Becoming a profitable business is not as simple as signing up a customer and immediately being in the black. As lovely as that sounds, that's not the reality SaaS businesses are dealing with. Software companies selling a subscription need to price competitively, which means reaching profit usually takes several months with each new customer.
If a customer churns too early, you lose money. Understanding the CAC payback period is essential to a company's long-term success. It helps you identify ineffective marketing channels and invest your advertising dollars more effectively.
The CAC payback period is the time it takes for your company to recover the cost of acquiring a customer. Potential investors will be very interested in this fundamental metric as it provides an accurate view of a company's growth potential.
This article will break down what the CAC payback period is, how to calculate it, and why it matters for your business. We'll also provide advice on creating a shorter payback period so that you can get a better return on your investment
The CAC payback period measures how long it will take to make back the money spent on acquiring a new customer.
Signing on a new customer should be a positive for any business, but if they bounce during the CAC payback period, you've lost at least some of the money spent on marketing.
Acquiring a customer isn’t free. There are costs associated with every new customer, such as marketing and advertising costs. Even for organic leads, there’s the salaries of your sales and content team.
On average, it will cost a company $205 to acquire organic customers. Subscribers gained from inorganic methods like advertising will set a business back by $341.
Since SaaS companies use a subscription model to generate recurring revenue, they need customers to stay on the service long enough to start profiting. A SaaS business is in good health if the CAC payback period is somewhere between 5 - 12 months. The longer the payback period, the more time it takes to make a customer profitable. Since SaaS companies use a subscription model to generate recurring revenue, they need customers to stay on the service long enough to start profiting.
That’s the thing. If you’re spending hundreds of dollars to acquire a single customer, you need them to stay with you for the long term. So your product needs to be worth paying for and offer enough features to keep your clients happy. Otherwise, they may choose to end the relationship early.
The CAC payback calculation is a board-level target metric. It indicates whether a company is priced correctly and has a viable marketing strategy. Getting it right requires cross-department collaboration, including marketing and sales.
So key sales and marketing staff (VP of marketing, head of sales) often use it as a “north star metric” to help them decide which marketing channels to focus on to contribute effectively to the bottom line.
Figuring out the CAC payback period is a simple process, so it's worthwhile for any business to know how to do it. First, you need to calculate the customer acquisition cost (CAC) before the payback period can be determined.
Speak with marketing and sales to get the figures for ad spend, content creation, publishing costs, and the department overheads. Once this information has been gathered, divide the total costs by the number of customers gained.
This is the average acquisition cost for the business, and now you'll be able to calculate the CAC payback period. Calculating the CAC payback period is as simple as taking the customer acquisition cost (CAC) and dividing it by the monthly recurring revenue (MRR).
If your CAC works out to be $200 for each new customer, and they pay $20 per month, then you will break even on month ten.
However, if the customer leaves the service before month ten, you will have lost money.
$200 / $20 = 10 months
By using this CAC payback period formula, you can track and monitor the progress of your customer retention programs, as well as the effectiveness of any changes in marketing strategy. If customers are churning before the breakeven point, it's a strong indicator that something's wrong.
Ineffective marketing can increase customer acquisition costs. You can identify where your ad dollars are better spent by breaking down the CAC payback period by advertising channels.
Reaching profit quickly means your company is doing something right. Gaining your investment back means there's more money to play around with. You can take bigger risks with marketing to see what attracts new customers (or turns them off).
Various things can affect the time to reach profitability, and some companies will manage it much sooner than others. A strong marketing strategy helps, as does having a product that solves people's pain points.
The average payback will change as your business grows. Factors like changes in the market, competition increases, and new operational costs can increase or decrease the CAC payback period. Early in a startup's journey, it's typical for the payback period to fluctuate, but anything under 12 months is a good sign that the company is on the right track.
In the case of larger, well-funded SaaS companies, the CAC payback period benchmark may be longer. They have access to extra funds, which means they don't need to be as quick to make a profit.
According to the 2021 Financial & Operating Benchmarks Report, to be considered 'best in class' for seed funding, your payback period should be 15 months or less.
