SAAS CAC Ratio: What Should it Be?

February 14, 2011

Last week I wrote about focusing on improving your 4 SAAS numbers rather than getting overly excited about calculating and debating a lot of metrics that won’t improve your business:

SAAS Metric 1: The cash you consume acquiring a new customer (the lower the better)

SAAS Metric 2: The cash you generate from customers over the customer’s life net of the cash you consume serving the customer. This includes customer service, customer marketing, account management, professional services, equipment, network, data center, etc. (the higher, the more it grows over time, and the longer the time, the better)

SAAS Metric 3: The number of paying users you have (the more, the better)

SAAS Metric 4: The number of active users you have (the more, the better)

Learn more about these metrics here.

One of the great derivative measures of these numbers is how long it takes for your customer acquisition cost (metric 1) to be paid for by the cash generated from the customers (metric 2). When I made my first investment in a SAAS company, ExactTarget, in 2004, I spent a lot of time trying to understand what others were doing., Omniture, and others proved to have some useful data to take a look at and I settled on the idea that paying off the cost of acquiring a customer in 12-18 months made a lot of sense. The customers generally grew over time, so the salespeople and marketing would be paid back in the first year or so and the customers would be profitable from that point forward.

I later learned that Josh James, CEO of Omniture, had used a “magic number” that was similar and I felt satisfied that I had it right.

The Rule of Thumb May Not Fit Your Economic Model

Over time, many people (too many to link to) have essentially repeated this perspective, while I have moved away from using this as a strict benchmark. The basic issue I find is that the world of SAAS and SAAS-related companies is much more complicated than this simple benchmark would indicate and blindly following the rule of thumb could be the wrong thing for your company.

Some examples related to the economic model:

– If you have a land-and-expand strategy, whereby a customer samples or pilots your product for a while and then increases the spending over time, then you might want to allow more time for your customer cash to pay back your sales and marketing cost because the future customer profit is that much better than the first year.

– If you have a lot of customer attrition or a relatively new product with limited long-term customer data and you can’t depend on later profit from customers, then you may want to be paid back more quickly.

– If you are evangelizing a market and expect the sales results to get better as you reach the mainstream customers, then you may want to invest more in sales and marketing and not worry so much about the economic model for a while until you determine the level of success of your efforts.

The Rule of Thumb May Not Fit Your Strategy

The other issue with having a 12-18 month payback “rule” is that it may not be aligned with your specific strategic goals. For example:

Financial Strategy: If you can get a 5x valuation multiple on SAAS Revenue, then you can spend roughly 5x the rule on customer acquisition and still create value in the company (assuming your customer revenue is maintained). The pure financial math actually suggests that as long as the valuation increase in your company is higher than the dilutive effect from the capital you raise to boost your sales and marketing resources, then you should keep boosting your resources. However, though it has been executed successfully in the past, it is an aggressive and risky strategy and you will need sources of growth capital.

Company Exit Strategy: If you want to prove out your product in the market, get to a minimum size, and then sell to a larger company, you may want to goose your sales and marketing resources and get close to the minimum size as quickly as possible before dialing in the economic model.

Business Growth Strategy: You may have a business growth strategy of entering a new target customer segment such as a new geography which will give you poor customer acquisition economics until you get to some critical mass.

Competitive Strategy: If you want to focus on creating competitive advantage, get broad adoption and figure out your revenue and economic model later, then this rule of thumb is completely off the table as you have no customer revenue to even make the calculation.

Company Development Strategy: You may have a company development strategy to hire a very experienced and senior team in sales and marketing. This will reduce your customer acquisition economics (at least if you include their costs in your calculation, which you should).

My point in writing this post is that I have found so far that every SAAS company in which I have seen and/or invested is different and you need to consider your unique circumstances before blindly following a rule of thumb that was created for a different circumstance. I still consider the rule of thumb when I look at SAAS company metrics, but I don’t blindly follow it.

As I pointed out in my prior post, the most pragmatic thing you can do is calculate your 4 SAAS numbers and then explore and test ways for improving them while you grow your business! Whatever your current numbers, simply try to improve them and make sure this work aligns with what you are trying to achieve strategically!

Now consider your company…what should your target be?

Founder & Partner

As the founder of OpenView, Scott focuses on distinctive business models and products that uniquely address a meaningful market pain point. This includes a broad interest in application and infrastructure companies, and businesses that are addressing the next generation of technology, including SaaS, cloud computing, mobile platforms, storage, networking, IT tools, and development tools.