Using CAC to Make Decisions

You’ve got to spend money to make money, and how effectively you do so will determine your startup’s success or failure. Finding and selling to potential customers is a costly endeavor. Computing and measuring this cost is called Customer Acquisition Cost. Knowing your CAC is important in order to understand how much revenue per customer you need to be profitable. Just as important, you will need to know how long your CAC investment will be tied up before your customers start paying back that investment, which is called the Customer Acquisition Payback. CAC Payback is critical in managing your cash burn and runway. For example, you may have great customer unit profitability metrics, but if you underestimate your CAC Payback, you may run out of money or be resource constrained from longer payback periods.

Customer Acquisition Cost (CAC) = Sales & Marketing / # of New Customers

Customer Acquisition Payback = CAC / Average Revenue per Account * Gross Margin %

Not all customers are the same. Your customers will vary in the product lifetime, usage, upgrade, support time, and sales cycle time which will impact your profitability, so your initial CAC investment shouldn’t be the same. For example, spending $100K on an Enterprise rep to generate 2 SMB customers who pay an annual amount of $10K, wouldn’t be a profitable CAC investment. Point being, it’s important to segment different CAC investments in order to optimize profitability whereas may be missed if CAC is viewed at an aggregate level only.

Optimizing for CAC

In order to increase profitability within your CAC strategy, you cannot measure only the aggregate CAC but rather segment CAC by department and channel in order to find the levers that are driving the successes and failures in your CAC strategy. For example, you may have more than one sales channels such as self service, inside sales, outside sales, or channel sales.

By segmenting the Sales channels, you can see the Inside Sales CAC is much higher than the other channels. Investigating into the Inside Sales channel, you may find that the lack of new customers is driven by Go-To-Market strategy where potential customers buying process is more suited to Enterprise sales reps, who can provide in-person demos and meetings. By drilling down into your CAC’s Sales channel, you learn more about your customers interaction with your product, which then leads you to get rid of the Inside Sales function and doble-down on Outside Sales.

Segmenting your Marketing CAC channels is crucial in understanding what marketing strategies are driving success because most companies have several marketing channels. In the example below, common marketing channels are Referrals, Content, Advertising, and Events. Dropbox, Airbnb, and Uber are examples of companies who have had great success with referral programs. Content marketing is largely considered the most affective and informative marketing program but difficult to scale. Hubspot is great example of excellent SaaS content marketing. Advertising has many different forms such as online, TV, and print. Fortunately there are many advertising attribution tools to measure success, such as Adroll and Bizible. Marketing events is a highly affective channel, that provides many in-person demos and company awareness that otherwise wouldn’t be possible at the same scale. SaaStr is one of the biggest SaaS events in the world. However, in lieu of Covid-19, marketing events are now remote, not offering the same in-person appeal. Time will tell how marketing events change in the future. Marketing programs are imperative to building company awareness and driving leads to the sales funnel. Marketing is both an art and science and your strategy and channel success will often change as your customers and product evolve and change, so continuous AB testing of your Marketing CAC strategies are essential.

SalesWeb SalesInside SalesOutside SalesChannel Sales
Spend         13,000      120,000         150,000         75,000
New Customers                   5                   1                     5                   2
CAC per Sales Channel           2,600      120,000           30,000         37,500
Blended Sales CAC         27,538
Spend         10,000      100,000           50,000      200,000
New Customers                   2                   5                   1                   7
CAC per Marketing Channel           5,000         20,000           50,000         28,571
Blended Marketing CAC         24,000

Understanding your CAC has many valuable use cases.

Customer Profitability Optimization: Stated previously, segmenting CAC channels helps optimize costs, while driving customer profitability.

Business Unit Economics: The Customer Lifetime Value to Customer Acquisition ratio provides the monetization efforts from CAC investments. There are many ratio benchmarks online, the standard being an LTV of $3 to $1 of CAC, meaning for every $1 of CAC, must equate into $3 of customer value to pay for other operating expenses while striving for profitability.

Cash Management: The cash flow dichotomy between CAC and LTV is where the upfront investment to acquire a customer is recouped incrementally over the life of the customer contract. This cash disparity makes it difficult for early state startups to survive, if they can’t manage their cashflows precisely. The CAC Payback period provides you with you the number of months it will take to recoup your CAC investment. By actively understanding your CAC Payback, will help guide you in managing your cash burn and runway.