boost your customer satisfaction and retention!