What is CAC?

Customer Acquisition Cost (CAC) is a measure of costs associated with acquiring new customers for a business. In the simplest of ways, CAC takes into account all sales and marketing costs for a particular period of time.

It is calculated by adding up all costs related to acquiring new customers and dividing them by the number of newly acquired customers during a given period. Some businesses include various other costs, variable costs, and fixed costs in CAC calculation and that is why CAC calculations may vary.

For example, Lincoln Murphy, a SaaS expert, stresses “fully loaded CAC” which means businesses should include every cost they bear to acquire new customers.

These costs can be advertising costs, marketing costs, sales costs, or any other costs that are associated with customer acquisition in any way whatsoever. 

Table of content

  1. CAC SaaS
  2. The importance of CAC SaaS
  3. CAC SaaS – How to calculate CAC for a SaaS business 
  4. The simplest method of calculating CAC 
  5. Why do CAC calculations exclude customer success strategies? 
  6. Life Time Value of a Customer (LTV)
  7. The SaaS Life Time Value of a Customer (LTV) and Customer Acquisition Cost (CAC) ratio
  8. Other key aspects to consider when looking at LTV to CAC ratio
  9. How can SaaS businesses reduce CAC? 
  10. Important SaaS metrics and KPIs to track
  11. Ways to reduce your CAC

CAC SaaS

Customer Acquisition Cost is one of the key tools for businesses to assess and judge the performance of their organic and paid plans to acquire new customers and SaaS isn’t an exception. SaaS businesses burn too much money on acquiring new customers and that is why it is absolutely imperative to analyze “is a new customer worth it or not?” 

Some people argue that customers don’t care about your costs, so don’t base your product or service’s price on your costs. It is true but that doesn’t necessarily mean that businesses should ignore their costs. Businesses need to and should consider costs, especially CAC because CAC understanding serves both sides – targeting the right customers and solve pricing issues. When SaaS businesses do that, they actually open the doors of maximized revenue.

What is the reason behind this? The reasons are quite simple but logical – businesses can’t afford to direct efforts on those customers who bring lots of revenue but at the same time, costs a lot. Similarly, businesses cannot afford to waste their efforts on customers who are easy to acquire but contribute nothing to the revenue. 

The importance of the SaaS CAC

Unfortunately, most of the SaaS businesses understand CAC but not thoroughly enough to substantially enhance their profitability. Moreover, most SaaS businesses underestimate the importance of CAC and its impact on profitability. Although CAC is crucial for all businesses across all industries, it is more crucial and imperative for SaaS businesses.

Why so? Because SaaS businesses depend on one thing – the lifetime value of customers. It is obvious that you, as a SaaS business owner, wouldn’t care much about a customer with high lifetime value but also costs so high. Therefore, CAC SaaS is important and it is important because of the following reasons. 

  • CAC helps SaaS companies to analyze how much and how many months’ revenue from a customer can cover costs incurred on acquiring that customer. CAC measure becomes more and more important as a SaaS business grows because it often takes much longer than you expect to recover acquisition costs and begin to make a profit from a customer. 
  • CAC also helps on pricing’s end as it allows SaaS businesses to adjust pricing equations in the best possible way. It paints a clear picture of revenues, margins, and profits. 
  • CAC also helps SaaS businesses analyze whether they are directing their efforts on acquiring customers that are easy to acquire, maintain, and significantly contribute to revenue, or they are directing their efforts on customers who are difficult to acquire, maintain, and contribute less to the revenue. 
  • CAC leads you to find the best and the most effective channels and tactics to acquire new but valuable customers. 

So, CAC SaaS is a remarkable measure that makes the management of revenue and expenses easier for you. If SaaS businesses track CAC in an effective manner, they can achieve success by being effective in pricing, customer acquisition, and customer retention. Thus, all those factors lead you to an improved business that can be scaled more effectively. 

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SaaS CAC – How to calculate CAC for a SaaS business

CAC is a simple performance metric but it does wonders. It helps you keep an eye on the performance of your SaaS business. CAC assists you in measuring performance on both fronts – measuring the efficiency and performance of your sales and marketing strategies and determining how profitable your existing clients are. But, how you can calculate CAC and use this extremely useful metric. Let’s take a deep dive into how to calculate CAC for a SaaS business. 

