As a business owner, keeping track of your customer acquisition costs (CAC) payback period is essential. CAC is the total cost of acquiring new customers, while the payback period is the time it takes to recoup your CAC investment. Knowing these numbers can help you decide where to allocate your resources. This guide will show you how to calculate CAC payback period and take action to ensure steady growth.
CAC Payback Basics
CAC Payback is a measure of how long it takes, in months or years, for the cost of acquiring a customer to be recouped.
A low number of customers acquired means you’re not doing enough to acquire new customers, while a high number is a sign you are overspending on acquiring them.
One of the challenges of accurately calculating your CAC is that there are multiple ways to do the calculation, depending on how you want to present the numbers (including upsells). This can make it difficult to accurately understand your sales efficiency. Continue reading to learn how to calculate CAC payback period quickly and accurately.
One small change in your calculation method can significantly impact the accuracy of your results and make it difficult to understand the actual state of your sales efficiency.
To calculate your payback, we recommend using this formula:
CAC payback is sales and marketing expenses in the period divided by (net new monthly recurring revenue acquired in that period * gross margin).
This calculation cannot be accurately completed without a firm understanding of your sales and marketing expenses, MRR by the customer, and gross margin. Gross margin is an important number to consider when calculating CAC. Remember to include expenses for customer success resources focused on onboarding in your Cost of Goods Sold.
Before you can master the art of getting through to your prospects, you need to nail down your pitch.
When calculating your CAC, you must use net new MRR in your figure. Net new MRR equals the sum of MRR from new customers, expansion MRR from existing customers, and churn MRR from lost or downgraded customers. This will give you the most accurate picture of your CAC payback period.
If you have a long, drawn-out, complex, or expensive sales process, it’s acceptable to offset the sales and marketing expenses by the average length of your sales cycle.
Be sure to use your best judgment when offsetting, as being overly generous can make it seem like your CAC payback is better than it is.
As a reminder, it is important to keep in mind that MRR is not cash. In addition, it is essential to have a strong understanding of retention and receivables dynamics when forecasting cash flow.
Start calculating CAC payback as soon as you can.
You will still benefit from keeping your target CAC payback in sight at a small scale. This will help you plan and hit your goal more effectively. However, the numbers may be slightly skewed because you’re not operating at full scale.
By tracking your phone calls, you can identify areas for improvement.
As you measure and investigate fluctuations in your CAC payback, you’ll gain a deeper understanding of the underlying inputs – such as cost per lead by channel, lead conversion, and sales cycle length. This knowledge will enable you to make changes that reduce your payback period. Additionally, knowing that everyone is keeping an eye on this metric will support a culture focused on efficient growth and keep your entire team committed to controlling CAC.
When everyone is aware of the CAC payback metric, it creates a culture focused on efficient growth. This, in turn, keeps the entire team committed to keeping CAC under control.
This article was initially published in June 2019 and refreshed in January 2022 with new data from the 2021 Financial and Operating Benchmarks Report. Curt Townshend provides helpful information on calculating your company’s CAC payback period.
While it may be true that spending money is an inevitable part of running a business, it’s arguably more important for software as a service (SaaS) companies to focus on how to acquire new customers.
These costs, collectively, are called customer acquisition costs, or CAC.
CAC is the total cost of marketing and sales expenses that a company has to incur to acquire a new client.
In addition to your salary, advertising costs, and commission, there are additional substantial business-related expenditures such as office rental and salaries.
While CAC is accepted as the cost of acquiring a customer, it should not be a free pass for sales & marketing to spend as much as they want.
CAC payback is a crucial metric for SaaS companies. It’s essential to ensure that your CAC payback is consistent and predictable and that you’re regularly discussing it at a board level.
Failing to manage your (or your investors’) CAC can break (or make) your business.
CAC payback is a complex topic that can make or break your company. Even at the board level, there is no universally accepted framework for calculating, managing, and positively affecting the metric. Cash payback is the real difference between the life and death of your startup.
