What Does Customer Acquisition Cost (CAC) Mean?
Customer Acquisition Cost (CAC) is the average cost incurred by a business to bring on a single new customer. Customer acquisition cost is the fundamental part of your unit economics. It enables you to understand how effective your sales and marketing efforts are at bringing in new clients.
When put in the appropriate context, customer acquisition cost can help investors understand how long your business model will last. In turn, factor into the worth of your company during any funding rounds.
In almost all cases, businesses with Venture Capital (VC) backing strive for efficient growth. Even though many different metrics are available to monitor growth efficiency, Customer Acquisition Cost (CAC) is at the core of many of them.
A strategic understanding of your growth and capital efficiency begins with knowing how much it costs to acquire a customer. However, Customer Acquisition Cost, CAC is a metric that appears simple, but it is a metric that is often misunderstood by many.
Examples and Formula for Calculating Customer Acquisition Cost (CAC)
You can calculate your Customer Acquisition Cost by following these simple steps:
- Firstly, add up your sales and marketing expenses (cost of sales and cost of marketing)
- Then divide the sum by the total number of new customers acquired during the specific period
The formula for Customer Acquisition Cost (CAC)
The formula for calculating Customer Acquisition Cost (CAC) is simple. But it is also easy to make a mistake in your calculations. The Chief Financial Officer (CFO) of SaaS, Ben Murray, asserts that there are two nuances to the CAC calculation that you must remember. These include:
1. Ensuring that CAC is Completely Burdened
When calculating your Customer Acquisition Cost, do not just include the salaries of your sales and marketing personnel in the CAC calculation. Add up all your relevant costs to get a complete picture of your acquisition costs.
These include salaries, taxes, benefits, travel, Search Engine Optimization (SEO), paid advertisements, and swag. Additionally, if executives are involved in the selling process, do not forget to include a percentage of their salaries.
2. Sales Cycle Alignment With CAC Period
When determining the appropriate period to use for CAC calculations, pay close attention to the length of your sales cycle. Your sales cycle length is the time it takes from when you first contact a prospect to when you close the deal.
For instance, your sales cycle is 40 to 50 days, but your CAC calculation is on a one-month basis. What it means is that you are missing out on sales expenses incurred to close the relevant deals.Examples:
By keeping those nuances in mind, you can set up your formulas to have a deeper understanding of your customer acquisition cost. Take into account this calculation example for a Business-to-Business (B2B) SaaS company with a 30-day sales cycle.
You would add up the total expenses for sales and marketing for one month. Then, divide that amount by the total number of customers who signed up during that time. Here, the sales expenses include payroll and benefits or any travel or sales-related expenses. On the other hand, the marketing expenses include agency partner costs, Pay-Per-Click (PPC) costs, social media advertising expenses, payroll, and benefits.
Another illustration to take into account is a startup that is still in its early stages and is still doing founder selling. In addition, it has not fully developed its sales or marketing departments.
To determine the appropriate payroll and benefits costs to include, you would create an assumption about how much time the founders spend on sales and marketing efforts (perhaps 30 percent). Then use that information to determine what payroll and benefits costs are appropriate to include. Add in any marketing expenses and divide the total to get your Customer Acquisition Cost.
Why Is Customer Acquisition Cost (CAC) Important?
Monitoring your customer acquisition cost helps you to understand how effective your sales team and marketing initiatives have been at attracting new clients. In addition, it helps you know how scaleable your sales team and marketing strategies are for future growth.
If sales are only bringing in money sufficient to retain your current clients, then you will not have any money to spend on attracting new customers. And if marketing is investing more to draw customers than it does to secure new business, then you know you have a big problem.
However, the value of customer acquisition cost depends on the context in which you put it. Because of this, Ben Murray emphasizes the idea of a CAC profile rather than focusing on acquisition costs in isolation.
There might not be a single best approach to examine your CAC profile (your business model will determine this). However, the typical metrics you can include in customer acquisition cost to provide more context for your company are as follows:
- CAC payback period: this is the amount of time it takes to recover acquisition costs for the average customer. According to Ben Murray, you can calculate CAC payback in terms of a logo and terms of dollars.
- CAC ratio: This is one of the SaaS metrics that focuses on the cost to acquire annualized recurring revenue (ARR). The CAC ratio puts this cost on a dollar basis instead of a logo basis. The CAC ratio is also known as the cost of annual recurring revenue on a dollar basis.
- SaaS magic number: This is a sales efficiency metric that reveals how much revenue (dollar worth) you generate for every dollar spent on marketing and sales.
