Your cost of customer acquisition (CAC) is a critical SaaS metric to know. With this key business metric, you can make better decisions to increase monthly revenue. Without it, you have to rely on guesswork to hit the numbers on your business plan. Keep reading to find out how to calculate customer acquisition costs and ways to improve your scalability and profitability. When you know that you can spend $10,000 in a time period to generate $20,000 in total revenue, you will have a truly viable business model.
Calculating Customer Acquisition Costs
Your approach to calculating customer acquisition costs requires that you have reasonably robust data and then use customer acquisition cost formulas. Unlike cost of goods sold or payback period, customer acquisition cost keeps you focused on the cost to increase total revenue. When you know how much budget it takes to increase the total number of customers in your business in a given period, marketing planning becomes much more manageable. When you understand your customer acquisition cost, you’re much more likely to achieve your return on investment and payback period goals.
Example of Customer Acquisition Cost For A Monthly Time Period
Fancy SaaS App has a $500,000 marketing budget, and the marketing team has been working hard to acquire more customers. Last month, the company spent $50,000 on a marketing campaign to acquire 100 customers generating $100,000 in total sales revenue. In this case, the company’s customer acquisition cost was $500. They can use that number to evaluate performance in the current month and see if they exceed the industry standard. If they fall short, it might be time to make changes to their inbound marketing or review your acquisition strategy. For example, you might find that cost per lead has started to increase in your social media advertising campaign. In that case, you probably need to look at changing your sales process to include strategic partners and content marketing.
Successful companies never assume that their marketing staff has the final answer to lead generation. They are always looking for new ways to improve campaign costs, reduce cost per action, conversion rate, and improve cost per acquisition. Before you start to make changes to your operating expenses or sales costs, you need to calculate your current cost to acquire a new paying customer.
Formula for Customer Acquisition Cost For A Monthly Time Period: The Basic Version
As a starting point, consider the following customer acquisition cost formula, at its most basic, is a simple equation. You divide your total marketing spending by the number of customers you acquired. Finally, you also need to choose a time period for reporting, such as monthly or quarterly. That way, you can compare results in any given period over time (e.g., June 2020 compared to June 2019). If you have a self-serve business model, instead of a sales process with multiple meetings, where customers can buy online, this basic version works well.
For the formula to provide meaningful results, you must have high-quality data. For example, your marketing expenses need to be comprehensive – covering Google, Facebook, the effort to publish a blog post, other social media services, and everything you do to convert a potential customer to a paying customer. In the current month, you might find out that Google Ads has a far better return on investment than inbound marketing. In that case, you might ask for a larger marketing budget so that you can continue to grow your customer base.
Beyond tracking the cost of your marketing efforts, you also need to track the source of each paying customer. For example, are you getting customers from LinkedIn, email marketing, a blog post, or a specific landing page or some other advertising channel? Without this information, it will be very challenging to grow your customer base predictably.
Tip: Running out of leads? You might need to explore some new SaaS marketing channels.
Formula for Customer Acquisition Cost: The Advanced Version Including Sales Expenses
If you run a simple, self-serve e-commerce business model, the basic customer acquisition cost formula is all you need. For example, if a customer can enter a credit card and buy the product from your website, your SaaS business is similar to an e-commerce business. However, many SaaS companies need advanced customer acquisition costs because they have a multi-step acquisition process.
Sometimes known as “fully loaded CAC,” this advanced approach to customer acquisition cost gives a more accurate picture of your total cost to acquire a paying customer. It is different from the basic version because it involves your total cost to get customers rather than just marketing spend. As a rule of thumb, fully loaded CAC includes the cost of the sales team, marketing spend (including the cost of inbound marketing), sales expenses, overhead costs, and all other marketing efforts like marketing salaries. By the way, make sure your sales costs calculation includes any expenses that your sales people spend, like sending gifts to potential customers.
By the way, calculating the cost of content marketing isn’t difficult. The important thing is to track it. If your marketing team handles blogging, publishing a podcast, and infographic creation internally, you need to use time tracking. Use a tool like Toggl and ask your marketing team to track how much time it takes to create each content marketing asset (e.g., 5 hours to create an advertising campaign, 16 hours per month for blogging, and so forth). Then you can analyze the cost of your marketing efforts in relation to the total new customers you attract in each time period.
Tip: HubSpot’s article on customer acquisition cost makes a great point that CAC should also include marketing and sales software, outsourced services, and overhead for marketing and sales.
A Key Lead Generation Question: Is Your Customer Acquisition Too High?