The report reveals that the acceptable period varies depending on your business's funding series. It can be as high as 28 months for Series C funding. If your SaaS model is coming in under these numbers, it's a good sign that you're doing something right. Investors may not be willing to fund your business if it takes too long to break even.
CAC payback period keeps the reality of business growth clear. New subscribers might be growing in number, but if the cost to acquire new business is growing at an equal or greater rate, the payback period will increase.
10,000 new subscribers look good on paper, but if the acquisition costs have 10x'd in the same period, it will take 10 times as long to break even. The payback period helps to identify when things aren't working.
If your company charges a monthly or annual fee that doesn't cover the acquisition cost upfront, you'll need to keep each customer around. A longer payback period risks that you won't recover the investment spent acquiring them.
When a product is sold in a shop, the cost of manufacturing, materials, labor, and profit is acquired in a single transaction. SaaS companies don't operate in this manner. Customers sign up for a subscription which generates recurring revenue.
This allows software businesses to offer a smaller upfront fee to their customers but exposes them to the risk of not recovering the costs spent on sales and marketing.
By measuring your CAC payback period, you can quickly identify any issues you have with retention and churn. If most customers stop their subscription before fulfilling their CAC payback period, you’ve got a serious issue on your hands.
If a company has a high churn rate, it'll need to keep acquiring new customers at an ever-increasing rate just to keep existing. Try to find any commonalities among those who have churned. If people from certain channels are leaving after month 6, what could be happening to cause that?
Creating the right pricing structure takes experimentation to get right. Many factors come into play, such as the perceived value of the product, what the customer is willing to pay, and what will ensure a healthy margin.
If the CAC payback period is too long, it might indicate that the product is priced too low. The company can try increasing prices or introduce premium or enterprise tiers to see if it affects the payback period positively. Alternatively, a product priced too high won't get as many conversions which increases the CAC payback period.
The CAC payback period metric is a good way to assess whether current marketing efforts are working. If the payback period is too long, it might indicate that the company is overspending on marketing or that you are pursuing the wrong target market.
Poorly converting ads is a common cause of high CAC. A change in strategy can significantly reduce the cost of acquisition and the payback time. Break down the CAC payback period by looking at the different marketing channels.
If YouTube ads are bringing in more customers at a lower CAC, it's a good idea to focus more marketing resources on this avenue. Adjust the campaigns that aren't converting as well to improve the ROI.
If you spend $1,200 on Facebook Ads and onboard two clients at $25 per month, it will take two years to profit from these customers.
Tweak the ad campaigns by changing the target audience, adding the Facebook Pixel to your website, and run multiple ad groups with different ads to see what's resonating with the type of people you want to convert.
A change in strategy could lead to more conversions or a larger average deal size. If you instead onboard 2 customers, but they both opt for the premium $50 per month plan, it reduces the CAC payback period by 50%.
CAC Payback is not the only metric SaaS companies use to analyze their growth. Nowadays, many startups prioritize having a 3:1 LTV:CAC ratio instead of the length of their payback period.
CAC payback is a metric marketing and sales teams can use to gauge the efficiency of different channels, and the overall performance of all acquisition efforts.
With LTV:CAC, you instead divide the average lifetime value of a customer by your acquisition cost, making it a more detailed measure of the return on your investment — it literally shows if your marketing is profitable or not.
The formula looks like this:
LTV:CAC = (Revenue Per Customer – Expenses Per Customer) / (1 – Retention Rate) / (Number of Customers Acquired / Marketing Spending)
The problem with LTV:CAC is that it looks at averages, so it’s not necessarily useful for evaluating the results from a single specific channel. It’s also only an accurate measurement when you have years of high-quality data on churn, customer lifetime value, and customer acquisition costs for each cohort.
And, it’s not always going to help you make smart marketing decisions for your business (especially for newer or smaller companies). Your LTV will change as your company grows and you expand to new marketing channels (usually for the worse), which means you could be losing money on advertising without realizing it.
The CAC payback period isn’t a perfect metric, but it can be calculated with less information and can be more helpful to guide critical business decisions.