- LTV/CAC: This is the ratio of Lifetime value (LTV) compared to Customer Acquisition Cost(CAC). LTV/CAC ratio compares your return on investment (ROI) of new customers to the cost of acquiring these new customers. It shows your ROI based on the expenses you incurred to bring in a customer and the amount they have paid you throughout the relationship at the time of calculation.
Strategies to Reduce Customer Acquisition Costs
The wide variation in the calculation makes benchmarks for customer acquisition costs of little use. For instance, having a high CAC is not bad if you sell high-ACV enterprise deals and your associated operational KPIs are solid. In other words, benchmarking yourself against aggregate data could mean comparing your CAC to businesses with much smaller Annual Contract Values (ACVs) or higher-volume deals.
Thus, it is better to focus on the aspects of your business that you can control rather than looking for the ideal benchmarks. The following are some of the strategies that can help you reduce the cost of acquiring new customers:
1. Put More Emphasis on Retention
Ben Murray advises SaaS business owners to consider customer acquisition costs as debt. According to the SaaS CFO, if you have poor customer retention, you invest all this money in customer acquisition costs. Also, you are sometimes losing customers before they pay back CAC.
As a result, you are now dependent on acquiring new clients to pay for those previous clients and the CAC for themselves. Increasing and strengthening your CS department could help you improve retention and reduce customer acquisition costs if you have churn issues.
2. Determine How Much you Should Invest in Advertisement
Your budget for paid advertisements is one of the simple levers to pull for marketing expenses. Collaborate closely with your partners to understand past marketing strategies' ROI.
Furthermore, develop models to predict advertising spending better. In addition, look for ways to make the most of your advertising budget.
3. Reduce your Travel Costs
Before the COVID pandemic, travel costs were a significant part of Customer Acquisition Costs. Teams had to develop strategies for selling during lockdowns that did not involve going to conferences or visiting potential customers in person. Since these teams made sales during the pandemic without traveling, you can think of ways to reduce travel expenses for sales now that there is no lockdown.
4. Balance your Marketing Spend Both short- and long-term
Not all marketing activities have the same immediate return on investment (ROI) as a paid advertisement. Nevertheless, do not stop funding those brand-building activities to strengthen the long-term pipeline.
To reduce customer acquisition costs, you need to work with marketing to limit the more experimental channels. Also, focus more on what is already showing positive results.
Note: These strategies for reducing customer acquisition costs depend on one factor. The factor is a thorough understanding of what customer acquisition cost is and whether or not it is okay in the context of your business.
Why is It So Difficult to Track Customer Acquisition Costs (CAC)?
The customer acquisition cost formula appears simple at first glance. Most people see it as just division and addition; pretty simple mathematical skills. But things quickly get much more difficult when you consider compiling all that data.
Your CAC equation often draws data from different systems that are not normalized. For instance, your HR system houses the salaries and commissions paid to your sales and marketing teams. Your ERP system contains your advertising expenditures. Then your Customer Relationship Management (CRM) system houses a list of your customers.
In addition, you will likely need to include some indirect costs such as:
- Costs associated with travel for sales representatives to meet with clients
- The price of the software tools your teams employ to follow leads and interact with clients
- The cost of related hardware and equipment
Your ERP houses these expenses along with the countless other expenses related to running a business. These include marketing costs not expected to drive direct acquisition, such as brand strategy and product positioning. There may also be cases where a non-marketing, non-sales employee or an affiliate is engaged in booking business.
No system gathers, distributes, and calculates this data for you. It has always been a metric driven by people and one that is not measurable or available in real time. It is usually something you can see every three months or once a month if you are fortunate (and typically a few weeks after the end of the period).
An Easy and Efficient Way of Tracking Customer Acquisition Costs (CAC)
There are strategic finance platforms that link all of the vital data sources that support your CAC calculation. With platforms like this, you can easily configure what is included in your customer acquisition cost using clear, simple dialog and intuitive components. It saves time compared to spending a lot of time manipulating data manually in Excel.
Furthermore, you can create forward-looking models using these strategic platforms. It will enable you to determine how your customer acquisition cost will change if you increase your advertising spending or hire more sales representatives. In turn, it will help you to respond to business needs strategically by adjusting your marketing and sales budgets.
To know how wisely you spend your money on marketing and sales, you must know how much it costs to bring in new customers. However, to achieve this, you need to gather and normalize all your dispersed CAC data in HR, CRM, and ERP systems.
One way to achieve this is by using one of the strategic finance platforms. The software can help collate and normalize your scattered CAC data by integrating systems (your HR, CRM, and ERP systems).
Once connected, you can easily track your customer acquisition cost at any time. In turn, it will enable you to make data-driven and informed plans based on what you see to ensure your teams, programs, and budgets are ready for success.