CAC Payback Basics: What It Is, How to Calculate It and Why It Matters
As the old adage goes, you have to spend money to make money – SaaS businesses are no exception. Arguably the most important spend decision SaaS operators make is focused on acquiring customers. Collectively, these expenses are referred to as Customer Acquisition Costs, or CAC for short.
CAC encompasses all of the sales and marketing costs that a business has to shell out to land a single new customer (calculated as total sales & marketing expense in a period / total customers acquired in a period). This includes expenses like ad spend, creative development, and commissions along with more substantial overhead expenses such as salaries and rent. While CAC is accepted as a cost of doing business, it should not be a blank check for your sales & marketing team.
CAC, and more specifically CAC payback (how long it takes to recoup your customer acquisition costs), are key SaaS go-to-market metrics, and leading businesses make the metric a board-level priority and have ongoing discussions to ensure that CAC payback is consistent and predictable. Managing (or failing to manage) CAC payback can quite literally make or break your company. The challenge for operators is that CAC payback is a complex topic. Even at the board level, there is no universally accepted framework for calculating, managing, and positively affecting the metric.
Through our Expansion Team’s proactive engagement with the OpenView portfolio, we’ve devised several CAC payback best practices we find ourselves turning to time and time again.
Calculating: CAC Payback Basics and How to Calculate It
CAC payback is the single best measure of the efficiency of your go-to-market engine. It tells you how long, in months, quarters, or years it will take to earn back the money spent on a new customer. A high figure is a signal you’re spending too much on customer acquisition, a low number the opposite. The trickiest part of getting CAC payback calculations right is that there are several different ways you can calculate it (just Google CAC payback and you’ll see what I mean) and position the numbers (should you include upsell?). One minor nuance can dramatically change your calculation’s outcome and obscure the reality of your sales efficiency.
We recommend adopting the following formula that will provide you with the most accurate view of payback:
CAC Payback = Sales & Marketing Expenses in Period / (Net New MRR Acquired in Period * Gross Margin)
Obviously, this calculation assumes you have a firm grasp on your sales & marketing expenses, MRR by customer, and gross margin (don’t forget, expenses for customer success resources focused on onboarding should be included in your Cost of Goods Sold). If you haven’t already nailed those down, you need to start there.
Keep in mind, the MRR figure used in this calculation should include net new MRR which in a given period is equal to MRR from new customers plus expansion MRR from existing customers less churn MRR from lost or downgraded customers. If you have longer sales cycles (three or more months), it’s acceptable to offset sales & marketing expense by the length of an average sales cycle. Be sure to use your best judgement when offsetting, as being overly generous can paint a better CAC payback story for your board, but might obscure reality.
We recommend that you start tracking CAC payback as early in the game as you can. Numbers will be skewed in the early days because you won’t yet be operating at scale, but even at a small scale you will benefit from keeping your target CAC payback in sight and contemplating how you’re going to hit the goal. Tracking from the get go also gives you the greatest opportunity to make improvements over time. By measuring and investigating fluctuations in your CAC payback, you’ll start to understand the underlying inputs (cost per lead by channel, lead conversion, sales cycle length, etc.) more thoroughly and will be better equipped to make changes that will help you reduce your payback period. Finally, just knowing that everyone is keeping an eye on this metric will support a culture focused on efficient growth and keep your entire team committed to keeping acquisition costs from going off the rails.
Benchmarking: CAC Payback Goals
When it comes to CAC payback, faster is (almost) always better. In general, most people think of 12 months as a fantastic CAC payback and use this figure as their rule of thumb; however, it’s important to focus on peer benchmarks and not just rules of thumb. A “best-in-class” CAC payback period is highly dependent on your go-to-market motion and customer type and must also be put in the context of two other metrics: logo retention and net dollar retention.
For example, if you sell to large enterprises and see long sales cycles supported by a field sales model with highly compensated sales reps who have extended ramp-up time, your business will naturally have higher payback than a product-led company that leverages virality and a self-serve freemium model to target businesses of all sizes. Our 2018 SaaS Benchmarking Report includes peer benchmarks that you can leverage to monitor the appropriate ranges for best-in-class CAC payback as your business matures. While software type (i.e. horizontal vs. vertical platform) also plays a role in selecting peer benchmarks, go-to-market motion and customer type move the needle most significantly.
With that said, no metric exists in a silo, and CAC payback is no exception. Because CAC payback is an implied value, you also need to look at CAC payback in the context of logo retention and net dollar retention. For example, perhaps your CAC payback is worse than peer benchmarks but your retention is best-in-class. If you never churn customers (100% logo retention) and on average your customers pay you more over time (net dollar retention >100%) then you should feel confident that you’ll eventually recoup all of your sales & marketing costs and breakeven on each customer you acquire even if it takes 24 or more months. Conversely, if your CAC payback is six months but you churn most of your customers by month three, you’ll never recoup acquisition costs. Retention is the best and only check on whether your implied CAC payback will ever be realized CAC payback.