The best way to tell whether your CAC is too high is to measure it in relation to another metric. Specifically, we are going to look at customer acquisition costs in relation to customer lifetime value. If your CAC is less than customer lifetime value, you have a successful marketing and sales process. Congratulations! If customer acquisition costs are greater than customer lifetime value, there is a problem. If you have a small business, you will need to be more conservative in how much you spend because you may not have a free product available to attract the interest of your target audience.
There are two ways to improve your ratio of customer acquisition cost to customer lifetime value. Start by double-checking if your customer lifetime value amount is reasonable. For example, you may have a referral program where 20% of customers tend to bring in new prospects. In that example, there is a value in your referral that should be added to your customer lifetime value.
Next, take another look at your customer acquisition cost over time. If your customer acquisition cost has recently increased significantly, that situation may be acceptable. You might have decided to put more resources into high-quality customer success story videos in the past quarter. Creating those assets involves paying upfront while the resulting increased SaaS conversion rate will only appear later. What if you don’t have any long term marketing projects recently?
The most common other causes for high customer acquisition costs are poor tracking and ineffective marketing. In the case of poor tracking, you cannot track conversions. For example, your marketing may have generated 100 leads this month, but you only logged half of them. Improving the accuracy of your marketing and conversion tracking is the first area to improve. Finally, you have to face the reality that your marketing may have failed. That happens to many companies! It is especially common when you are first developing your go-to-market plan, launching a new product, or pitching to a new type of potential customer.
Importance of Customer Acquisition Cost: It’s One of The Best SaaS Metrics
In sales and marketing, customer acquisition cost (CAC) is one of the most exciting metrics to track. By tacking this measure, you can make better marketing budget decisions. You can add another $10,000 to a specific marketing channel with a high level of confidence of a good return. Further, a robust understanding of customer acquisition cost means you can have better conversations with lenders, the sales team, funders, and management.
Since there are some measurement difficulties involved in customer acquisition costs, make sure you understand your data. I wouldn’t want you to make irresponsible promises about growth based on a $1,000 CAC! When in doubt, I suggest taking a conservative approach where you assume that marketing costs will increase over time. This assumption is grounded in the reality that almost all marketing channels, especially pay per click advertising, have shown higher costs over time. If customer success plays an active role in growing total revenue, then including customer success costs into customer acquisition cost makes sense.
Since customer acquisition cost is usually calculated based on a monthly or quarterly time period, there is a time lag. That’s why you should also keep track of a leading indicator like cost per lead as you manage week by week.
Improving Customer Acquisition Cost: Your Top 3 Steps
There are multiple proven strategies to improve your customer acquisition. You have already learned a few of these methods. Use this section as your to-do list to get more conversions at a lower cost.
1. Improve your conversion tracking accuracy
Start by checking your website analytics to ensure that tags are in place. After that is confirmed, check that you have correctly set up goals. For those of you using Google Analytics, use this resource to set up a goal.
For LinkedIn Ad conversion tracking, consult this official article, “Set Up LinkedIn Conversion Tracking.” For Facebook Ad conversion tracking, use the following resource: Facebook conversion tracking.
2. Define and reduce the sales cycle
The amount of time sales take to close is an essential factor in your customer acquisition cost. For example, let’s say that you have a 30-day free trial. Most customers sign up for a paid account after 25 days. Coincidentally, your email marketing system sends out a message on the 24th day of the free trial telling users that their free account is about to expire.
In this example, you can reduce your sales cycle by changing your email marketing. Specifically, attempt an experiment where you send more emails in the second and third weeks of the free trial. This approach may cut your sales cycle down by a week or more.
3. Identify low performing marketing channels for reduction
Optimizing your customer acquisition costs also requires taking a look at costs. Put on your CFO hat for a moment and ask yourself if your marketing channels are generating results. For example, you might have tested Instagram for 60 days to see if you might diversify your SaaS marketing channels. Unfortunately, you saw almost no new leads or traffic from Instagram. Assuming your conversion tracking is correctly set up (see tip one above), it might be time to cut your losses on Instagram or reduce your time investment on that platform.
Redirecting marketing budget from low performing marketing channels to higher performing channels is one of the best ways to improve your customer acquisition cost.
What Should You Fix Next In Your SaaS Marketing
I recommend improving your SaaS conversion rate as the next step in boosting your total revenue without increasing your advertising budget. With a better conversion rate, you can increase the number of leads you get from each landing page, you can reduce your cost per lead over time. A better conversion rate in your upsell process us another way to grow total revenue from your existing customers is another great area to develop.