The definition and calculation of CAC can vary between different sub-industries within the software industry. Understanding these differences and tailoring your CAC definition and analysis to your specific market, product fit, and audience (or segmentation) is essential.
For example, the sales process in the enterprise software industry can be much more complex, takes much longer, require additional resources, and involve multiple buying personas. All these factors lead to a higher CAC. On the other hand, in the consumer software industry, the sales process may be more straightforward and involve fewer buyers, leveraging the PLG/ PLS, leading to a significantly lower CAC. Although the relationship between LTV and CAC is evident, companies must understand the underlying factors for proper industry or competitor benchmarks.
According to a recent survey by OpenView Partners, a venture capital firm, 70% of Series A and Series B startups track CAC as a critical metric. In addition, a study conducted by For Entrepreneurs, a startup advisory firm, found that 85% of successful SaaS companies use CAC as a critical metric. These statistics demonstrate the importance of CAC in measuring the efficiency and profitability of customer acquisition efforts for startups.
There are a few essential principles to remember while defining or refining this metric:
Cost: Ensure to include all costs associated with customer acquisition, including marketing and sales acquisition expenses and other supportive functions participating in the sales acquisition process; the spend data must consist of salaries, commissions, systems costs, and any additional costs incurred to attract and convert new customers.
Time horizon: Determine the period for which you will calculate CAC, whether monthly, quarterly, or annually. You might decide to use them all, but you must ensure data is contextualized, as not all costs occur with the same schedule. That might blur the readout and lead to a wrong decision.
Exclude non-acquisition expenses: Exclude any significant product development expenses (there is one small caveat here that I'll explain later) from your CAC calculation to ensure that your CAC accurately reflects your cost bucket accordingly. Before you start the computation, you must define all these costs by team and cost categories. Often using aggregated categories is against the principle of this metric. You have to go deep in detail.
Customers: Make sure to include all customers acquired during the time in your CAC calculation, including those acquired through direct or indirect channels. Make sure that you analyze that in the context of your segmentation. Your resources are often allocated based on anticipated effort; therefore, your segment cost will differ. You are omitting that an essential part of the analysis is keeping management blind.
LTV: The CAC metrics are only half of the equation. To benchmark yourself, you need to calculate the ratio between LTV/CAC. This is not a profitability indicator but a good proxy. The market wisdom suggests that ratio (according to a report by Insight Partners, the average LTV/CAC ratio for Series A companies in the US is around 3:1, while for Series B companies, it is around 4:1). Please keep in mind that there is no standard for that each company might look at this differently.
The calculations of CAC would look different depending on the industry. I've focused on two, including cybersecurity and financial services, as an example highlighting their potential differences (please note these are just hypothetical examples that companies in these industries might use. However, this doesn't mean it's the case).
A cybersecurity CAC example will include the following costs:
Marketing, advertising, and discretionary marketing-related expenses may include online advertising, content marketing, and events to promote the company's products and services. Yes, this includes headcount cost (in the case questioned by some "professionals")
Sales expenses: This may include salaries and commissions for sales representatives, sales tools and resources, and travel expenses for customer meetings; systems (like CRM) should also be included in the metric. Many sales and marketing organizations tend to inflate that cost under other departments (like IT), but this cost must be associated with the CAC.
Partnership and channel expenses may include fees paid to partners and resellers for selling the company's products and services.
Research and development expenses may include expenses associated with enhancing existing products.
Customer onboarding and training expenses may include onboarding new customers, customer support, and training. This might happen if the implementations take longer and revenue needs to be recognized later. I recommend keeping that in CAC instead of CTS (Cost to Serve). It's a gray area that could be debated in a separate thread.
On the other hand, for a financial services company, the CAC may include the following costs:
Sales expenses: This may include salaries and commissions for sales representatives, sales tools and resources, and travel expenses for customer meetings.
Marketing and advertising expenses may include online advertising, content marketing, and events to promote the company's products and services.
Partnership and channel expenses may include fees paid to partners and resellers for selling the company's products and services.
Regulatory compliance expenses may include compliance with regulatory requirements, including audits and legal fees.
The standard doesn't exist between the industries; even within the industry could deviate from these examples. However, the CAC definition for a cybersecurity company and a financial services company may overlap, but there are also some significant differences. For example, a cybersecurity company may have higher research and development expenses, while a financial services company may have higher regulatory compliance expenses.
It's important to note that the CAC definition and calculation should be tailored to the specific market and product of the company. However, understanding the common costs associated with customer acquisition in your industry can help you develop a more cost-effective acquisition strategy.
