Companies constantly face financial challenges, and SaaS companies are no different. Even startups that grow revenue year over year may take a long time to become profitable or break even—if ever.
One of the factors influencing success or failure at this point is CAC, or cost of acquiring customers. Here’s everything you need to know about CAC—what it is, why it’s important, how to calculate it, and how to determine if it’s too high or low.
What is Customer Acquisition Cost?
In practice, the cost of acquiring customers can be higher than expected. CAC covers the full cost of marketing and sales over a given period of time—including salaries and other expenses related to finding and contacting customers—divided by the number of customers acquired over the same period of time.
In SaaS, scalability allows new customers to be won without necessarily necessitating an increase in the number of employees. If there are employees who have aren’t involved in the sales or marketing process, don’t count them when calculating CAC.
If you’re not calculating CAC now, this is why you need to start doing so.
Why is measuring CAC for startups important?
The cost of acquiring customers is one of the pillars that determine the viability of a business. Once the initial buzz and excitement of a startup’s launch go by, you need to look carefully at the business model and sales.
Without a balance between cost and price, the business becomes unsustainable. Your business runs the risk of losing money each time a new customer signs up for a contract.
In general, the viability of a startup business depends on two variables: the cost of acquiring customers and the Lifetime Value (LTV) of each customer. The LTV is the revenue generated by a single customer and it makes all the difference when deciding how much money to invest in prospecting.
Let’s look at an example. Imagine that you spent $500 to acquire a customer who spends $100 per month on your software. If that customer subscribes to your software for an average of 4 months, in the long run you will incur a huge loss. Let’s calculate exactly how much acquiring this customer will cost you below.
How to calculate the Cost of Acquiring Customers
As mentioned above, CAC covers the entire cost of sales and marketing over a given period, divided by the number of new customers obtained.
Here’s a step-by-step look at how to calculate CAC.
Set a time period to be analyzed
You can select any time period. However, the ideal time period isn’t too short (less than two weeks is too short), nor is it too long (more than a year is too long). For this calculation, three months is a reasonable starting point.
Count all costs related to sales and marketing
Now is the time to consider every direct and indirect cost linked to customer acquisition. Think of each of the processes and areas of the company so you do not forget anything.
To help you, here are the expenses that usually appear at this stage:
- Advertising costs
- The cost of tools (emails, website domains, etc.)
- Social media and blog costs
- Public relations costs
- The salaries of every employee responsible for acquiring customers
- The cost of selecting and hiring the above employees
- Meetings (transportation, food, etc.)
Add up all costs from the previous list and divide by the number of customers won in that period
By doing the above calculation, you now have your CAC. Finally, it’s time to figure out whether your CAC is at an acceptable level or if it’s too high.
How to evaluate if your CAC is too high
Determining if the CAC is too high is as important as understanding the impact your CAC will have on the health of your company. Remember how we mentioned LTV earlier? We must take it into consideration to determine whether the cost of acquiring customers is in the right range.
According to experts, for SaaS or other recurring revenue models, the ideal LTV is at least three times larger than the CAC to ensure the viability of a business. Many of the most successful startups operate with a ratio of 5 to 1. That is, the LTV is up to five times the value of the CAC.
Some companies (such as banks) ignore this rule, but they have access to a lot of capital to grow. If you want to ensure the viability of your startup without having to rely on huge capital investments, you should be aware of the ratio between LTV and CAC.
The cost of acquiring customers is an essential factor for the survival of startups. CAC should be calculated as soon as the first client is won. If you haven’t done so already, the best time to start is now! The sooner your company understands CAC and uses it as a benchmark, the sooner you can invest resources in improving internal processes and prospecting to maximize profits.