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Customer Acquisition Cost (CAC)

Step-by-Step Guide to Understanding Customer Acquisition Cost (CAC) in SaaS Investing

Last Updated February 20, 2024

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Customer Acquisition Cost (CAC)

How to Calculate Customer Acquisition Cost (CAC)

CAC stands for “Customer Acquisition Cost” and is a critical metric in the SaaS industry used to determine the cost efficiency at which a particular company operates.

The customer acquisition cost (CAC) measures the average costs incurred by a SaaS business, per customer – i.e. the amount invested to acquire new customers – to inform a better understanding of the effectiveness of their current sales and marketing strategies at attracting new customers.

In simple terms, the customer acquisition cost (CAC) quantifies the average amount spent by a SaaS company to convince each customer to purchase its products or services.

The long-term economic feasibility of the business model of a SaaS company is ultimately determined by its sales and cost efficiency, where the allocation of capital must generate enough monetary value to offset any spending.

SaaS businesses exhibiting high growth with significant upside potential with regard to market expansion and product development are able to raise funding from venture firms, but that starts off with ideally first reaching a balanced ratio between the customer acquisition cost (CAC) and lifetime value (LTV).

While a company achieving a positive growth trajectory in revenue is perceived to be positive by most, neglecting the spending required to attain the growth would be a costly mistake.

In short, the operating strategies and tactics used to acquire customers is not viable for the long term if the profits retrieved from customers do not exceed the total costs incurred to acquire said customers.

The step-by-step process to compute the customer acquisition cost (CAC) is as follows.

  1. Determine the Specific Time Frame to Analyze the Customer Acquisition Cost (CAC)
  2. Calculate the Total Costs Incurred on New Customer Acquisition Strategies
  3. Count the Total Number of New Customers Acquired in the Selected Period
  4. Divide the Total Costs Incurred by the Number of New Customers Acquired

Customer Acquisition Cost (CAC) Formula

The formula to calculate the customer acquisition cost (CAC) is as follows.

Customer Acquisition Cost (CAC) = Σ Sales and Marketing (S&M) Expenses ÷ Number of New Customers Acquired

Counting the number of new customers who completed a purchase or signed up for a subscription should be relatively straightforward, but identifying the costs can be less intuitive at times.

The following list contains some of the more common types of costs to include in the calculation of the customer acquisition cost (CAC):

  • Employee Salaries (i.e. Sales and Marketing Team)
  • Ad Spend and Marketing Campaigns (e.g. Social Media Ad Placements, Commercials, Billboard Advertising)
  • Creative Costs and Production Costs (e.g. Affiliate Marketing, Editing Software)
  • Technical Tools (e.g. CRM Software)
  • Content Creation and Digital Marketing (e.g. SEO, SEM)
  • In-Person Events (e.g. Hosted Events, Trade Shows, Travel Expenses)
  • Third-Party Professional Services (e.g. Strategy Consulting Fees)

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Customer Acquisition Cost (CAC) Calculator

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1. SaaS Business Operating Assumptions

Suppose we’re tasked with calculating the customer acquisition cost (CAC) of four comparable seed-stage SaaS startups.

For illustrative purposes, we’ll assume the New MRR – i.e. the monthly recurring revenue (MRR) earned from new customer acquisitions – is $1k for all four companies.

Likewise, the number of new customers acquired, gross margin (%), and sales and marketing expenses (S&M) will be assumed to be the same for each companies.

  • New MRR = $1k
  • Number of New Customers Acquired = 25
  • Gross Margin (%) = 60.0%
  • Sales and Marketing Expenses (S&M) = $5k

Starting off, we’ll calculate the average MRR for each new customer by dividing the New MRR by the number of new customers acquired.

Since we straight-lined the assumption across all four companies, the average MRR per new customer is $40.00 for each.

  • Average MRR per New Customer = $1k ÷ 25 = $40.00

The $40.00 represents the subscription paid on a monthly basis to the SaaS provider by the new customers.

2. SaaS Lifetime Value (LTV) Calculation Example

In the next step, we’ll calculate the lifetime value (LTV) metric for each of the SaaS companies.

However, note the MRR churn rate assumption increases by 0.5% using a step function.

  • MRR Churn Rate (%) – Company A = 2.5%
  • MRR Churn Rate (%) – Company B = 3.0%
  • MRR Churn Rate (%) – Company C = 3.5%
  • MRR Churn Rate (%) – Company D = 4.0%

In practice, there are several methods to compute the lifetime value (LTV) metric but we’ll use the following formula to determine the lifetime value (LTV) of each of our SaaS companies.