The simplest method of calculating CAC

The simplest and the easiest method to calculate CAC is to add all sales and marketing costs during a given time period and divide it by the total number of acquired customers in that period. So, the CAC formula is;

CAC = Total Sales Costs + Total Marketing Costs ÷ Total Number of Newly Acquired Customers

For example, if you spend $10,000 and $5000 on sales and marketing respectively during a particular period and acquire 15 new customers during that period, the period’s Customer Acquisition Cost will be;

CAC = ($10,000 + $5,000) / 15 = $1,000

In order to calculate the time required to recover CAC, you can use the following formula;

CAC Payback Period = CAC ÷ (Monthly Recurring Revenue Per Customer – Average Cost of Service)

For example, if your CAC is $1,000, monthly recurring revenue per customer is $400, and the average cost of service is $200, then;

CAC Payback Period = $1,000 / ($400 – $200) = 5 months

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5. Why do CAC calculations exclude customer success strategies? 

Customer success strategies and customer success teams bring a lot of revenue to the table. They fully capitalize on techniques such as customer renewal, cross-selling, up-selling, and so on.

Those techniques generate significant revenue far more than often. Still, they are excluded from CAC calculation. The logic is – CAC metric is a measure that totally focuses on generating new revenue from new customers by expanding on sales and marketing campaigns.

So, including customer success in CAC measures distorts the purpose of CAC. Therefore, most CAC calculations do not include customer success.

Life Time Value of a Customer (LTV)

The lifetime value of a customer (LTV) is another important measure that helps to get a better view of the efficiency of your sales and marketing. The formula to calculate LTV is;

LTV = (Average Revenue Per Customer × Gross Margin %) ÷ Average Churn Rate Per Month

For example, if your average revenue per customer is $400, gross margin percentage is 30, and average churn rate is 5% then

LTV = $400 × 30% / 5% = $2400

The SaaS Life Time Value of a Customer (LTV) and Customer Acquisition Cost (CAC) ratio

The LTV to CAC ratio is the next step in CAC calculations as you cannot rely on CAC only because CAC in isolation cannot provide you a clear picture. You cannot judge whether CAC is good or bad unless you take into account the revenue generated from newly acquired customers. 

CAC’s real value lies in its comparison with LTV. The LTV to CAC ratio helps you evaluate and analyze the efficiency and effectiveness of your sales and marketing expenditure. In fact, this ratio tries to estimate how much revenue new customers are expected to bring over the lifetime or over the period of their relationship with your SaaS business. The formula for LTV to CAC ratio is;

LTV: CAC

For example, if the expected lifetime value of a new customer is $5,000 and the total cost to acquire that customer is $1,000, the LTV to CAC ratio will be 5: 1. 

$5,000: $1,000 = 5: 1

According to the traditional view on LTV to CAC ratio, a ratio of 3 to 1 is a good one because you can generate more revenue while spending just a third of that revenue. It also makes sense that your LTV should be greater than CAC. However, too high a ratio indicates that you are sacrificing the growth of your SaaS business for increased profit margins. SaaS business experts believe and assert that SaaS businesses should focus on growth rather than focusing on increasing profit margins. Therefore, it is logical to aggressively spend on sales and marketing and achieve a lower LTV to CAC ratio instead of cautious spending and achieving a higher LTV to CAC ratio. 

Other key aspects to consider when looking at LTV to CAC ratio

There are other key aspects that the traditional view on LTV to CAC ratio fails to address. For example, if your SaaS business is in an advanced and established stage, the increased profit margin is more desirable than growing at a turtle’s pace. It is quite obvious that a higher profit margin is an area of focus for established businesses as they are at a phase in the business life cycle where profit matters the most. So, a higher LTV to CAC ratio is desirable. 

Secondly, SaaS businesses evolve over time by offering new program features, new programs, which also increase their goodwill. Their evolution automatically raises LTV and their CAC declines. So, LTV to CAC ratio also automatically rises over time. Thirdly, successful SaaS businesses capitalize on the productivity of organic marketing sources such as SEO, webinars, e-mail marketing, and so on. Those organic channels prove more impactful over time as compared to paid marketing channels. Thus, the CAC declines as total sales and marketing expenditure declines and the LTV to CAC ratio increases. So, what should be the LTV to CAC ratio? 

