Every SaaS company starts with one clear goal, and wants to conquer that goal by any means necessary. While that is admirable, it’s a recipe for doom. This mindset ignores things like your mission, vision, a proper customer acquisition cost (CAC) formula, marketing expenses, and much more.
That is why SaaS companies usually see a disparity in their growth rates. A SaaS company that has a growth rate of less than 20% has a 92% chance of not existing in just a couple of years.
The SaaS business model and industry will be peaking at $157 billion in 2021, and will only continue to grow. With the sheer number of new customers coming in every day, SaaS companies are seeing more and more paying customers.
As the SaaS industry expands, companies are trying to control and reduce the cost of customer acquisition. At the moment, CAC calculations show that it contributes a lot to the total cost of all SaaS marketing efforts.
What is Customer Acquisition Cost (CAC)?
There is a common misconception between the SaaS metrics CPA (cost per acquisition) and CAC. People usually consider them to be the same thing, but they aren’t.
CPA tends to include a lot of acquisition events such as signups, clicks, and even lead submissions.
On the other hand, CAC is simply the cost of acquiring actual paying customers. The number of new customers that come on tends to increase after every sales cycle, which is why CAC is important.
To summarize, CAC is the cost of acquiring a customer while CPA is the cost of an action.
The total marketing costs of any company can boil down to a few things. You can mainly divide the amount of money spent into a few categories – leads, CAC, and after-sales support.
The Customer Acquisition Cost Formula
Calculating CAC is not as easy as it sounds, however, if you have the numbers ready, you can get it over with pretty fast.
In essence, CAC is when you divide the total marketing spend by the number of customers brought on during a period of time.
The following is the customer acquisition cost formula:
Customer Acquisition Cost = (Cost of Sales + Cost of Marketing) / New Customers Acquired in a Given Period
Calculating Customer Acquisition Cost Formula for SaaS in 8 Steps
Use the following 8 steps to make sure your CAC is calculated accurately.
1. Ad Spend
Your ad spend is all the money you’re spending on advertising. These ads include paid ads on Google, social media, and other traditional marketing channels. They’re a great way of attracting new customers, however, you have to make sure that your ads resonate with your target audience.
It’s important to find the ROI of such marketing campaigns. You can do so by dividing the revenue you’ve earned through ads, by the amount of money you spent on them.
2. Content Creation Costs
Your content creation costs or creative costs include all the money spent on creating and promoting your content.
These costs aren’t limited to the actual cost of the content created but also include things like money spent on acquiring talent, company promotion, money spent on team lunches during meetings.
3. Salaries of Employees
While it may seem like employee salaries make up a significant part of your expenses, it’s a necessary expense and one that’s worth the investment.
You don’t have to lay someone off to counter losses. Nowadays, the average customer is equally satisfied talking to chatbots or other marketing automation alternatives.
However, whatever you decide, the cost of that will have to be added.
4. Technical Costs
Technical costs include all the money spent on marketing technology that could help the sales process, marketing teams, and sales teams.
This can include investing in tools like SEMrush, Ahrefs, etc. This also includes other sales expenses like buying and setting up sales software.
5. Content Production Costs
These are all the costs associated with creating new content. For example, if you’re making a new video, the cost of buying a video camera, a set, a backdrop, editing software, and other small expenses add up to the production costs.
Even if you’re hiring a third-party to produce that content, it would still count.
6. Content Publishing Costs
Your publishing costs include all the money spent on making your content public. This includes things like boosting Facebook posts, Twitter sponsors, etc.
7. Maintenance Costs
Maintenance costs are the monthly and yearly fees incurred to keep the business running. This includes the recurring payments on all the software you’re using, such as your domain, server, upkeep costs, etc.
8. Count New Customers and Calculate
Add up all the costs in the last 7 steps and you’ll have the total marketing and sales spend in a given time period. The time period can be a month, quarter, year, or any other.
Then calculate the number of new customers you have gained in that time period.
Use the customer acquisition cost formula and you’ll know how much the average customer has cost you, and you’ll have a gross margin of how much you potentially earn per new customer.
Customer Lifetime Value (CLTV) Compared to CAC
It’s important to compare CAC with other metrics because it helps you get insights into your customer acquisition strategy.
One of the most important metrics you can compare CAC to is CLV (Customer’s Lifetime Value). The CLTV is the average predicted revenue any given customer will provide over the course of their relationship with the company or product.
How to Calculate LTV
Calculating LTV can be a little complicated, but to simplify it, keep these four variables in mind.