Lifetime Value (LTV) = Average MRR per New Customer × Gross Margin (%) ÷ MRR Churn Rate (%)

Upon inserting our assumptions into the LTV formula, we are left with the following figures:

  • Company A – Lifetime Value (LTV)= $40.00 × 60.0% ÷ 2.5% = $960
  • Company B – Lifetime Value (LTV)= $40.00 × 60.0% ÷ 3.0% = $800
  • Company C – Lifetime Value (LTV)= $40.00 × 60.0% ÷ 3.5% = $686
  • Company D – Lifetime Value (LTV)= $40.00 × 60.0% ÷ 4.0% = $600

3. SaaS CAC Calculation Example

In the final section of our exercise, we’ll calculate the customer acquisition cost (CAC) for each company, and then insert the LTV and CAC values computed thus far into the LTV/CAC ratio.

The customer acquisition cost (CAC) is estimated by dividing the sales and marketing expenses (S&M) metric by the number of new customers acquired.

Since the assumptions are the same for all four companies, the CAC of each company will be of equivalent value.

  • Customer Acquisition Cost (CAC) = $5k ÷ 25 = $200

Therefore, the average amount spent to acquire a customer amounts to $200.

CAC Calculation Example

4. LTV/CAC Ratio Calculation Example

By dividing the LTV by the CAC for each company, we can determine the LTV/CAC ratios, which will provide insights regarding the cost efficiency of each company.

For example, the LTV/CAC ratio for Company D is 3.0x, the benchmark targeted by most SaaS companies, but recall from earlier that for companies earlier in their lifecycle, a LTV:CAC ratio on the lower end is acceptable and not considered to yet be an issue.

SaaS CAC Calculator

In fact, a lower LTV:CAC ratio implies that the startup is moving quickly and spending capital at an aggressive pace, which is normally expected for startups striving to show the “potential” to disrupt a market in order to raise capital soon after.

The alternative would be an early-stage startup sitting idly, which most investors would not view positively.

Therefore, the implied LTV/CAC ratios of our four SaaS startups are as follows.

  • Company A – LTV/CAC Ratio = $960 ÷ $200 = 4.8x
  • Company B – LTV/CAC Ratio = $800 ÷ $200 = 4.0x
  • Company C – LTV/CAC Ratio = $686 ÷ $200 = 3.4x
  • Company D – LTV/CAC Ratio = $600 ÷ $200 = 3.0x

Customer Acquisition Cost Calculator (CAC)

New CAC vs. Blended CAC: What is the Difference?

There are two distinct variations of the customer acquisition cost (CAC) metric: 1) New CAC and 2) Blended CAC.

  1. New CAC → The new CAC metric focuses solely on the efficiency of the company’s sales and marketing (S&M) spend at acquiring new customers. Since only newly acquired customers are counted, the metric isolates the more challenging (and costly) objective, i.e. convincing a new customer to purchase or subscribe, which is substantially more challenging than upselling or cross-selling tactics to existing customers.
  2. Blended CAC → In contrast, the blended CAC metric factors in upselling, cross-selling, expansion revenue, etc. Therefore, the efforts related to deriving more revenue from the existing customer base are also considered in the metric. Fewer costs are incurred compared to new customer acquisitions, as these existing customers have already purchased a product or subscription in the past, which makes the sales and marketing (S&M) team’s job much easier.

B2B SaaS Customer Acquisition Cost Calculation Example (CAC)

For instance, suppose a B2C SaaS startup incurred a total of $20k in sales and marketing (S&M) expenses in Q1 of 2023.

The outcome? The startup acquired 500 new customers over the period.

Given those assumptions, the cost to acquire each customer, on average, amounted to $40.00 in Q1-2023.

  • Customer Acquisition Cost (CAC) = $20k ÷ 500 = $40.00

Note: The formula to determine the customer acquisition cost (CAC) must count only the new customers acquired in the pre-defined period.

What is a Good CAC for SaaS?

Customer acquisition cost (CAC) as a standalone metric is not too informative by itself.

Instead, the CAC metric must be analyzed in conjunction with the customer lifetime value (LTV) metric to derive practical insights regarding the operating efficiency of a given SaaS company.

Conceptually, the customer acquisition cost (CAC) is the “hurdle rate” that the lifetime value (LTV) must exceed in order for the SaaS companies to be profitable.

In the SaaS industry, an LTV/CAC ratio of 3.0x is widely recognized as the standard target benchmark.

Hence, most SaaS companies strive to meet quarterly targets to reflect an upward trajectory, converging toward a 3.0x ratio, as part of their internal strategic planning. In effect, SaaS startups must constantly be optimizing their sales and marketing channels and tactics to acquire new customers to ensure the LTV:CAC ratio is on the right track of positive progress.