CAC payback represents a specific moment in time and the long term trend is key. Don’t forget to look at how the numbers trend over time to develop a clear picture of what’s actually happening and remain vigilant about your efficiency, particularly as your company grows. It’s common to see a reduction in efficiency as a business scales, markets saturate, and competition increases. In addition to bringing on new team members as you scale, adding new operational costs (don’t forget to include rent expense for your sales & marketing teams!) can also cause changes in your CAC payback period. The key to riding these waves successfully is anticipating them (so no one panics) and being consistent about measurement so you can quickly diagnose and address any growth challenges.
The Product-Led Advantage – Lower CAC, Faster Payback
As an important aside, it’s worth noting that product led growth (PLG) companies have a shorter CAC payback than companies with a traditional sales & marketing driven go-to-market model. The reason is intuitive—product-led companies have fewer sales & marketing costs because their bottom-up business model relies on the product to acquire, convert, and upsell users.
Our data suggests that while CAC payback in PLG businesses is initially on par with non-PLG businesses, the two diverge in the expansion stage when the PLG model hits its viral inflection and drives CAC payback nearly 100% lower. With fewer sales & marketing dollars to recoup, product-led companies have an innate advantage and realize continued efficiencies as they mature, benefitting from stickiness, delightful user experiences, and virality. And because PLG businesses are so much more efficient they can reprioritize investment into product & engineering and customer success efforts to continue to build on their model and realize compounding go-to-market efficiencies over time.
Positively Affecting: Tips for Reducing CAC Payback
Continually Experiment to Optimize CAC
- Leverage PLG best practices. The data doesn’t lie – PLG companies are more efficient. Refer to OpenView’s PLG resources and begin implementing PLG best practices throughout your funnel to realize the efficiencies of product led growth. You can start by simply using virality and word-of-mouth to reduce reliance on paid advertising. Focus on delivering value and delight via a superior user experience to create powerful network effects and referral opportunities. If you can get people talking about your product, you won’t have to spend as much on expensive marketing campaigns.
- Nail Product / Market Fit. When you know exactly who you’re selling to and what problem you’re solving, your brand message becomes much more effective and each dollar spent is more effective. Taking the time to create buyer personas, conduct market research, perform customer segmentation, and formalize other sales & marketing due diligence will keep you from spending sales & marketing dollars targeted at the wrong buyers.
- Drive Funnel Efficiencies. Powering up your marketing funnel is a two-part endeavor. Step 1: build a funnel that encompasses every stage of the buyer journey from the top to the bottom. Too many companies hyper-focus on only one thing—driving website traffic or booking demos—and miss many opportunities in other areas. Step 2: take advantage of automation. Marketing automation tools help you scale your sales & marketing efforts easily and effectively without costly staff additions.
- Optimize Conversion Rates. Invest some time and resources into ensuring that users encounter as little friction as possible on their way to buying. This may include optimizing your mobile experience or signup flow. It might include beefing up buyer resources, a knowledge base or implementing a chatbot. Alternatively, it could even be as simple as performing a website content audit to identify opportunities to improve clarity and persuasiveness.
Retention Is Your Secret Weapon
- Take Advantage of Upsell and Cross-sell. It is easier to sell to an existing customer than a new one, and customers who expand from their initial purchase achieve payback more quickly. If you can pay to acquire a customer once and then sell them additional users, features, or products you will soon find yourself dramatically improving CAC payback.
- Avoid the Lifetime Value Trap. Lifetime value (LTV) is an output, and you should focus key inputs that you can control: CAC and retention. Be careful about getting too hung up on how LTV (lifetime value) relates to CAC. While there has traditionally been a strong focus on the importance of the LTV:CAC ratio, time has shown that the formula is far from perfect and not always the best measure of success. If you can manage best-in-class retention and CAC payback versus peers, you’ll be in good shape.
Don’t Forget About Your Margins
Often overlooked, gross margin is a key variable in the CAC payback formula and one that you can readily impact. For SaaS businesses, hosting (AWS) costs and customer onboarding are the key costs of goods sold and are constantly being optimized. Pricing, though, is, in fact, the most impactful near term lever to improve your gross margin.
Pricing doesn’t have to remain static. In fact, it’s pretty typical for SaaS pricing to evolve over time as features and packages change and target audiences expand. Nearly two-thirds of the companies we surveyed in 2018 reported that they changed pricing in 2018, and 98% indicated they expect their price changes to positively impact ARR. Experiment with different pricing strategies to see what the market will tolerate. You might find you’ve been leaving money (and margin) on the table.
Bottom Line – Faster Payback, Stronger Company
While the SaaS community agrees that you have to spend money to make money, we also agree that the money you spend to acquire new customers isn’t money well spent until the revenue generated from a customer exceeds the cost of acquiring that customer.
Once you have a handle on all the elements of the equation that determine CAC payback you’ll have the insight required to benchmark your performance and prioritize experiments to positively affect each of those variables and improve CAC payback. Zoom’s successful IPO proves that companies that demonstrate strong efficiency and permission to believe in sustained, efficient growth are more valuable. Having a handle on CAC payback is a must to successfully position any SaaS business.
When it comes time to fundraise, have you thought about focusing on your current investors? Learn why it’s the best option here.
Some software companies are leveraging GDPR to identify and address organizations that are pirating their applications, overusing licenses or otherwise infringing on their intellectual property. Learn how they do this with the new data laws here.