Why Calculating CAC is Important for SaaS?Most SaaS businesses today are using recurring revenue as their business model, especially the subscription-model. In this model, there are several factors to consider in relations to CAC:
- Usually, in a subscription-based model, we are selling our product far below the usual value (i.e. selling a $1,000 software for $70/month). In most cases, this monthly value is even lower than your actual COGS. Meaning, you need to maintain cash-flow, hence lowering CAC is extremely important.
- The actual purchase is not the end of your marketing efforts, and you will need to aim for a long-term relationship with each customer. Hence, we will need to consider customer lifetime value (LTV) and its relations to CAC.
- CAC is usually one of, if not the most significant cost in a recurring-revenue model, especially for online businesses that are not selling physical products, including SaaS businesses. On the other hand, lowering your CAC too aggressively might cause a significant decrease in growth, creating the dilemma.
The LTV/CAC RatioEspecially in the SaaS environment, we can’t properly discuss CAC while neglecting LTV. Why? Because to really optimize our CAC, we will need to understand the “true” value each customer will bring, which will be calculated through LTV. What is LTV? In its simplest term, Lifetime Value (LTV) is the amount of revenue generated by a single customer over the course of their relationship with your business. For example, if a customer subscribed for your software for 6 months before finally cancelling the subscription, and a 6-month subscription is worth $100, then this customer’s LTV is $100. For further understanding on calculating LTV for SaaS, you might want to check out this guide by ChartMogul (PDF). Now, we have mentioned that in a SaaS business, we can’t discuss CAC properly without also discussing LTV. Why? Because the relation between CAC and LTV will determine the level of success of the SaaS business: if your CAC is sufficiently lower than your LTV, you are making profit. If you can’t recover CAC quickly enough according to your LTV— or worse, if your CAC is higher than your LTV— your business is failing. So, what should we aim for when optimizing CAC and LTV? There are two things to focus on:
- Your LTV should be at least 3 times higher than your CAC (A LTV to CAC ratio of 3). The higher, the better. Some of the best SaaS businesses have up to 8 LTV/CAC ratio.
- You need to recover your CAC within a year. If you can recover your CAC in below 6 months, even better.
Calculating Your SaaS CACBefore we can learn to lower our CAC, we must first understand our current state, which is calculating our current CAC. Depending on the complexity of your business/ product, this step can be really easy or really complicated. First, however, we should reiterate the importance of understanding your CAC based on what we have discussed above:
1. Understanding your CAC helps to optimize your LTV/CAC ratio to at least 3As we have discussed, increasing LTV to CAC ratio is essential for any SaaS business, and it can only be done by mainly two things:
- Lowering your sales and marketing budget (lowering CAC)
- Optimizing the output of your sales and marketing campaigns to increase LTV
2. CAC is an investment, so treat it like oneSince CAC is in essence, the cost of acquiring a customer, this simply means everytime you acquire a customer, you have lost money. CAC is an investment, and so the first thing to keep in mind is how to get this money back as soon as possible. The sooner you can recover your CAC, the healthier your SaaS business is. So, properly calculating your current CAC will help in achieving this goal.
3. Maximizing your SaaS business profitIn the end, the purpose of your SaaS business is to create a profit margin, not solely to generate more revenue. Obviously there are only two ways to achieve this: lowering your cost or increasing your price. The lower you can make your CAC, the better your chance at achieving a higher profit margin.
The Main Factors of Calculating SaaS CACWhen calculating CAC, there are three main factors to consider:
- CAC is about calculating the cost of acquiring a new customer, and not about the cost of retaining an existing customer. Seems fairly simple, but it is surprisingly a common mistake made by many SaaS business. While customer retention is undoubtedly an important aspect of SaaS businesses’ profitability and growth, keep in mind that when calculating CAC, it’s not our main focus. Instead, CAC will focus on the acquisition aspect.
- Sales and marketing expenses are the key elements of any CAC, which can further be divided into three: tools and infrastructure expenses, human resources costs, and other spendings. The more detailed you can calculate all of these costs, the better you can calculate CAC. Remember that your goal here is to optimize your CAC, and avoid hiding flaws and bad expenses. You are not approaching stakeholders and investors here, but you are calculating CAC for your business’s sake. Be honest and transparent.
- Since it is quite common for SaaS businesses to adopt the freemium model. Keep in mind that you should only calculate the cost to acquire paying customers. You can still measure the cost to acquire a free registrant, which can be a good sales and marketing indicator. However, it should not be included in a CAC calculation.
Calculating CAC: The Simple FormulaThe formula to calculate CAC is fairly simple, which is:
CAC=The total sales and marketing costs / Total number of acquired (paying) customersSo, the hard part is figuring out the total costs of sales and marketing expenses that contribute to acquiring a customer. As mentioned above, there are generally three key components here: human resources costs (the salaries of your sales and marketing employees), tools and infrastructure costs, and other expenses (advertising costs, cost to start a specific marketing campaign, and so on). The more detailed you can break down these costs, the more accurate your CAC calculation will be. For example, if the total cost for sales and marketing is $50,000, and if within the same period you spent this money you acquire 1,000 paying customers, your CAC is $50. Meaning, if you aim to have an LTV/CAC ratio of 3, your LTV should be $150 or higher.