Two of the most important metrics that a SaaS company founder has to look into to determine the health of the business are CAC (customer acquisition cost) and LTV (lifetime value) of the customer. These metrics can help you determine whether you need to pump more resources into the business or hit the brakes. In this article, we will look at CAC and why it is important for a SaaS or subscription business to watch the metric.
The customer acquisition cost (CAC) is one of the key performance indicators (KPIs) of a SaaS company. You need to measure the CAC together with other metrics to know the direction to steer your company. Let’s look more into CAC.
What is CAC?
Simply put, the CAC refers to how much it costs to acquire a customer. You can calculate the CAC based on the marketing costs your business incurs or you may also wish to include the attributed overheads e.g. total costs of sales and marketing that have lead to signups or deals. When you include the overheads when calculating the CAC, you are essentially looking at the cost of sales and marketing (including salaries of your team) of a particular period and dividing the figure by the number of new customer signups got during the period.
Any SaaS business has to understand the relationship between their CAC and LTV to ensure its business models is commercially viable.
Human involvement in your sales and marketing effort can determine the direction that the CAC will take. For example, if your product is easy to understand, you can automate the sales process and thus cut on human expenses. For example, a user can click a PPC advert, read your product copy or check the video, and sign up. In this case, minimal effort is needed from your sales team to close deals.
In another scenario, if you have a complex solution and you need a sales team to identify and meet with prospects to explain the solution in order to close deals, the CAC will be significantly high. For your SaaS company to be profitable, the customer lifetime value (LTV) should be higher than the CAC.
How to Reduce You Customer Acquisition Cost
Your SaaS company can take different approaches to reduce the CAC:
- Product design: If users can easily understand your service, they will self serve and this will reduce your customer acquisition cost.
- Improve your conversions: Find ways to increase your conversions after sign ups e.g. through upgrades and reducing churn. Improved conversion will reduce the customer acquisition costs.
- Managing your marketing spend: Using cost-effective ways such as inbound marketing to reach your target customers can significantly reduce the CAC.
The Importance of CAC
One of the biggest killers of SaaS companies is the customer acquisition cost. For a SaaS company to be profitable, it has to find a way to lower the CAC and monetize the customers during their lifetime relationship.
To calculate the LTV (we’ll talk about this in our next blog post), you need to look at the profits you would expect from a customer over the time that he or she will stay subscribed to your services. When calculating your gross margin, consider any services installations and support costs.
For a healthy start-up, the customer acquisition cost should be lower than the monetization value of the customer. SaaS business executives have to find ways to reduce the CAC and improve conversions to remain in a healthy state and be on course to profitability. Business can adopt different methods to keep the CAC down such as viral effect, inbound marketing, inside sales, strategic partnerships, free trials and others.