In marketing as in our personal lives, no one has an unlimited budget. We always have to balance purchasing all the things we need with the cost it takes to acquire them.
We’d all love to drive Bentley’s and live in mansions overlooking the beach, but not if it means spending the money your family relies on to buy food.
Similarly, every business wants to get as many customers as possible, but not if it means going broke in the process. In order to achieve that balance, a crucial metric for businesses (especially startups) to track is customer acquisition cost (CAC).
It ultimately comes down to this: you can’t achieve sustainable growth if you’re losing money on every customer you bring on board.
And in the crowded and competitive world of SaaS, growth is the holy grail. In order to grow quickly, there are few metrics more important than your CAC.
What exactly is CAC?
While CAC is often conflated with cost per acquisition (CPA), they are two distinct metrics and shouldn’t be confused. CPA is a more broad term that can encompass a range of acquisition events — such as a lead submission, a signup, or even a click.
CAC, on the other hand, refers to the cost to acquire an actual paying customer. Again, let’s hammer this into your mind.
CPA measures the cost of an action, CAC measures the cost of acquiring a customer.
With Customer Acquisition Cost, it doesn’t matter whether your lead came in from a free trial, a blog post, a referral — this metric is catchall that takes into account your entire sales and marketing spend over a given period of time and relates it to how many new customers were brought on board in that same time period.
Here’s the formal definition of CAC:
CAC is equal to the amount spent on sales and marketing divided by the number of customers you brought on board during the time period that you are measuring.
Let’s look at an example to illustrate how CAC works
Let’s say you run a company called Tyrion’s Ties, which sells Game of Thrones inspired menswear accessories.
From June to December 2018, you spent $100,000 on sales (mainly sales team salaries) and marketing (Google ad spend, Facebook ads, content creation, marketing team salaries).
In that same time frame, you made 10,000 sales.
Dividing $100,000 by 10,000 gets you 10. So, for this time period, Tyrion’s Ties has a CAC of $100.
If you want a simple way to calculate CAC for your business, you can play around with this interactive customer acquisition cost spreadsheet template.
On the tabs at the bottom of that sheet, you can switch to see between CAC calculations: a simple CAC formula or the net 60 CAC calculation (to see the effect of customers converting in future months from ad spend in previous months).
LTV to CAC ratio
While knowing your CAC is great — what businesses really want to know is how CAC relates to customer lifetime value (LTV).
LTV represents the amount of money you get from a customer over their entire relationship with your business. If you sell software, that’s the total amount of revenue you can expect from a subscription before a customer churns. To calculate the lifetime value of a customer, use the following formula:
(Average Revenue Per User (ARPU) x Profit Per User)/Churn Rate
This brings us to the vaunted LTV to CAC ratio. The LTV to CAC ratio is a great barometer for the health of a business because it gives you insight into the business’ overall efficiency. If you are keeping your spending down and getting great bang for your buck, you’ll be able to grow quickly — therefore, the goal is to spend as little as possible while still acquiring the highest value customer. The seesaw graphic below graphic represents a healthy business model.
If you have an LTV to CAC of 5:1, it means that for every dollar you spend you get five dollars back in customer lifetime value. For growing SaaS companies, the industry standard for LTV to CAC is 3:1.
“VCs expect that a customer generates at least 3 times what it cost you to acquire him (it’s a minimum).” -Clement Vouillone, Point Nine Capital
A lower ratio (for instance 1:1) signals you’re going to lose money. While a higher ratio (for instance 5:1) can signal you’re under-investing in marketing. You could be more aggressively focusing on growth marketing to capture the market before competitors enter.
How to predict customer acquisition cost
In order to predict your CAC, you cannot just look at your marketing spend for a given month, and check the number of customers you acquired.
Your CAC has to be measured over a specific period of time, and it has to account for the time it takes a lead to become a customer.
For example, you might spend a ton of money on marketing that brings you a lot of qualified leads in March, but those leads might not convert into customers until May. If you were to look at your CAC for only March, the numbers would be way off.
Consider the example below, where the marketing spend significantly increases in the month of March.
Notice how CAC increases in March even though the increased Marketing expense doesn’t convert new customers until April and May.
For that reason, it’s important to know the average amount of time it takes for a lead to become a customer, based on the first marketing touch point. If it’s 60 days from touch to conversion, you can incorporate that gap into your calculations.
In this example above CAC is calculated on a 60 day ago basis, meaning that Customer Acquisition Cost here is calculated by dividing Sales & Marketing Costs from 60 days prior (2 months) by the number of new customers acquired in a current month.
So for May, that’d be dividing $71,375 by 643 — yielding a $111 CPA.