So, what does an 3.0x LTV/CAC ratio mean?

The 3.0x LTV/CAC ratio implies that for each dollar allocated to acquiring new customers, the company earns $3.00 in return.

How to Analyze LTV to CAC Ratio in SaaS Industry

The customer lifetime value (CLTV), or lifetime value (LTV), estimates the revenue that the average customer generates for the company over the course of their time as an active customer.

The LTV/CAC ratio, or “Lifetime Value to Customer Acquisition Cost”, is a fundamental SaaS metric that measures the operating efficiency of a SaaS business.

By comparing a SaaS company’s lifetime value (LTV) to its customer acquisition cost (CAC), the resulting figure – the LTV/CAC ratio – measures the return on investment (ROI) earned per dollar spent on acquiring new customers.

  • Lifetime Value (LTV) > Customer Acquisition Cost (CAC) → Viable Long-Term Business Model
  • Lifetime Value (LTV) < Customer Acquisition Cost (CAC) → Unsustainable Business Model

Early on, the LTV/CAC ratio of most SaaS startups in the initial stages will be lower since management is rather unlikely to have figured out yet the most effective sales and marketing (S&M) strategies to acquire new customers, the optimal pricing strategy, and the end market(s)to focus on based on the target customer profile, among various other factors.

But over time, the LTV to CAC ratio of the SaaS startup must demonstrate tangible improvements as the company moves beyond the early stage of its overall lifecycle.

Otherwise, raising capital from venture firms to fund plans to drive growth and expansion strategies to increase scale will be difficult, especially amid unfavorable market conditions.

Therefore, SaaS companies pay close attention to their LTV/CAC ratio and aim to optimize their operational strategies and business model to extract more revenue from customers, while reducing the costs incurred to acquire new customers.

Learn More → LTV/CAC Ratio

How to Reduce Customer Acquisition Costs (CAC)?

The following table contains common methods used by SaaS companies to reduce their customer acquisition costs (CAC) and improve their LTV to CAC ratio.

Method Description
Know Your Customer (KYC)
  • SaaS companies must understand their customer base’s collective needs (i.e. the “pain points”) to create a product that sufficiently solves the identified problems faced by the target end market.
  • Product demand from customers in the market is a function of offering a solution to a problem.
  • Therefore, it is critical for companies to have an open dialogue with their customer base, which can come in the form of cold calling, surveys, post-purchase follow-up emails, and more.
  • In addition, the product offerings and customer experience should align with the preferences of the target end market (e.g. digital self-serve).
Value > Cost
  • From the perspective of the customer, the value received from the purchased product must be perceived as worth the cost.
  • If the value proposition is not evident to the customer, a high churn rate is the inevitable outcome.
  • With that said, the continued monetization of customers stems from continuous improvements to the product and adjusting the levers, such as the pricing, as deemed necessary to ensure consistent demand.
Customer Engagement
  • The SaaS business model is oriented around recurring revenue.
  • Constant engagement is an essential component of building long-term customer loyalty.
  • For instance, reaching out to existing customers to receive product feedback (and more importantly, fixing the points of criticism) would be an example of establishing a positive customer experience, where customers feel that their opinions are valued and considered.
Customer Retention
  • The spending related to acquiring a new customer is far more expensive than retaining an existing customer.
  • Therefore, there must be strategies in place to reduce the customer churn rate (or “attrition rate”), such as securing multi-year contracts, product bundling, upselling or cross-selling tactics, and rewarding existing customers with discounted rates (i.e. loyalty programs).
Word-of-Mouth Marketing
  • Consumers tend to be more likely to purchase a product or service if recommended by their friends or family.
  • The creation of a customer referral program to encourage word-of-mouth marketing with monetary incentives to promote active participation in referral conversions is an effective tactic to reduce customer acquisition costs.
  • For example, a completed referral could reduce the pricing rate charged on the next purchase of the referral partner, or a commission based on a set percentage of the referral income could be distributed.
  • In effect, existing customers begin to contribute directly toward the sales and marketing initiatives of the company, which is frequently connected with the concept of product-market fit (PMF).
Perform Cohort Analysis
  • The historical customer data in the performance of specific sales and marketing (S&M) campaigns should demonstrate noticeable patterns around which to optimize.
  • Based on the collection of actionable customer data separated into cohorts, the customer acquisition strategies can be further refined.
  • The target customer profile after analyzing the traits of repeat customers most likely to convert, the end markets most receptive to certain marketing campaigns, and the effectiveness of different marketing strategies (or channels) per demographic should be understood, at a bare minimum.
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