- Average Purchase Frequency – is the average number of purchases in a given period. You can calculate it by dividing the total number of purchases by the total number of unique customers who made purchases in the same time period.
- Average Purchase Value – is the average value of each purchase. You can calculate it by dividing the total revenue of your company by the total number of purchases in the same time period.
- Customer Value – is the value each customer provides you, on average. You can calculate it by multiplying the average purchase frequency with the average purchase value.
- Average Customer Lifespan – is the average amount of time a customer has a relationship with your brand or company. You can calculate it by averaging out the number of years a customer made purchases from your brand or company.
When you have all this information, you can calculate LTV by multiplying the average customer lifespan with the customer value.
This will give you the average revenue any customer will give you over the course of their relationship with the company or brand.
Customer Lifetime Value (CLTV) = Average Customer Lifespan X Customer Value
Here’s an online CLTV calculator to make your life easier.
Knowing the LTV, you can now find out how much it costs to earn any given customer.
Lifetime Value (LTV) to CAC Ratio
The LTV:CAC ratio is an indicator of a customer’s value compared to how much it costs to acquire them.
This ratio is used by SaaS companies to dictate their sales, marketing, and customer service spending. It shows whether the money spent on acquiring new customers is actually worth it.
You don’t need to evaluate your entire customer base for this. All you need is to make sure that you find the right balance for this ratio. It ensures that you’re getting maximum utility from the investments you’re making.
Without getting into any conversion rates, the ideal payback period of the cost of acquisition should be around one year. Your ratio should be 3:1 on average. What this means is that the value of your customers should be at least 3 three times as much as it cost to acquire them. In a way, this also ensures that there is minimum churn since you make sure your customers remain satisfied after you acquire them.
If your ratio is around 1:1, that means your gross advantage is zero. You’re spending as much money on acquiring customers as they’re spending on your company. However, this goes both ways because, if your ratio is too high, that means you’re missing out on a lot of good marketing and sales leads.
For any e-commerce or SaaS business to succeed, you need to find that balance between having a good LTV:CAC ratio and making sure you’re doing everything in your power to acquire new customers.
Another question that may pop up is how much CAC a typical company should have. While there’s no definitive answer since every industry is different, you can break it down to the costs in different industries.
CAC Per Industry
While the CAC will be dependent on a lot of things, it can be boiled down to the following for the SaaS industry.
- Purchase Frequency
- Purchase Value
- Customer Lifespan
- Company Maturity
- Length of Sales Cycle
Ultimately, it’s about breaking down all the costs your company incurs in a given time period.
Improving Your Customer Acquisition Cost
Improving your CAC is about making sure you get to that 3:1 ratio. Here are some ways you can improve your CAC.
- Add More Value: Increasing customer value can be a great way to improve your CAC, and you can do that by giving the customers exactly what they want. To determine what that is, you need to collect constant customer feedback regarding product fixes, advice, and reviews. You’ll find out what most people expect from your brand, and providing that (no matter how outlandish it is) will ensure that customers gain more value.
- Introduce Customer Referral Programs: Referral programs are a great way of quickly (and easily) building a network of leads. It’s like having a free sales team that functions on one of the most successful marketing tactics – word of mouth. If a customer successfully refers your product to someone who wanted to know more about your service, your CAC for acquiring that customer will be $0. You essentially gain a customer for free. Over time, these free customers help lower the CAC.
- Conversion Rate Optimization (CRO): It’s important to make sure that your leads are easily converted into paying customers. You can use a CRO strategy to make sure most, if not all, of your potential leads turn into customers. A good example of this is to start with a Freemium service, i.e. where you provide limited options via a free version of your product to bring a customer in and impress them. Furthermore, it’s best to optimize your site for mobile submissions, test your copy, and streamline the sales process.
Your job is to streamline your sales cycle to the point where it’s a seamless transition from being a lead to a paying customer. Decrease the length of the sales cycle while increasing the number of sales.
Excelling in the SaaS Industry Using CAC Optimization
When it comes down to it, the cost of customer acquisition is a startup killer. Startups, especially SaaS startups, fail to get their product/market fit right. However, their failure to address the cost to acquire customers is equally responsible. Keep in mind that it's not always SaaS; this methodology applies to subscription communities like the one I built for Maintenance Manager HQ or even subscription ecommerce products.
Furthermore, they can’t figure out how to successfully monetize those customers, whether it be a lack of effective customer lifecycle marketing strategies or a lack of real value, altogether.
However, for every SaaS company, the primary goal is to get as many customers as possible - the more customers you have, the greater your growth rate.
That is why minimizing your CAC is imperative for maximum growth.