SaaS businesses should aim for LTV to CAC ratio of 3: 1. However, if your business is established and you are more focused on gross margins and don’t want to focus on growth, a 6:1 can be an ideal ratio. 

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How can SaaS businesses reduce CAC? 

CAC is a measure of your acquisition team’s performance and the profitability it brings. If your LTA to CAC ratio is 3:1 or higher, you are performing well as you are meeting or exceeding the industry’s CAC benchmark. Even though the benchmark isn’t an absolute measure and it depends on your business’s life cycle whether you should seek LTV to CAC ratio of 3:1 or higher. 

However, if your costs to get customers on board are higher than the Customer Life Time Value (LTV), then you need to step back and think about reducing CAC as your SaaS business isn’t viable at all. But, how can you reduce the CAC of your SaaS business and optimize profitability? There are few fruitful ways of reducing CAC costs. You can reduce CAC costs by;

1. Optimizing your sales and marketing channel

Measure each step of your sales and marketing channel in order to optimize the overall performance. Analyze how many visits become leads, how many leads become potential opportunities, and how many opportunities turn into your customers. You can apply the Balfour Method of the growth process to ensure your sales and marketing channel has proper mechanics in place. 

2. Optimizing your business’s pricing policy

CAC helps in analyzing your business’s pricing policy as well. You can optimize pricing policy by implementing a value-based pricing policy. With an optimized pricing policy, your business will start making profits in no time.

3. Optimizing effectiveness of sales and marketing funnels

You can optimize the effectiveness of your sales and marketing funnels but invest in tested and proven channels that ensure maximum leads against your expenses. 

4. Optimizing your ability to turn leads into your customers and engagement of new customers 

You can optimize your ability regarding turning leads into your customers and also engaging new customers. The quicker you call your new customers to take action, the higher your revenue will be against lower CAC. 

5. Optimizing use of customer data

Data is the most powerful tool in the world right now. You can optimize the use of customer data you have and improve your marketing efforts. You can study and analyze factors like demographics, interests, preferences, what makes customers take action, and so on. Once you start optimizing the use of customer data, your marketing efforts become more fruitful as you begin to target the right audience at the right time.

6. Optimizing everything in your SaaS business

When you don’t optimize the performance of each aspect, each personnel, and each department, you cannot prevent friction points that always drag you back. For example, if you don’t have a quick-loading website, you cannot expect to grow your business. Similarly, if you don’t provide the ultimate 24/7 customer support services, you cannot expect your business to grow. Therefore, it is imperative to optimize each aspect, each personnel, and each department to reduce CAC. 

7. Optimizing the use of organic marketing sources

Several reports have appeared suggesting the productivity and effectiveness of organic marketing sources as compared to paid marketing and advertising. You can optimize the use of organic marketing sources such as SEO, webinars, e-mail marketing, and so on while limiting the use of paid marketing and advertising to reduce CAC. It will help in two ways – your business will attract more customers and CAC will be low as you spend less on paid marketing. 

8. Optimizing efforts to retain existing customers

When you direct your efforts to what you already have in your customer base, your revenue continues to grow while CAC remains low. Therefore, you can optimize your efforts to retain existing customers to reduce CAC.

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Important SaaS metrics and KPIs to track

Why is it so important to track SaaS metrics and key performance indicators (KPIs)? Because tracking those metrics and KPIs help you optimize the use of resources at your disposal, accelerate your efforts on areas where you seriously lack, and invest more in areas of your business that need to grow. In the simplest of words, when you have a clear picture of where you stand, you get a better picture of your destination. The following are some key metrics related to customer acquisition costs you must track.

1. Unique, active, and organic/paid users

Unique visits

Unique visits mean how many unique visitors your website gets. You can track this metric on monthly basis with the help of Google analytics. This metric demonstrates how efficiently you are bringing traffic to your website. Each business needs unique visits and SaaS businesses aren’t an exception. They can substantially grow their business with monthly unique visits.

Active users

Active users are those who frequently visit your website and interact with you during a specific time period. The active users metric is an important one to track because it demonstrates how effective your engagement process is. It is also a measure of potential sales. If active users frequently visit your website, read content, and buy a product or service, that means they are satisfied with your product or services. 

