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According to a survey by ProfitWell, 75% of SaaS startups track CAC payback as a critical metric. The survey also found that SaaS startups' average CAC payback period is 5-12 months. Another survey by RevOps Squared found that the median CAC payback period for all B2B SaaS companies was 16 months in 2021. The survey also found that CAC payback correlates to company size, with smaller companies having shorter payback periods.
Most sales leaders think that SaaS startups' critical job is bringing customers. Although some income is better than none, only some customers create value for the company in the long run. Instead of focusing on any customer, the emphasis should be on attracting top-tier customers who remain loyal to the product or service over time.
The sales teams must target the ideal audience and consistently offer value to achieve this, improving their return from the efforts they put in. On the other hand, minimizing customer churn is essential, which can be addressed by delivering the vision and solution you are committed to. The other fallacy is customer success. You must create a superior customer experience, making you partially successful. This statement is not against superior customer success function. It's quite the opposite. Your product must be strong to have even more vital customer support. That doesn't mean the CSM teams should give up when that's false. It's just a limited result you can get without one or another consistently delivering stellar customer support and regularly enhancing their offerings. Lastly, to boost the lifetime value of a customer, startups can present opportunities for upselling and cross-selling, as well as provide incentives for prolonged commitment to their products or services. Knowing all this, what is the easiest way to assess whether you are on or off track? That's precisely what I'm suggesting here.
Having your ICP, Persona, TAL, etc., all of that is important. However, if you don't measure your ROI on this effort, it will not make you better or likely convert you to a spender instead of making a money machine. Having CAC measurement in place is helpful, especially if you break it down into several categories following your segmentation. The next level of improvement on that front could be your CAC payback measure that can help to explain to your marketing and sales teams whether they are doing a good job acquiring a good quality of customers.
Let's use an example to illustrate how the logic should work. Company A is a SaaS startup providing small businesses with customer relationship management (CRM) software. The company has a CAC payback period of 12 months. This means it takes Company A 12 months to earn back the money it spends on acquiring a new customer.
Company A's marketing team develops a new campaign to acquire new customers. The campaign is booming, and Company A is acquiring many new, smaller customers. However, Company A's CSM team cannot keep up with the volume of requests from the, and as a result, their onboarding process hurts. As a result, many new customers churn within the first few months as a company can't have more dedicated support for their customers.
The same company's CAC payback period increases to 18 months. This means it now takes Company A 18 months to earn back the money it spends on acquiring a new customer. This hurts Company A's cash flow, as it takes longer to generate revenue from its new customers or might not even generate profit for an extended period.
Company A is now forced to cut back on its marketing and sales expenses. This makes it more difficult for the company to acquire and retain new customers. As a result, Company A's growth rate slows down.
In this example, Company A failed to plan for the impact of its marketing and sales spending on its CAC payback period. As a result, the company's cash flow was negatively impacted, and its growth rate slowed down. Although a hypothetical example, it's happening often with companies that fall into the trap of premature scaling without evaluating their product scaling abilities.
That buck doesn't stop here. While the growth impact is clear, we should remember that the consequences are far-reaching, impacting the company's balance sheet and cash flow statements. A few bullet points on that front below about each statement:
1. CAC payback can impact the balance sheet in two ways:
Assets: CAC is typically expensed as a marketing or sales expense on the income statement. However, if a company needs more revenue from its new customers to cover its CAC within 12 months, it may need to capitalize its CAC as an asset on the balance sheet. This is because the company is investing in its future customer base. Without getting too much into the details, if you are planning something in this space and you are on your money, this process works to your advantage; conversely, if you miss and you planned to amortize this over the 12 but it takes you 18 months, you expose the company to a negative impact on the company's earnings. Second, capitalizing CAC can increase the company's balance sheet leverage. This can make the company more vulnerable to financial distress in the event of a downturn in the economy.
Liabilities: If a company cannot generate enough revenue from its new customers to cover its CAC, it may need to borrow money to finance its growth. This will increase the company's liabilities on the balance sheet, lowering the equity. It's not a great selling point to your investors.
2. Impact on free cash flow CAC payback can also impact FCF in two ways:
Cash flow from operations: CFO is calculated by subtracting operating expenses from revenue. If a company's CAC is high, then this will reduce its CFO. Operating expenses include all the costs associated with running the business, such as salaries, marketing expenses, and rent. Thinking about the negative impact, it can reduce the amount of money the company has available to invest in its growth (your GTM team, for starters). Second, it can make the company more vulnerable to financial distress in the event of a downturn in the economy. Third, it can make the company less attractive to investors, as it shows that it cannot generate enough revenue from its new customers to cover its acquisition costs.
