Get to grips with customer acquisition cost as a saas metric, why it's important and how to use it to understand and grow your business' performance.
What is customer acquisition cost?
Customer acquisition cost (CAC) is the money a business spends to secure a new customer. CAC is important because it is a signifier of profitability and customer revenue. If CAC is low and the revenue you make from a customer is high, profitability will be high, and vice versa.
The tricky part is determining which costs to include, but broadly, SaaS businesses have two options. The first is to only count new business marketing costs, such as advertising. The second is to also include all other costs of acquisitions, including salaries, software, third-party fees, and overheads. The latter will provide a more accurate measure of CAC but is more difficult to calculate as it requires cross-functional and year-round spend to be attributed to a specific acquisition activity and time period.
SaaS businesses can also achieve a more accurate CAC reading by segmenting CAC by customer types, marketing channels, and product lines. We will look at these and how to measure each later.
When is customer acquisition cost important?
CAC should be an important KPI for every SaaS business. But it will be more important for some than others.
For businesses targeting profitability or competing in a low-margin sector, costs (and therefore CAC) have a profound impact. SaaS companies with an established client base may choose to be more selective about new customers, and use CAC as a threshold. While a business readying itself for further investment or a sale will be aware that CAC is a key instrument of the long-term profitability that investors look for. CAC is also an important metric for SaaS businesses that need to contract, as it can point to areas of inefficient spending.
CAC matters less to businesses at a high-growth stage that are prioritizing customer numbers. This is more so if the business is cash-rich, perhaps as a result of recent investment funding, as the pressure on cash flow (and so costs) is reduced. That said, CAC should never be ignored. Establishing a high CAC is difficult to reverse, and ultimately unsustainable.
How to calculate customer acquisition cost
CAC can be calculated over any defined time period. Most businesses analyze it monthly, quarterly and annually. Overall CAC can be calculated in simple and complex terms. Importantly, all CAC calculations include money that was spent that did not result in new customer acquisition.
Simple CAC divides the total marketing costs to acquire new customers by the total number of customers acquired in a defined period.
A business spends $50,000 on advertising in September, and generates 200 new customers from that activity. The CAC is 50,000/200 = $250
Complex CAC adds in other costs that can be attributed to acquiring new customers, such as the share of wages, software costs, third-party suppliers, travel and overheads, to name a few. These ‘extra’ costs should be calculated as a share of the company’s overall spend on these activities and by the timeframe in question.
A business spends $50,000 on advertising in September, and also attributes additional costs of $15,000 in generating 200 new customers. The CAC is $50,000+$15,000 ($65,000)/200 = $325
How to analyze your customer acquisition cost
SaaS businesses that prioritize CAC, or those with large and complex structures, will want to go deeper in analyzing CAC. By understanding CAC by individual customer types, marketing channels and product lines, you can identify issues and opportunities and dial-up (or down) activity accordingly. There is almost limitless segmentation you can perform with CAC, and each of these can be calculated using both ‘simple’ and ‘complex’ terms. The most common include:
- Initial CAC: The cost of acquiring a customer for the first time.
- Renewal CAC: The cost of renewing a customer. This can be segmented further by looking at CAC for first-time renewals, second-time renewals, and so on.
- Reactivation CAC: The cost of acquiring a customer that previously churned.
- Market CAC: The cost of acquiring customers in a specific country or region, or by vertical sector.
- Customer CAC: The cost of acquiring customers of a specific age, gender, professional level or even based on their previous engagement levels with you, to name just a few.
- Product CAC: The cost of acquiring customers for a specific product.
- End Users CAC: The cost of acquiring customers by the number of users their licence affords them. This can be expanded to look more specifically at User Acquisition Cost, where costs are divided by the number of end-users rather than contracted customers.
A business has quarterly acquisition costs of $520,000 and generated 175 new customers. 100 of those new customers bought 10 licences (1,000 users); 50 bought 25 licences (1,250 users); and 25 bought 40 licences (1,000 users).
User Acquisition Cost is $520,000/3,3250 users = $160
The relationship between customer acquisition cost and customer lifetime value
Analysis of CAC should go hand-in-hand with customer lifetime value (CLV). CLV is the amount of profit a customer is expected to bring over the course of their entire relationship with your business. Together CAC and CLV help a business work out Return on Investment (ROI).
