Note: This article is part of my deep dive series on SaaS metrics
Customer acquisition cost (CAC) payback is one of the most important metrics for growing SaaS companies to understand and improve. When you can improve CAC payback, you improve your capital efficiency and your ability to grow rapidly.
What Is CAC Payback?
CAC Payback is the period of time in which you earn back the cost of acquiring a new customer through the revenue that customer brings to your business.
If you spend a lot on acquiring each new customer you will have to attract high-paying customers or wait months before that customer brings that amount of revenue to your business.
Conversely, if you are able to attract new customers through low-cost or free channels, you will be able to recoup your marketing cost quickly and make each customer net profitable to your business more rapidly.
How To Calculate CAC Payback Period
To calculate the CAC payback period you will need three pieces of information:
- Sales and marketing expense: the cost spent on attracting customers to your company in a period
- New Monthly Recurring Revenue (MRR): The new MRR that was brought in during that period. Some companies choose to use net new MRR instead, to account for churn during the period. You also could choose to include or exclude expansion MRR from existing customers in the calculation – was your marketing campaign directed exclusively at new customers, or was some of the marketing expense directed at upselling existing customers as well? What you include or exclude from CAC payback calculations depends on your unique spending and how precise you need your calculation to be.
- Gross Margin: What percentage of the new MRR is profit to the company. Some of the MRR is going to go to overhead, and for this calculation we need to get rid of that. CAC payback only looks at how much profit the customer will bring to the business, not total revenue.
CAC Payback Period Formula
The formula for the CAC Payback Period is as follows:
Sales & Marketing Expense/(New MRR x Gross Margin) = payback period in months
Depending on the quality of the data you have available, you could calculate the average CAC per customer using ARPA (average revenue per account), or you could calculate it in bulk based on monthly or quarterly sales and revenue figures.
CAC Payback Calculation Example
Let’s assume that a company spent $20,000 on sales and marketing expense in a month, which brought in 50 new customers. Each of those customers buys a subscription worth $100 per month. The company’s gross margin percentage is 75%. The CAC payback period calculation would look like this:
$20,000/($5,000 x 0.75) = 5.33 months
This shows us that after the 5 months and change are over, every dollar over the gross margin that those 50 customers pay will be net profit to the business.
Or think of it this way: you have to spend money to make money, but if you aren’t making your money back fast enough, you will spend too much and go out of business before you can see the return on your money.
Let’s change things a bit and assume the company is marketing to a different clientele that is younger, smaller, and otherwise cannot spend as much money on a subscription.
The company spent the same amount on marketing, $20,000, but they only attracted 25 new customers at $50 per month each. The gross margin percentage is the same. Now the calculation looks like this:
$20,000/($1,250 x 0.75) = 21.3 months
At this rate, it would take the company almost 2 years to recoup the cost of acquiring those customers – and that is assuming that all those customers stay and none churn during that time period.
Why CAC Payback Period Is Important
The CAC payback period is important because companies need to keep an eye on cash flow as they grow.
Let’s say an ambitious new SaaS company spends a fortune – all of its cash reserves – on acquiring customers that will someday pay the company an even bigger fortune. That means the company can’t spend money (or do anything) in the meantime until those cash flows come back. The company does not have the cash reserves to sustain itself until their customers brought by that marketing campaign begin to show a return on the marketing funds spent.
In the opposite scenario, let’s imagine that there’s a company that – as soon as they deploy marketing dollars – the customer NEAR INSTANTLY pays the company much much more in revenue. This is great! It means the company has a money printing machine. Even if the startup only has $1 to deploy into marketing – because it pays back so quickly (instantly) – it will very quickly turn that $1 into a huge sum, as they quickly recycle the profits from the first $1 back into marketing again and again.
As such, the shorter the CAC payback period is, the faster and more efficiently the company can grow, since it will not need to raise outside capital! They just keep recycling their own profits (which come back quickly) from new customers.
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What Is A Good CAC Payback Period?
This depends a lot on the industry, but one “industry standard” benchmark for the CAC payback period is 12 months. If a company can make back their marketing expense in profit from new customers within a year, they are considered healthy and well-managed.
As a general rule, 12 months works well. That said, you also have to consider how your competitors are doing. If one of your close competitors has a substantially lower CAC payback period – less than 6 months for instance – that company will be in a much healthier financial position and is making much more effective use of their marketing dollars.
Some DTC startups — which rely heavily on Facebook and other paid marketing channels – have sought to be net profitable on customers on their first transaction. In essence, this would mean their CAC payback time is zero! Therefore, their growth is only limited by their ability to find efficient growth opportunities.
Also of note, small companies sometimes “must” have a shorter CAC payback period simply because they have less access to cash reserves and financial resources than larger companies. This requires them to make back their marketing investment faster than a larger company that can afford to take longer or that has a slower burn rate.
How To Improve CAC Payback Period
The most obvious way to improve the CAC payback period is to reduce the overall marketing cost. This can be done in various ways. However, the company could also explore other ways:
- Check the effectiveness of your marketing funnel – How long is your funnel? How many steps do your prospects go through before they become paying clients, and how many of them are lost along the way? Look at the various types of marketing you are doing – pay-per-click ads, email marketing, social media ads – and see which ones are the most effective. It may be worthwhile to you to eliminate the less efficient marketing campaigns and focus all your efforts into the most successful one or two channels.
- Increase the value of your existing customers – We spend a long time talking about new customers in relation to CAC payback, but don’t forget that it can be a lot less expensive and painstaking to market to your existing customers with upsells and cross-sells, making each marketing dollar go farther. Don’t forget to adjust your formula to include expansion MRR if you are including existing customers in your CAC payback calculations.
The other metrics in the formula can also be adjusted to improve CAC payback, though usually to a lesser extent. You can tweak your pricing until you find what works to get the ideal balance of new customers and quick return on your marketing investment, although you can’t do this continually without risking confusing your customers.
Finally, there are ways you can increase your gross margin percentage by cutting expenses. This is where reducing your marketing expense really shines. By reducing your overall marketing cost or making it more effective, you are also reducing your total expenses, making your company a few percentage points’ more profitable. This is probably the factor that is hardest to change in light of the total formula, as SaaS companies usually have more fixed costs (like hosting and payroll) that cannot be practically reduced or done away with.
CAC payback cost is one of the most important metrics for an SaaS company to focus on because it says several things about the company. It can show how effective the management is, whether the product is priced well, how good the product is, and how efficiently each marketing dollar is being spent.
Check out my series on SaaS and growth metrics to go even deeper.