Capital expenditures: Capex is the money that a company spends on long-term assets, such as property, plant, and equipment. If a company needs to capitalize on its CAC, it will increase its capex. Wondering why? It's not intuitive but logical, though. Capitalizing CAC means the company records it as an asset on its balance sheet (please see the Balance Sheet section above for amortization reference purposes). Assets are typically long-term investments, such as property, plant, and equipment. Therefore, capitalizing CAC will increase the company's capex. Many companies have another reason to pay attention to that. Capitalizing CAC can improve the company's return on assets (ROA) and equity (ROE). This can make the company more attractive to investors. The bottom line is that if your CAC payback period is longer, you will likely need to reconsider your other capex investments.
Here is the math behind the CAC Payback:
CAC Payback Period= MRR/ CAC
Where:
CAC = Cost of Acquiring a Customer
MRR = Monthly Recurring Revenue per customer
CAC Payback Period = $500 / $100 = 5 months
This means it takes Company 5 months to recover the cost it invested in acquiring a new customer.
Another way to think about it is that Company A generates $100 in revenue from each new customer each month. Therefore, it takes Company A months ($500 / $100) to generate enough revenue from a new customer to cover the cost of acquiring that customer.
Conclusions: Remember the quote from Michael LeBoeuf about the customer: “A satisfied customer is the best business strategy of all.” We all know that but often forget about to get there. The CAC Payback is not a metric that will get you more volumes or more revenue in the company but will tell you how much you pay for what you get. Let's be honest big component that can support or skew the numbers are incentives you put for your sales teams. They can be opportunistic in their pure nature or more aware of what they focus on and make your work easier. If customers are lured by the low-price incentives, I'd question the potential for the loyalty or effectiveness of your value proposition. That's more of an act of desperation than a planned, methodical approach to customer acquisition. All in all, you want to ensure that your groundwork is in place before you start a conversation about the CAC Payback. If your CAC definition sucks, your CAC Payback will too. Take time to set the basics first and adopt them before you start setting hundreds of metrics that are not getting you anywhere. Once done with basics, create a culture of understanding them, and elevate one level up before introducing another level of sophistication. Below are a few key points on setting CAC Payback metrics in your organization:
Plan with Purpose: Incorporate CAC Payback into annual planning processes. A shorter CAC Payback indicates a faster return on investment, which can be a green flag during board presentations or investor pitches. Start trimming your costs before you see them on incoming invoices. Sorry, it's just a reality.
Stay Liquid: A prolonged CAC Payback period can strain cash reserves. Ensure you have enough liquidity to navigate through the payback duration. Don't simulate your planning for the capacity and P&L; enhance that to your Balance Sheet and Cash Flow statement. Share assumptions behind them with your exec team. It's worth it.
Iterate and Optimize: Regularly review your marketing and sales strategies. If the CAC Payback period is extended, it may be time to reassess and optimize, which means cutting or reshuffling your budget. It's not a great mid-year conversation with your employees, but it's very likely necessary.
Know Your Benchmarks: Understand industry-specific CAC Payback standards; broadly speaking, Saas is 5-12 months, e-commerce is 12-18 months, B2B 18-24 months and Consumer might be 24-36 months. Of course, each of the subsegments or subindustry will be different.
Value Over Volume: Prioritize acquiring high-quality customers who can provide more significant MRR, thus reducing the payback period. This is the focus area on multiple fronts, including sales incentives, marketing campaigns, and pricing discounts; create them to ensure that this can get you ahead.
Transparent Talk: That's hard, but it might bring you unexpected positive ideas on optimizing it. Communicate CAC Payback metrics to stakeholders and investors.
Strategic Scaling: For startups, as you scale, keep an eye on how the CAC Payback period changes. Rapid expansion should come at a manageable cost of prolonged payback durations. Remember, it will likely not stay the same, and make some tradeoffs while you scale your sales team.
Review your pricing: it's about the unit price vs. volume game. If you can get a higher volume of deals with the same value of the bookings while you're scaling, it's worth adjusting your pricing strategy for the high quality of customers. At least consider the discounts while you talk to your investors about the extended payback period (please see the point about the transparency). While working on your annual planning, you should evaluate the pricing fit for what you want to achieve from the P&L perspective.
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