You probably noticed a bit of inconsistency in the above explanation. On the one hand, I mentioned that production costs should be excluded; on the other, I suggested that they might be included in the case of cybersecurity companies. Here is the rationale behind why both statements might be correct:
Competitive differentiation: In the highly competitive cybersecurity industry, companies may need to continuously enhance their products and services to remain competitive and attract new customers. By including product development and enhancement costs in the CAC calculation, the company can better understand the actual cost of acquiring a customer, including the cost of developing and enhancing products to meet customer needs.
Customer retention: In the cybersecurity industry, customer retention is just as necessary as customer acquisition (a no-brainer for all readers by now). However, by investing in product development and enhancement, companies can improve their products and services and keep existing customers satisfied, leading to higher retention rates and lower churn. It's like hedging upfront for better results later.
Upselling and cross-selling opportunities: Cybersecurity companies can create upselling and cross-selling opportunities for existing customers by continually improving their products and services. Including product development and enhancement costs in the CAC, the calculation can help the company better understand the long-term value of acquiring a customer and the potential for upselling and cross-selling. Similar to the second point above. This is just a tradeoff you make between more effort provided earlier in the process before you can benefit from that later. It will require further adjustment on the CTS metric later, but at least it pushes sales and marketing departments to increase the quality of the account they are trying to acquire.
Let me use a good live example in the cybersecurity world that comes from Crowdstrike company which provides endpoint protection provider, threat intelligence, and incident response services. Adding a new product like Falcon X Recon that complements its services with automated data collection and analysis makes it's core offering more attractive. While the development and launch of Falcon X Recon may not be directly related to customer acquisition, CrowdStrike may still include these costs in its CAC calculation. This is because the launch of Falcon X Recon can help CrowdStrike differentiate itself in the market and attract new customers. The product may also provide upselling and cross-selling opportunities for existing customers, increasing their lifetime value.
It's important to note that this suggestion directly relates to a specific cybersecurity market and how it's organized as "slices of bread." A highly competitive and rapidly evolving industries like cybersecurity, investing in product development and enhancement may be critical to attracting customers and expanding their presence in other parts of the industry.
Moving onto the financial services with a live example (almost there, guys, and will wrapping up) that includes regulatory-related expenses in its CAC metric is Charles Schwab, a leading brokerage and investment firm. As a financial services company, Charles Schwab is subject to various regulations and compliance requirements, which can result in significant expenses related to customer acquisition.
Each time a new customer opens an account with Charles Schwab, the company must conduct various compliance checks and due diligence processes to ensure that the customer meets all regulatory requirements. This can include verifying the customer's identity, conducting anti-money laundering (AML) checks, and screening the customer against various sanctions lists and watchlists. These compliance-related activities can be time-consuming and costly, especially for new customers unfamiliar with the account opening process. But that's not the end. Companies in this industry may require to invest in new technology or systems to ensure compliance, ultimately increasing the acquisition cost.
By including these regulatory-related expenses in their CAC calculation, Charles Schwab can better understand the actual cost of acquiring a customer and the impact of regulatory requirements on their business. This can help the company make more informed decisions about customer acquisition strategies, such as targeting specific customer segments or adjusting pricing to reflect the actual acquisition cost.
Regulatory expenses include the costs associated with compliance with various laws and regulations, such as the Dodd-Frank Act and the Sarbanes-Oxley Act. These expenses are necessary for companies operating in the financial services industry and acquiring new customers. Failing to comply with regulations can lead to significant legal and financial penalties.
It's important to note that not all financial services companies may include regulatory-related expenses in their CAC calculation. However, for companies that operate in heavily regulated industries like finance, including these expenses can provide a more accurate picture of the cost of acquiring a customer.
Finally, the write-up and conclusion. Understanding and accurately calculating CAC is critical to any growth strategy, regardless of industry or business model. By including all relevant costs in the CAC calculation, businesses can better understand the cost of acquiring a customer and make informed decisions about their investment strategy. The examples of Crowdstrike and Charles Schwab demonstrate how different industries and business models can impact the components included in the CAC calculation. Still, the underlying importance of accurately calculating CAC remains the same. For financial professionals in the venture capital industry, understanding CAC is essential for evaluating the financial return on their investments and helping their portfolio companies optimize their customer acquisition strategy. If you are revenue operations professional, you must understand and keep that metric under control. It's your job to ensure that vertical leaders understand the definition, metrics components, and leverage they have in their hands to make the acquisition process more effective. When the management and investors ask for insight, you must keep your documentation, numbers, and consistently revised narratives handy. This is not a matter of an empty muster in the org but a question of organizational credibility. Take it seriously.
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