What\u2019s the first thing you start to think about?<\/p>\n\n\n\n
Your technical infrastructure?<\/p>\n\n\n\n
The design of your product? <\/p>\n\n\n\n
Marketing? <\/p>\n\n\n\n
Sales<\/a>? <\/p>\n\n\n\n How about your business model<\/strong>?<\/p>\n\n\n\n Oh yeah, that thing.<\/p>\n\n\n\n A business model is all about finding a way to attract customers who pay you more money than it costs you to find and convert them.<\/p>\n\n\n\n After your product\/market fit, your business model is the most important consideration if you\u2019re to save your business from the startup graveyard.<\/p>\n\n\n\n This sounds complicated \u2014 how do you figure out and track whether each customer is profitable when you\u2019re dealing with hundreds (even thousands) of leads and prospects on a daily basis?<\/p>\n\n\n\n This is where the value of subscription metrics comes to the fore \u2014 and specifically the customer acquisition cost (CAC) and the customer lifetime value (LTV)<\/a>.<\/p>\n\n\n\n CAC stands for customer acquisition cost<\/em>. It is a measure of the total cost your business incurs to turn someone who\u2019s never heard of your company into a paying customer.<\/p>\n\n\n\n To calculate CAC take all the marketing spend in a given period and divide it by the number of customers attracted in that same period:<\/p>\n\n\n\n CAC = Total sales & marketing spend (salaries, tools, ad budgets\/etc.) \/ Number of customers won<\/p>\n<\/blockquote>\n\n\n\n CAC can be calculated as a number that reflects the average<\/em> customer your business attracts. Or it can be segmented by marketing channel, geography\/market, cohort, or any other way that makes sense to your business.<\/p>\n\n\n\n On the ground level, the formula for CAC looks simple, but dig a little deeper into the details and the discussion gets heated.<\/p>\n\n\n\n Every team has their own slightly different way of calculating the cost of customer acquisition. The discussion usually rotates around questions like:<\/p>\n\n\n\n These questions are all important and worth spending some time on. Generally, if any part of your team is working on an activity that\u2019s touching on acquiring customers all their expenses should be included in the calculation \u2014 salaries, rent, and so on.<\/p>\n\n\n\n My advice is that once you have picked a way to calculate CAC, you should try to stick with it \u2014 the metric is more useful when the formula stays the same, so you can compare it over time.<\/p>\n\n\n\n I also want to suggest a slightly nuanced way to calculate and think about CAC. For that, I\u2019d like to use Lincoln Murphy\u2019s distinction<\/a> between Simple and Fully-Loaded CAC.<\/p>\n\n\n\n Note:<\/strong> We don\u2019t calculate CAC in ChartMogul because of the subjectivity of how different businesses calculate it and use it. However, our users use attributes to enrich their data<\/a> and use segmentation to understand their metrics (including CAC) better.<\/p>\n Some customers use the LTV charts in ChartMogul to compare with numbers that they are generating from marketing spend and sales time. Here are a couple of pieces on how to use LTV and CAC in an actionable way:<\/p>\n Let\u2019s say you\u2019re trying to compare two ads and decide which one to allocate more budget to. <\/p>\n\n\n\n (We\u2019ll ignore the different customers\/LTV each might produce for now.)<\/p>\n\n\n Assuming you\u2019d spent approximately the same amount of time coming up with each ad, is it really worth adding in all the costs related to employee time and tools to get the perfect CAC number?<\/p>\n\n\n\n Yeah, I don\u2019t think so either.<\/p>\n\n\n\n Simple CAC is the perfect tool when you need to make a quick tactical decision.<\/p>\n\n\n\n Fully-Loaded CAC that includes a robust calculation of all inputs that go into acquiring a customer is a much better option for strategic decisions perhaps when deciding on how to optimize and prioritize marketing channels.<\/p>\n\n\n\n As often as it helps you make a decision about your business.<\/p>\n\n\n\n In many cases, this would mean daily \u2014 simple and fully-loaded CACs are useful here because they can help you understand various aspects of your business and make better decisions.