October 10, 2022
Adam Hoeksema
The cost of acquiring each new customer in SaaS businesses can range from around $70 to well over $14k, depending on the industry, and the scale of the company. This cost determines the value of each customer over their lifetime and gives companies an idea of what’s working and when isn’t when it comes to sales and marketing.
However, startups can have this metric heavily skewed by early expenditures, so it’s important to know what to put in and what to leave out when calculating for early-stage companies.
If you’re interested in knowing this, we’ve got some tips coming up on what to include, how to calculate it, and how to keep your customer acquisition cost (CAC) down, followed by an example of a CAC SaaS calculation that companies might use. But first, what exactly is CAC for SaaS?
The SaaS Customer Acquisition Costs (SaaS CAC) and Why it’s Important
SaaS CAC is a single figure of how much it costs to get one brand new customer to purchase a SaaS product for the first time. It has no reflection on any subsequent purchases; it’s simply a focus on first purchases and the individuals who make them.
The standard CAC calculation is a total of all the sales and marketing costs, divided by the number of customers acquired with them. This simplified form of CAC isn’t necessarily useful in early-stage SaaS companies. We’ll go into why this is later. However, the calculation itself will depend on the specific state of each company and what the metric will be used for.
Customer acquisition cost is a critical SaaS metric to follow, as it relates to customer success, retention rates, and the customer lifecycle value. Knowing the cost of acquisition of each customer is necessary to calculate this lifetime value, and in SaaS, with the subscription model being so commonly used, this value is improved with retention.
The customer lifetime value is a primary focus of SaaS companies trying to predict their profitability and reflects the expected profit generated from each customer, over the length of their relationships with the company. With repeat revenue, this means, the longer that relationship, the more revenue is generated. It’s pretty simple: a customer who renews their subscription of $10 every month for ten years has a lifetime of ten years and a value of $1200.
However, this is only one side of the equation. The cost of acquiring the customer in the first place needs to be recovered and then a return has to be made for the company to be profitable. Again, this is the simplest rule in business; a customer providing a lifetime revenue of $1200 needs to cost the company less than this value to acquire, or the company is losing money.
For example, if your CAC calculations tell you that each customer costs $300 to acquire, you know that you’re going to make $900 profit on each customer over their lifetime. This figure then becomes the customer lifetime value. CAC therefore also provides you with an understanding of your payback period (in this case, 30 months), which is important for projections and understanding your annual ROI.
This may all sound obvious, but it’s still an overlooked principle in many startups. While CAC is a critical factor in calculating profit, it’s also a powerful tool for identifying the best-performing channels of customer acquisition. So, even businesses that are clearly making a profit can improve those margins by using CAC to find where to double-down and where to cut back on customer acquisition resources.
From these insights, CAC provides businesses with a means of keeping up to date with customer demands and expectations, and this all translates to the ability to stay relevant in a changing market. It also shows that a company is doing its due diligence and understands its financial prospects for the future.
Ultimately, including CAC in your business analyses provides a robust business plan, helps to predict profit margins, and shows potential investors that the founders or owners of the company are making educated business decisions.
There are different ways to calculate CAC, and the metrics you make use of will be determined by the stage of your company, your preferences, and the way you’re planning to use the calculation. Here’s a look at some of the things you may want to consider including and excluding in your SaaS CAC calculation.
The CAC Calculation SaaS Startups Should Consider
The basic formula for calculating CAC in SaaS is simple. Divide the total sales and marketing expenses by the number of a new customers acquired. However, how do you figure out the costs of sales and marketing, and which costs can be attributed to customers?
A primary rule for calculating these costs is:
“If it touches the prospect, include it”.
What this means, is that basically anything that the prospects don’t come into contact with can be excluded. In this example, we’re going to eliminate marketing costs, and there will be some explanation as to why that is coming up. For now, here are some examples of what to include and what to leave out:
- All paid ads – If you’ve paid a company to serve ads on behalf of your company, include these costs. Your prospects and customers have contact with these ads.
- Sales teams – If you’re using a sales team, the salaries and bonuses of this team are all relevant to the acquisition costs.
However, some things need to be excluded. Here are some examples:
- Marketing teams – It might seem intuitive to add the salaries of your marketing people in the calculation, but since marketing has no direct interaction with your prospects, they shouldn’t be included; especially in the early stages of business (we’ll go into why in a moment).
- External marketing expenses – Any consultancy fees, marketing software, and any other marketing things that don’t touch your prospect should be excluded.
Now, it’s time to look at the customer side of the equation. There are a lot of rookie mistakes made at this point, so here are the important things to consider:
- New customers only! – These are people, not orders, and they are brand-new converts. This includes both the customers who are coming in from your paid ads channels and those who come in organically. Referrals, word of mouth, and any channels that don’t cost you a thing can still feed you new customers, so these need to be included.
- Not recurring purchases – The flipside of the above point. Exclude any recurring payments, and any orders that have been made; the CAC calculation is only interested in focusing on people. While lifetime value calculations will need recurring revenue factors, CAC is only using first-time individual customers.
This is the rough overview of the CAC calculation SaaS startups should be focusing on, but the specifics will depend on the nature of the company and its stage of development. But, why exactly are we leaving out marketing costs? Let’s go over an example.
Marketing Costs: To Include or Exclude in CAC SaaS Calculation?
If you are at the early stages of your SaaS company, and you’re building your marketing strategy, perhaps you’ve paid for a website, and you’re also building a small team of marketers who are on the payroll, you’re immediate overheads are going to be high.
So, if you launch after 3 months, you’ve already paid 9 monthly salaries, plus the website design, and now it’s time to put out some ads. This is going to net you a significant cost before you even acquire your first customer.
