Acronyms are everywhere in the business world, but what is CAC? Like other industries, customer acquisition costs (CAC) for software-as-a-service (SaaS) companies refers to the money spent to convert prospects into buyers of your software and services. This amount includes the total costs associated with marketing and sales spend for staff and programs related to the acquisition of a customer. This includes:
- Salaries, benefits, commissions, and bonuses for marketing and sales personnel
- Equipment used by marketing and sales employees like laptops, phones, printers, etc.
- Marketing and advertising activities, including digital and print advertisements, direct mail, broadcast advertising (TV and radio), event and conference participation and sponsorships, podcasts, webinars, etc
- Third-party agencies and consultants
- Software applications like configure price quote (CPQ), marketing, and billing
- Discounts provided to acquire the customer
While these are the most common expenses and determine what is CAC, your organization may incur other associated expenses. These can include product and service costs of freemium products, referral costs, overhead costs, production costs, inventory upkeep and more.
Why CAC is Important
Do underestimate the importance of CAC business. It’s a key metric in understanding the profitability of your SaaS business, as well as providing the potential future success of your company. Put another way, CAC provides the insights needed to know and understand the return on investment (ROI) for the efforts made to acquire customers during a predetermined period of time.
How do you currently answer the question, “How profitable is your SaaS business?” Without knowing your CAC, the response is most likely a guesstimate. However, when you know your CAC, you can more accurately respond to the profitability and sustainability of your organization.
CAC is a metric all SaaS companies should calculate, but it’s not the only statistic needed to keep your business running at top financial performance, as well as fully understand your profitability. Customer lifetime value (CLV) measures the total income your SaaS business can expect to receive from a customer across the entire lifespan of the relationship with the customer. This simple calculation (average purchase value * average purchase frequency * average customer lifespan) provides the metric.
The Importance of CAC and CLV Metrics
When using CAC and CLV in tandem, you gain the ability to determine how much you should spend on inquiring customers. For instance, a 1:1 ratio indicates that your SaaS business is spending as much on customer acquisition as the customer is spending with your company. Over time, a 1:1 ratio leads to loss of profitability. On the other hand, a 3:1 CLV to CAC ratio is a clear indication that the value of your customer is greater than the customer acquisition cost.
Think of this ratio as a scale. If it’s tipping in the direction of CAC, the cost of acquiring a customer is greater than the value the customer brings to the company. Basically, this means you are spending more money on acquiring customers than what you will receive, which over the long term will negatively affect profitability.
Alternatively, if the CLV side of the scale is heavier than the CAC side, you’re receiving more revenue than what it cost to acquire the customer. Want to know more about the relationship between CAC and CLV? Check out our blog here.
A Simple CAC Equation
To calculate CAC, simply add the marketing and sales spend for a predetermined period and divide that total spend by the number of customers acquired during the same time period. For example, if you spent $3,000 acquiring new customers in Q3 and acquired 150 customers during the same period, your CAC would be $20 ($3,000 / 150).
While simple enough, there are other considerations such as time to acquire a customer, blended and paid CAC, what is a good CAC payback period and a CAC payback period benchmark.
CAC: Taking Everything into Consideration
When evaluating CAC, you need to be cognizant of the amount of time it takes to acquire a new customer. Additionally, there are two distinct CAC methods – each providing valuable insights such as costs that did not lead to revenue.
Time to acquire a customer: It’s very rare that a prospect immediately becomes a customer after a sales call, attending a webinar/conference, reading a blog, or receiving a marketing campaign. In most cases, it can take months of follow-up to convert the prospect to a customer. If you calculate CAC on a monthly basis, that month’s CAC will provide a skewed measure. So it’s recommended that CAC calculations are done for a longer period of time – like on a quarterly basis.
Blended CAC: Blended CAC provides an overall view of your SaaS business. It takes into consideration the various marketing channels used to acquire customers – even those that aren’t paid for directly.
Paid CAC: Paid CAC is the total customer acquisition cost divided by the number of customers acquired through paid channels such as marketing initiatives. This CAC method enables you to determine which marketing channels are most profitable and which should either be revamped, replaced, or discontinued.
Understand CAC payback calculation periods: Depending on whether yours is a start-up SaaS company or one that has profitably stood the test of time, payback periods will vary. While you can expect fluctuations, the average payback period for a start-up is 12-months or less. For enterprise SaaS companies, the CAC payback period tends to be longer. However given these companies profitability, there are funds available.
Remember that CAC payback periods fluctuate based on competition, market changes, increases or decreases in operational costs, etc. Regardless, the one thing all SaaS businesses desire is to reduce CAC.
What it Takes to Reduce CAC
As previously discussed, high CAC has a direct and negative affect on your profitability and long-term sustainability. Take a look at five proven ways you can reduce CAC.
1) Create the right pricing models
Products and services priced too high will decrease the prospect to customer conversion rate, increasing CAC. Alternatively, product and services priced too low may result in a longer payback period. When it comes to their customer acquisition cost SaaS companies can get the pricing right by reading this overview of SaaS pricing models.
2) Engage the right marketing channels
As touched upon previously, leveraging the right marketing channels not only enables you to reach your target market but by calculating and monitoring paid CAC you’ll have the information needed to know which channels are driving low CAC/high CLV customers. It’s also important to note that channels that provide the most customer conversions may not always be the most profitable. This is especially true if the churn rate is high for certain marketing channels.
3) Simplify the sales process
It’s no surprise that a long and arduous sales process will lead to high CAC. Depending on the SaaS deal size, it can take anywhere from a few sales calls to 12 months or more to close the deal. For instance, a $5k sale can typically close in a month or two, whereas a SaaS sale that ranges from $500k to over $1m can take upwards of 12 months. To get the most accurate CAC possible, be sure to make appropriate adjustments for longer sales cycles. For example, if you have an 18-month sales cycle, CAC gets calculated over a two-year period. This ensures that marketing and sales costs are associated with the customers acquired during that time period.
4) Reduce customer churn
While some level of customer churn is normal across all industries, it becomes problematic when customers leave before you’ve reached your break even on their CAC. Put in place processes to gain an understanding of why customers are churning. This information will enable you to rectify the situation and reduce churn. Let’s assume that a high number of customers are going to your competitor because they have sought after software features or provide continual software training with one of their packages. By gathering this information, you can take the steps needed to improve your software and services offerings.
5) Focus on upselling and cross-selling
Unlike other industries that rely on one-time sales, SaaS customers are continual users of the software they purchased. Use this to your advantage by sending low or no-cost upsell / cross-sell promotions to your customer base. Since the cost of acquiring a new customer is higher than upselling/cross-selling to your current customers, you’ll be on the road to decreasing CAC, increasing CLV, and improving revenue.
Squeeze Every Penny Out of Your CAC
Calculating CAC and CLV will provide the insights needed to:
- Offer the right pricing strategies
- Promote your products and services on the right channels
- Simplify the sales process
- Improve customer loyalty
- Develop the products, features, and services customers want
However, there is another piece of the puzzle. To efficiently accomplish low CAC, you need a platform that automates the entire revenue lifecycle process. One that delivers the agility needed to quickly adjust to changing customer and market demands.
Named a Leader for Recurring Billing Applications in the recent Gartner® Magic Quadrant™, BillingPlatform excels at supporting virtually all billing strategies – from one-time charges to complex hybrid and dynamic billing models… and everything in between. We ranked a stand out from all the other vendors, and our cloud-based platform is highly recommended for organizations with even the most complex requirements. If you think you’re ready to learn why and start modernizing your revenue lifecycle, get in touch today!