Organic traffic

Organic traffic is the visitors who find your website through unpaid sources such as through search engines like Google, Yahoo, or Bing. Conversely, paid users are the ones who visit your website through paid sources such as sponsored content, ads, PPC, etc. Organic and paid traffic metrics help you analyze how your traffic acquisition strategies are paying off. You can fully focus on only those strategies that prove effective. 

2. Monthly recurring revenue (MRR)

Monthly recurring revenue (MRR) is the revenue a SaaS company is certain of making each month. MMR is calculated by multiplying the total number of paying customers by the average revenue earned per customer. You can also break this metric into three sub-metrics for better analysis. 

MRR by new customers – demonstrates monthly recurring revenue brought by new customers. For example, if you acquired 2 new customers who bring revenue of $500, then your MRR by new customers will be $1,000.

MRR by expansion – demonstrates the revenue growth when a customer moves to a higher paid plan. For example, if a customer is currently using a $300 per month basic plan, and then upgrades to a $500 per month premium plan, then your MRR by the expansion will be $200.

MRR churn – demonstrates the revenue lost when a customer decides to cancel your subscription or downgrades to a low price plan. For example, if a customer is currently using a $500 per month premium plan, and then downgrades to a $300 per month premium plan, then your MRR by the expansion will be $200.

MRR is an important metric because it gives you a better picture of your predictable revenue or income. The continuous growth of MRR gives you better chances of continuous growth. 

3. Customer churn

Customer churn indicates how many customers you have last during a particular period of time. It is an important metric because high customer churn is detrimental to your SaaS business even if you have a low CAC. Moreover, you should track customers’ personas who don’t renew subscriptions or any other factors that indicate why they left your company. 

4. Annual Run Rate

Annual Run Rate (ARR) is a metric similar to monthly recurring revenue. The difference is the time period – it takes into account the expected revenue every year. ARR is calculated by multiplying MRR with 12. It is an important metric for SaaS businesses because it indicates the annual expected revenue of the year and can be used as an indicator of long-term growth. 

5. Average Sale Price

Average Sale Price (ASP) indicates the average price customers pay to subscribe. You can calculate ASP by dividing your total subscription revenue by the total number of subscribers. It is important to track the ASP metric because it helps you determine the best sales model for your SaaS business. 

6. Net Promoter Score

The Net Promoter Score (NPS) is another key metric that SaaS businesses should track. It indicates the satisfaction level of your customers. Besides, NPS also indicates the likelihood of your customers recommending your product or services to their acquaintances. You can measure this metric by asking the following types of questions from your customers. 

  1. How much satisfied with our product or service?
  2. What should we improve in your opinion? 
  3. Will you recommend our product or services to someone else? 

7. Average Revenue per Account

Average Revenue per Account is a metric that defines average revenue contributed by each account or customer on monthly basis. You can calculate it by dividing your total recurring revenue per month by the total number of active accounts per month. You can make this metric more fruitful by calculating it for both, existing and new customers. You should calculate it separately for both sets of customers if you are planning to change your subscription prices or if you want to analyze how existing and new customers are contributing to your total revenue. Average Revenue per Account is an important KPI that demonstrates how your customer accounts are performing and contributing revenue on month by month basis. 

8. Conversion rate

Conversion rate indicates the number of visitors who start with a free trial and at the end of the free trial, convert to paying customers. It is an easy-to-measure KPI that gives SaaS businesses how many free trials turned into paying customers. The conversion rate should increase regularly. For example, if your current conversion rate is 5%, you should aim at making it 7% and so on. It is a simple but very important metric that indicates how many customers find your product or services valuable during a free trial and whether your product or services are fully optimized. Moreover, it also helps to figure out what makes your customers convert into paying customers. Conversion rate helps SaaS businesses to improve the functionality of their product and optimize the funnel to increase conversion rate.

9. Customer Retention Rate 

Customer Retention Rate (CTR) indicates in percentage how many customers your SaaS business has during a particular period of time. For example, if you currently have 100 customers now, you lost 10 customers and acquired 5 new customers during a month, then your CTR will be;

(Number of current customers – Number of new customers) ÷ Number of customers at the start of the period × 100

(100 – 5) ÷ 95 × 100 = 95%

That means you retained 95% of your customers. It is an important metric that highlights how efficient your customer retention efforts are and how loyal your current customer base is.