<\/p>\n\n\n\n Intercom\u2019s model presents a useful way to think about this:<\/p>\n\n\n\n We all use simple CAC calculations to make daily decisions about how to spend our time and marketing budget. <\/p>\n\n\n\n Once a quarter, or even maybe once every 6-12 months, you can use the extended fully-loaded CAC model to measure the success of your overall marketing strategy and make changes if necessary. <\/p>\n\n\n\n The cost of customer acquisition is one of the most important metrics \u2014 SaaS businesses must keep a close eye on it at all times because of their unique circumstances.<\/p>\n\n\n\n Generally, SaaS companies have a low cost of goods sold (or COGS), typically 20-30% on average.<\/p>\n\n\n\n That allows these companies to subscribe customers on a very low entry fee where they look to earn a profit over time as a customer is using the software and paying subscription fees over many months (also known as the lifetime value or LTV of a customer).<\/p>\n\n\n\n Typically developing the software is much more expensive than the initial (subscription) fee a customer would pay. This is recouped over time as you attract more paying customers and as they remain subscribers for longer.<\/p>\n\n\n\n The customer acquisition cost works much the same way because of the focus on retaining a customer as long as possible \u2014 that means you can spend more on acquiring a customer than they\u2019re going to pay you initially.<\/p>\n\n\n\n You\u2019ll often see a popular ratio mentioned when it comes to the relationship between CAC and LTV:<\/p>\n\n\n\n LTV = 3xCAC<\/p>\n<\/blockquote>\n\n\n\n If your average LTV is $600, that means you can spend $200 per paying customer.<\/p>\n\n\n\n The low COGS ratio in SaaS companies can be misleading. These companies have low direct costs, but they spend a lot on developing and bringing that product to their customers.<\/p>\n\n\n\n Generally, most SaaS companies have 3 large expenses on their profit and loss statements:<\/p>\n\n\n\n If you look at the majority of software companies today, you\u2019ll notice that their expenses are roughly equally divided between the 3 areas outlined above.<\/p>\n\n\n\n It is so common, that you\u2019ll see companies called out<\/a> if they dare \u2018break\u2019 the parity.<\/p>\n\n\n\n If these 3 are roughly equal, that means a customer needs to pay roughly 3 times CAC to repay the investment made across the organization in bringing the specific product to them.<\/p>\n\n\n\n During Year 1: you repay your S&M expenses (CAC). This is where the 3xCAC = LTV formula comes from.<\/p>\n\n\n\n As mentioned, not all companies have the same cost structure, therefore not all of them need to follow the 3:1 ratio. Check out this post<\/a> for a detailed discussion on how this changes and why it might still work.<\/p><\/div>\n\n\n\n Peter Thiel is famously quoted for saying that startups fail because of bad distribution more than they do because of a bad product.<\/p>\n\n\n\n Most businesses actually get zero distribution channels to work. Poor distribution \u2014 not product \u2014 is the number one cause of failure. <\/p>\nPeter Thiel<\/a><\/cite><\/blockquote>\n\n\n\n Let\u2019s dig a little deeper into that.<\/p>\n\n\n\n There are many ways in which you can bring a SaaS product in front of customers:<\/p>\n\n\n\nWhat is the Customer Acquisition Cost?<\/strong><\/h2>\n\n\n\n
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How to calculate CAC<\/strong><\/h2>\n\n\n\n
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Simple vs. Fully-Loaded CAC<\/strong><\/h3>\n\n\n\n
![\"An](\"https:\/\/chartmogul.com\/blog\/wp-content\/uploads\/2021\/06\/lh--t__QI-6jOP0b6uiotYcZlTROYpo1Ag9ruPz6EppIcLDKTOyE42WL3mIJqGWVkxgq4wR7bML_lXNtj6f5_9A8crCRimIrGjnUQN21epOaFfDLfi8jtascA32NvL9ByUx4PywW5Zar1uF.png\")
How often should I be looking at CAC?<\/h3>\n\n\n\n
![\"Simple](\"https:\/\/chartmogul.com\/blog\/wp-content\/uploads\/2019\/10\/Screenshot-2019-10-03-at-16.14.06-1024x376.png\")
Why CAC is so important for SaaS businesses<\/strong><\/h2>\n\n\n\n
![\"The](\"https:\/\/chartmogul.com\/blog\/wp-content\/uploads\/2021\/06\/lh--t__zaB1hJF2OQydKntTOQAy8bDPH2ENgnYt7HB-I-2fQ2L-tdktTlX8iLPKeZGiuByS5Q-oOfi-Nuidi5BXqceAGShD59JKM8V-PfwvPZ6lD7821VTchJhyGr5irCFSCvkOb-lBvbRV.png\")
Source: <\/em>OpenView Expansion SaaS Benchmarks Report <\/em><\/a><\/figcaption><\/figure>\n\n\n\n\n
Where does the 3:1 ratio come from?<\/strong><\/h3>\n\n\n\n
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During Year 2: you repay your R&D expenses.
During Year 3: you repay your G&Q expenses.
During Year 4: you start turning a profit. <\/p>\nThibaud Clement, Loomly<\/a><\/cite><\/blockquote>\n\n\n\nCAC is a proxy for the distribution<\/strong><\/h2>\n\n\n\n
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