CAC should be seen in relative terms to CLV. For example, rising CAC is not necessarily an issue if CLV is also rising, especially if the rate of CLV increase is more. Likewise, falling CAC may not be the good news it seems, if the lower spend is bringing less profitable customers.
The relationship between CAC and CLV is expressed as a ratio.
CLV to CAC ratios explained:
- <1:1 - each customer costs more to acquire than they will make in profit.
- 1:1 - breakeven, but add in all the other business costs, and you’re still losing money.
- 3:1 - a standard SaaS benchmark to aim for.
Three ways to manage customer acquisition costs
While lowering CAC may not always be a priority, no business can afford to ignore CAC completely. Here are 3 ways to manage CAC in your SaaS business:
#1 Use segmentation to find opportunities
CAC is a useful indicator of the general health of a business, but it is not a very actionable metric. For that, you need to drill down and understand CAC at a more granular level.
The most obvious way is to calculate CAC by individual marketing channel. For example, how does the CAC for in-bound marketing compare with outbound; or how does the CAC for different types of events stack up? This is easier said than done. Modern omnichannel marketing is designed to engage prospects at multiple touchpoints and across multiple formats. What’s more, it can be hard to measure the relative influence of each touchpoint in a new customer journey. Clear and accurate data and sophisticated Marketing or Revenue Operations teams are needed. Segmenting CAC along more defined lines (i.e by country, customer demographic, product line) is easier.
By performing CAC segmentation analysis, you are able to identify actionable insights that would otherwise be lost through aggregation. Comparing the findings will inform which opportunities or issues to prioritize.
#2 Optimize your sales processes
Because CAC is the sum of lots of factors, there are multiple triggers you can use to keep it under control. The most obvious way to improve CAC is to cut costs. However, any potential cost savings should be balanced with the impact on sales volumes and CLV. For example, automating part (or all) of the sales process can save money on staff costs. But it may result in more unqualified (and so less profitable) customers.
Shortening the sales process could be another way of making savings, but might backfire if prospects do not convert because they feel rushed into making a decision. Sometimes you have to spend to cut CAC; making an investment in training staff to better handle objections will increase CAC in the short-term, but is designed to generate more sales (and so rescue CAC) in the long term.
Another way to improve CAC is to focus on getting more customers instead of driving down costs. Some SaaS merchants address this at the product level, by creating a stripped-back version that is easier to explain and onboard. Others will optimize the checkout to drive better conversion. The right price will also convert more customers, faster, and so lower CAC. That doesn’t necessarily mean having low prices. Indeed, low prices can devalue your product and harm volume sales. And the customer you convert may be opportunistic and be more vulnerable to churn. Low prices also extend the payback period and weakens long-term CLV. What’s important for merchants is having different price points that meet different customers’ budgets and the amount they are willing to pay for your product.
#3 Keep adding value
The best way to keep CAC as low as possible is to make your product as enticing as possible. Compelling products need less persuasion, and that means less marketing and sales resources, and shorter sales cycles. Rolling out regular new features and fixes keeps a product competitive. Engaging with customers about your product roadmap gives you a better chance of delivering capabilities that are in demand.
You can also reduce long term CAC by investing in other factors that prospects will judge your business on. The quality of customer support is increasingly being used as a point of differentiation and can make or break a sale. So too the ease of signing a contract. Prospects that get caught up in weeks of protracted legal negotiations can lose interest before the deal closes. So too if the onboarding process is cumbersome and buyer’s remorse kicks in, in time for them to cancel their contract and claim their money back.
Improving all these factors has the benefit of increasing CLV too, and so positively impacting that all-important CLV:CAC ratio.
Though these measures may require some additional investment in specific areas, it does not mean that CAC has to rise. For starters, if customer numbers are increasing relative to spend, then CAC will fall. Alternatively, SaaS vendors could look to redeploy budget from inefficient activities, and so maintain (or even reduce) overall spend. Where CAC does rise on the back of new investments, it’s important to take a long-term view. The impact of product and process innovations on new sales can take time to filter through. Vendors should have a target of when they expect this to happen, and keep track of progress to that point.