10. Average Sales Cycle Length

Average Sales Cycle Length is a measure of time you take to convert a lead into your customer between the first contact by the lead and the closing of the sale. It is another very important metric for SaaS businesses that demonstrates the efficiency of their team. Average Sales Cycle Length highlights the time taken by your team to convert a lead into your customer. Shorter the Average Sales Cycle Length, the better.

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Ways to reduce your customer acquisition cost (CAC)

Reducing CAC is crucial for the economic growth of the SaaS business. When developing a customer acquisition strategy, it is important to plan customer acquisition at the lowest possible cost. Why so? Because you need not only to continuously expand your customer base but also need to do it in a budget-friendly way. Therefore, it is imperative to know about different strategies to reduce customer acquisition costs. The following are some fruitful strategies you can follow to least break the bank on customer acquisition. 

1. Begin with a target CAC 

Your CAC for a SaaS business is the total sales and marketing costs plus other costs related to customer acquisition divided by a total number of newly acquired customers. For a positive return on investment, you should begin with a target CAC and use it as a benchmark against your actual CAC. If you are just starting your SaaS business, then you can look for average CACs in the SaaS industry and use it as a benchmark. A target CAC will help you stay on track as well as analyze your sales and marketing efforts.

2. Define your targets

It is very simple – if you don’t know who you should target, you are totally wasting your valuable time and money. Knowing who your SaaS business caters to and what are their needs, demands, and preferences is the second step to take after having calculated a target CAC in your endeavor to reduce your CAC SaaS. You need to filter out all those people your business doesn’t appeal to. If you have existing customers, you can start by researching them. You can check their backgrounds, demographics, job titles, interests, and so on. Moreover, you also need to consider whether you are publishing the right content, helping customers to solve their problems, or using the right social media platforms. All these details define how to shape your SaaS business according to their expectations. When you know the expectations of your targets, you can substantially lower your CAC SaaS. 

3. Retarget

Retargeting is another effective technique to bring visitors back to your website. When you retarget those visitors who visit your website but don’t turn into your customers, your ads encourage them to visit your website again and make a purchase. You can also divide such visitors into segments according to the type of product or services they viewed. Moreover, you also facilitate users by introducing a call to action on your ads.

4. Effective ad campaign

An effective ad campaign is a key to success when planning to reduce the CAC SaaS. There are multiple best practices to make your ad campaigns strong and effective. For example, using targeted keywords, SEO, landing pages, ad copies, and so on. Such practices optimize the user experience and significantly increase conversion rates. 

5. Analyze your ad copies

You can also optimize your marketing efforts by regularly testing and analyzing your ad copies. For example, you can analyze click-through rates to identify the most effective ad copy. You can also see why this ad copy is better performing than the others. Constant improvements and optimizing your paid ad copies are one of the most effective ways to reduce your CAC SaaS. 

6. Improve conversion and retention rates

Improving conversion and retention rates is also integral to reducing CAC SaaS. You can improve conversion rates by optimizing your ad campaigns, organic marketing, and so on. On the other hand, your retention rates indicate how good you are at retaining your existing customers. You can improve retention rates by ensuring quality services, customer support services, and so on. Moreover, you should also analyze customer churn – what are the reasons behind customer churns, what can you improve to avoid customer churn, and so on.

7. Optimize funnel

The optimized funnel also leads to better conversion rates and a reduction in CAC SaaS. When you understand the behavior of your visitors when they visit your website and where visitors exactly drop off, then you can better optimize and improve your website copy, content, and most importantly landing pages.

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The wrap-up

The customer acquisition costs significantly affect your SaaS business. You cannot underestimate the importance of CAC SaaS because;

  • CAC helps you analyze how much and how many months’ revenue from a customer can cover costs incurred on acquiring that customer.
  • CAC also helps you on the pricing’s end as it allows SaaS businesses to adjust pricing equations in the best possible way. 
  • CAC also helps you analyze whether you are directing your efforts on acquiring quality customers or you are directing your efforts on customers who are difficult to acquire, maintain, and contribute less to the revenue. 
  • CAC leads you to find the best and the most effective channels and tactics to acquire new but valuable customers. 

You can track all important SaaS CAC metrics to analyze and judge the effectiveness of your customer acquisition strategies. You can follow the tips mentioned in this article to reduce your CAC SaaS. You need to make sure that your LTV to CAC ratio is at least above the industry benchmark. And finally, we wish you good luck with your SaaS CAC and the growth of your business.