So, after the first month, you come to calculate your CAC, you have two options: include marketing spend or exclude it. If you include marketing, your CAC for the first month will be astronomical; in many cases, likely higher than your expected revenue of your new customers, and certainly a distorted image of how long it will take you to make a return.
If, on the other hand, you exclude marketing, you will immediately have a more accurate idea of where your ad spend was most successful, how long it will take to recoup it, and whether you’re likely to get a return over the course of the customer lifetime.
This is particularly relevant at the early stages of business. Later on, it might be a better idea to calculate the overall cost, including marketing, to provide you with what is known as a “fully loaded CAC”, when your marketing costs are more fixed and averaged out over the company lifespan. However, at the start, this is likely to give you a distorted and ultimately useless metric.
When you have the figures you need, you can calculate CAC in two ways. First of all, paid CAC is the total costs of your advertising, divided by the total number of customers you can attribute to the effects of that advertising.
Blended CAC is the same calculation, but using the total number of newly acquired customers, both as a result of your expenditures and from organic customers; those are people who were referred or found out about you by word of mouth. Tracking both can give you a deeper insight into which of your efforts is working and which isn’t.
Whether you choose to exclude marketing entirely or factor in a fraction of marketing or lump it in all together, is ultimately up to you. Still, the marketing costs are harder to work with, as there is a much less-defined line between marketing to new customers and marketing to current ones; especially when it comes to salaries.
Example Metrics to Track for Calculating CAC in SaaS and Sample Calculation
As we went over in the previous section, there are a lot of metrics that need to be excluded from the calculation, especially in the beginning. So let’s go over many of the common costs relating to sales marketing and identify which are useful and which need to be left out. Here are some operating expenses of a fictional SaaS company in the third month of launch, as they might appear on your spreadsheets:
Marketing Team Payroll – $300k
Sales Team Payroll – $250k
Sales Team Commissions – $50k
Marketing Software – $2k
Facebook spend – $20k
Google Spend – $25k
Television Spend – $35k
Consultants – $10k
Total - $692k
When we consider which of these expenses involves connections with your prospects, we immediately identify the items to exclude. The marketing team, as mentioned, needs to be ignored. The same goes for the software and consultants. This leaves us with a total cost of $380k.
Now lets’ have a look over some example customer stats.
Paid – 25
Organic – 10
Recurring – 8
Total – 43
Of these 43 customers in the third month of the new company, we can exclude all recurring customers and we are left with paid and organic acquisitions totaling 35 new customers. However, the distinction between paid and organic customers will be relevant when it comes to calculating paid CAC vs Blended CAC.
Again, skip total orders; CAC doesn’t need these data. So, from these examples:
- Your Paid CAC will be your acquisition costs ($380k) divided by your paid customers (25): $15,200
- For Blended CAC your acquisition costs remain the same, but you’re factoring in organic customers too. This makes the calculation $380k/35 = $10,857
Both of these figures give you a look at how much it costs to acquire new customers, and both will change as the months and years progress. The ratio of organic to paid customers is like to change over time, as will the efficiency of your ad spend as you learn where it’s working and where it isn’t.
So, now that you’ve got the CAC calculation down, it’s important to know why and how to reduce this figure.
How and Why to Reduce this Figure
There’s no set rule for how long you should aim to wait for a return, but in many cases, SaaS businesses are looking to make 5x or even 10x return on ad spend from the lifetime value of their customers. Many will recoup their expenses within the first year, and the CAC figure will be used as a way to improve this rate of return.
Ultimately, the lower the cost of acquiring customers, the greater the return, as long as their lifetime value is maintained. Reducing CAC has an obvious benefit: lower costs mean more profits on each customer. However, the process of lowering your customer acquisition cost is also a beneficial business practice that identifies and teaches businesses how to improve customer retention and the benefits of it.
Therefore, cutting CAC should be done with the right approach, and as part of a healthy business practice designed to improve the cost structure of the company. Cutting costs is not the same as cutting corners, and businesses need to identify the sensible areas to trim the fat and the promising approaches that deserve a greater allocation of resources.
If, for example, reducing CAC results in a lower-quality customer experience, you may see higher rates of churn, which will lower the lifetime value of your customers in the long run. This has a knock-on effect of lowering the lifetime value of your customers and cutting into your bottom line.
For startups, marketing may be gradually factored into CAC calculations over time, however, it will need to be partitioned into marketing at new customers, and disregard any costs associated with marketing aimed at existing customers.
As this happens, one of the most effective ways to reduce this cost is to align sales and marketing drives with the same intention of customer retention. The best-fit customers are going to be the ones with the highest ROI, and focusing your sales and marketing on these individuals will reduce unnecessary marketing and ad spend, ultimately reducing CAC. This has the added benefit of improving organic acquisitions.
Ironically, one of the best ways to reduce CAC is to focus on existing customers. A robust and effective customer success strategy maximizes the value of your product for each customer and dramatically improves the chances they will refer new customers your way. These customers are then onboarded at very low cost, and will significantly drop your blended CAC.
Conclusion
Calculating CAC, therefore, involves metrics that you’ll have to decide on, depending on how much detail is available to you, and how detailed you can make the calculation. The closer you get to the true cost of spending, the more powerful your CAC metric will be, but as a general rule, the calculation will become more accurate with time.
It’s a good idea to factor your CAC into your financial projections and to incorporate them well, we have designed some projection templates specifically for SaaS to will help calculate your CAC. These come with free support, are easily customizable, and provide you with detailed, 5-year projections that are professional and accurate.
Part of a startup’s most important market and financial research involves the knowledge, understanding, and implementation of calculations such as these, and getting your head around CAC will go a long way to persuading investors that you know what you’re talking about and would be a reliable business partner.