As the cash payback period is the main differentiator between a successful and unsuccessful startup, it is crucial to manage and positively affect this metric.
If you’re looking to recoup your cash as quickly as possible, it’s better to charge annual upfront rather than monthly in arrears. This way, you can get your money back within 18 months.
How to Calculate CAC Payback Period
The payback period is the time it takes for an investment to generate sufficient cash flows to cover the initial investment.
To calculate your customer acquisition cost payback period, you will need to know your customer acquisition cost and the total revenue that a single customer brings in over the course of one year. You can then use this formula:
CAC Payback Period = (Customer acquisition cost)/(annual revenue from customer).
Let’s take a look at an example of this.
You run a software-as-a-service (SaaS) company, which costs $75 per month. This means a subscriber pays you $900 a year.
If your CAC is $500, it means you’re spending $500 to acquire each new customer.
Now, we can calculate the CAC payback period.
To calculate the CAC payback period, divide the customer acquisition cost by the annual revenue from the customer.
(Customer acquisition cost)/ (annual revenue from customers).
50% of 900 = 450.
5 months 9.5.
55% of CAC is recouped within the first 12 months.
55% of CAC is recouped within 12 months.
The payback period for your customer acquisition costs is 0.55 years or roughly 6 months.
CAC Payback Period Benchmark
A shorter payback period is usually better when it comes to CAC payback. Most people think of 12 months as a great CAC payback time, but it’s important to compare your company to others in your industry.
A best-in-class CAC payback period will vary depending on your go-to-market strategy and customer type. However, it’s important to keep in mind two other key metrics: logo retention and net dollar retention.
The typical CAC payback period for a business that sells to large enterprises and has a long sales cycle supported by a field sales model is higher than for a product-led company that leverages virality and a self-serve freemium model targets businesses of all sizes. This is because businesses with long sales cycles typically have higher costs associated with their sales reps, who are often highly compensated and have extended ramp-up times.
As your business matures, keeping an eye on your CAC payback goals is important.
Vertical platforms, such as CRM, ERP, and SCM, play the most significant role in influencing benchmark selection, market-entry, and target customers.
That said, no metric exists in a silo, and CAC payback is no exception. Because CAC payback is an implied value, you also need to look at CAC payback in the context of logo retention and net dollar retention.
If your CAC is higher than average, but your retention rate is much better than your peers, you may have a business model that compensates for high levels of CAC.
If you have a high retention rate for your customers and they continue to pay you more over time, you can be confident that you will eventually recoup all your sales and marketing costs. Even if it takes a few years, eventually, you will reach a point where you are breaking even on each customer you acquire.
If your CAC payback goal is six months, but you’re losing most of your customers by month three, you’ll never make up the costs of customer acquisition. The best way to ensure your CAC payback goal is achievable is to focus on retention.
If you pay to acquire clients once and then sell add-ons, new features, or new products to them, you can soon improve CAC payback period. Don’t get so caught up in the lifetime value of a customer that you forget about CAC and customer retention.
CAC Payback represents a single point in time, and the long-term trend is more important.
Keep an eye on your numbers as your business scales. Remember, these numbers will only increase, so be proactive about maintaining your efficiency and quality.
As businesses grow, they typically see a decrease in their productivity. This is caused by market saturation, increased competition, and, in some cases, scaling of operations.
As you grow, you’ll likely need to bring on more employees, which will increase your monthly expenses. Don’t forget that you’ll need to factor in the cost of renting office space for your sales team.
The key to riding these waves successfully is anticipating them (so no one panics) and being consistent about measurement so you can quickly diagnose and address any growth challenges.
Conclusion: How to Calculate CAC
If you’re running a business, it’s important to know how to calculate CAC payback period. Knowing these numbers can help you decide where to allocate your resources. By following this guide, you will be able to do it quickly.