Customer acquisition cost by industry
It’s always good to have a customer acquisition cost benchmark to know where you stand. So, what is a good customer acquisition cost for my industry? Using several industry estimates, here is how it breaks down:
- Travel: $7
- Retail: $10
- Consumer Goods: $22
- eCommerce: $80
- Manufacturing: $83
- Transportation: $98
- Marketing Agency: $141
- Financial: $175
- Technology (Hardware): $182
- Real Estate: $213
- Banking/Insurance: $303
- Telecom: $315
- Technology (Software): $395
As you can see, there’s quite a variance across industries. Therefore, a good customer acquisition cost will be highly dependent on what vertical you do business in.
Your CAC will also vary based on factors such as the length of your sales cycle, the purchase lifespan, and, of course, customer LTV.
Digging further, customer LTV itself is based on factors such as average purchase value, average purchase frequency, and average customer lifespan.
Therefore, it’s important to track and measure all aspects of your business in order to figure out what CAC makes sense for you. It might be a lot of work, but it’s worth it.
Customer acquisition cost in SaaS
Hard data on the average SaaS CAC is hard to come by, but in terms of benchmarking, SaaStr’s Jason Lemkin provides a good rule of thumb:
“A rough rule of thumb is successful SaaS companies are spending about 20%-30% of the fully calculated CLTV on customer acquisition.”Jason Lemkin, Founder, SaaStr
So, if a SaaS customer LTV is $1,000, then their customer acquisition costs should be in the range of $200 to $300 to stay competitive. Or put another way, ⅓ to ⅕ LTV.
This article provides an explanation of the average customer acquisition cost calculations. Most SaaS marketers will go a step further and calculate CAC on a more segmented basis. For instance, consider the viewpoint put forward by Brian Balfour (former VP of growth at HubSpot and guest on Season 1 of Scale or Die).
“For internal operations and decision-making, however, average CAC is almost always useless.”Brian Balfour, CEO & Founder, Reforge
Why’s he say that? It’s true to a point — to discover meaningful information for your business you’re going to want a more complete and segmented picture of Customer Acquisition Cost. Brian suggests a few different methods:
- Segmenting by customer type (by plan type, by consumer vs business plan, by industry type)
- Segmenting by channel (Facebook vs Twitter vs LinkedIn vs SEM vs SEO)
- Segmenting by location (USA vs EMEA; this becomes especially important as you expand to new markets)
- Segmenting by bidding method (CPA vs CPC vs CPL)
Before you calculate CAC, it’s helpful to think about what you want to use the number for. Are you building a pitch deck? Optimizing your spend between channels? Different CAC segmentations are helpful for every scenario.
CAC Takeaways for Your Business
There are a couple main ways that you can lower your customer acquisition costs and boost your LTV to CAC ratio.
1. Improve your on-site conversion metrics
The better you are at engaging the users who come to your site, the less you’ll have to spend attracting new users. Tools such as Proof can be a game changer in improving your conversion rate, as there is nothing quite like social proof to incentivize action. You should also use analytics to target the customers you want and customize the user experience based on their profiles.
2. Always add value throughout the funnel
I know, I know, “add value” is pretty vague. But that’s because there is so much you can do in this regard! You can write high-quality blog posts, produce interesting, videos, personalize your landing page, design a compelling pricing page, and put out a podcast, just to name a few ideas. Then, collect customer feedback and tweak your efforts based on what they are telling you. And, as always, test out different ideas and only keep what works.
3. Personalize your site
It’s 2019. Why do most sites still treat every visitor the same way? With personalization, you’re able to create unique Experiences for visitors that feel especially human and designed with a specific visitor in mind. Customize testimonials for the industry, swap out headlines that call out your visitor’s title, the options are limitless. Once you drive traffic to your site, if you’re providing a more human and personal experience, it’s more likely that a conversion will occur while a visitor is on-site. That decreases CAC and can improve LTV. Win, win!
4. Segment your audience
If you think about what information you collect about your customers, I guarantee there’s a lot of info you have. If you’re not segmenting into cohorts or running experiments on high-traffic parts of your funnel, you’re wasting valuable leads and not converting like you should be.
5. Increase average revenue per user
If you increase the average revenue per user or customer, you’ll see a higher overall LTV. Higher LTV = more you can spend on customer acquisition cost. While increasing average revenue isn’t the easiest thing to do — there are several methods for iterating on your current pricing. Why not try out different pricing for each plan? Or offer up-sells and cross-sells throughout your funnel?
In SaaS, growth is everything
And while business metrics like churn, average revenue per user, and the number of marketing qualified leads are certainly important, nothing really matters if your CAC is too high. So, measure it, understand it, and optimize it. Your business will thank you.