For example, even if you’re a brand new SaaS with only 3 months of customer data, you can use CAC payback to make data-based marketing decisions. It immediately highlights how long it will take you to profit from customers from different channels and zeros in on any leakage in your marketing funnel.
It also indicates the level of risk you’re exposed to with your current marketing campaigns. For example, even with an LTV:CAC ratio of 4:1, if it’s going to take you 2 years to recuperate your marketing costs, your startup may run out of runway if you don’t have enough funding. So the CAC payback period here is the more important indicator of campaign performance.
It’s also easy to calculate your CAC payback period in the early stages of the new campaign, as you can forecast it based on the average monthly revenue of the new leads generated.
The payback period is not set in stone; you have the tools to change how long it takes to make a profit. It requires experimentation and a keen understanding of your business and its customers.
Promoting an annual subscription can lead to profit quicker if your CAC payback period is less than 12 months. Convertkit is a company that offers a yearly subscription that comes at a reduced cost.
Everyone walks away from this deal better off. The customer gets a good deal saving two months on their annual spending, and you get a lump sum when they sign up with you. If the CAC payback period is less than 10 months (2 months for free), you're in profit.
There is a lot of room to play with marketing. Campaigns need constant experimentation and analysis to ensure they're optimized. Evaluate what's working and what isn't. Make changes to your strategy and test how they affect the payback period.
What’s important is that you use an analytics platform and your CRM or billing platform (as well as customer surveys) to identify the lead source, and compare the average revenue per customer between platforms. Once you have this data, you can start prioritizing between digital channels like SEO, content marketing, or PPC.
Even if Facebook ads has the cheapest CAC at $277, it doesn’t matter if the average customer from Facebook only stays on for 3 months on a $50 per month plan. Focus on channels that drive larger deals and premium plans, not the ones that drive the most freemium users.
If you’re currently mainly focusing on small-scale mom-and-pop shops, expanding your service to enterprise customers is something that can immediately reduce your CAC payback period.
Firstly, these types of companies are more likely to want yearly contracts and pay in lump-sum (which means you typically recuperate the entire CAC up-front), even if they’re on monthly contracts, the high monthly cost means you can quickly pay down any marketing costs and start profiting.
To break into these markets, connect with potential customers and ask them what additional features they’d like to see from your product (like two-factor authentication, user access controls, etc.). Then address those needs in a custom plan for enterprises at a much higher price point.
(If you’re based in a country with low average income, like India, this could also mean expanding your offerings to countries with higher median household incomes, like the US or Norway.)
New SaaS businesses often underestimate the potential value of their existing customer base. It may seem counterintuitive to focus inward instead of bringing as many new customers into the business as possible.
But the fastest-growing SaaS companies on the planet owe between 20-40% of their revenue growth to “expansions revenue” — added revenue from upselling to existing customers.
Plus, since you don’t need to pay for access, upselling is also a lot cheaper than acquisition. It can be as simple as adding an automated “Did you know you can do this with premium?” email to your onboarding drip campaign.
A significant churn rate is very bad for business. If customers leave before you break even on their CAC, you're losing money on advertising (not to mention other running costs).
Some level of churn is bound to happen, and it presents a valuable learning opportunity. Introduce a non-pushy exit interview to determine what's causing a customer to leave.
Gather and analyze this information, and then develop an action plan to fix any issues. For example, you can develop new features that help your customers address additional pain points mentioned during the interview, or set up a more comprehensive onboarding process if that was highlighted as an issue.
Then, you have the last resort — if a customer opts to leave, try offering them an incentive to stay. For example, you can use a discounted rate or access to a higher tier to tempt customers into staying.
It may sound like a cliche, but it's true, you have to spend money to make money. CAC payback helps ensure the money you're spending isn't wasted on lousy marketing campaigns or customers who leave soon after signing up.
The key is to constantly learn and evolve your tactics to ensure you're getting the most out of your customers.
For pricing models that suit your business, check out Chargebee's Subscription Management service to help reduce your CAC payback period.