As a growing SaaS company every expense you make needs to be scrutinised, because there are several different channels you can invest in in order to generate sales. One of the traps that SaaS companies should avoid is spending money on low ROI activities. A great metric to take as the rule of thumb while determining the ROI is the customer acquisition cost (CAC), which we’ll talk about in this blog post.

Before we jump into it, here’s a list of the different topics we’ll be analyzing:

Defining CAC, CLV and CM

The effect on profitability and cash flow

How to lower CAC

Causes that increase CAC (brief explanations)

• cold-calling
• account executives focusing on prospecting
• a high number of human touches in the sales process
• high competition / low differentiation
• inexperienced sales staff

Solutions to decrease CAC

• adopting cold-calling 2.0
• making customer profiles
• increasing lead quality and relevance
• automating as much of sales as possible
• separating leads development and account management
• A/B testing to optimize sales related activities

Summary

Defining CAC, CLV and CM

In terms of numbers, there are a lot of metrics to track the profitability of your startup, but if you were to narrow them down as much as possible you’d realize that the three main ones are:

Customer Acquisition Cost (CAC)
Customer Lifetime Value (CLV)
Contribution Margin (CM)
In order to better understand these concepts I’ll breakdown each one to their core definition.

Customer Acquisition Cost

CAC is the average cost of acquiring a new customer. It is one of the key performance indicators (KPIs) of a SaaS company. You can calculate your CAC by using the following formula:

CAC = (Total cost of Sales and Marketing) / (Number of New Customers Acquired)

CAC can be calculated at different levels and there are fixed as well as variable components to your overall CAC calculation.

The salary you pay to your sales staff is a fixed component of CAC. The commission you pay on each sale is a variable cost included in your CAC. The money you spend on Search Engine Marketing, Paid Marketing, Social Media Marketing, affiliates, referrals among others are mixes of fixed and variable components of your CAC.

Customer Lifetime Value

One key variable affecting profitability of a company, in addition to CAC, is the Customer Lifetime Value. CLV is calculated by the average monthly recurring revenue generated per client multiplied by the number of months a client remains a customer. So if on average your clients pay you $500 per month and their life time duration is 24 months then your CLV is $12,000. Here’s the formula:

CLV = Monthly Recurring Revenue x Customer Lifetime Duration in number of Months

Contribution Margin

Your Contribution Margin is calculated by subtracting CAC from CLV. Assuming your CLV is $12,000 and your CAC is $2,000, then your CM is $10,000. All of your non marketing and sales expenses are subtracted from your CM, for example salaries of your developers. Most of the costs subtracted from CM are fixed so the larger the CM the higher your profitability.

The effect on profitability and cash flow

CAC influences profitability and cash flow of SaaS companies and since most are subscription based, revenues are generated over a period of time. A higher CAC means a longer period before the CAC is recovered, which impacts a SaaS company’s cash flow as well as profitability.

Let me illustrate the effect of CAC with an example. SaaS XYZ has a CAC of $2000, and earns $400 from a client per month. In this case, SaaS XYZ will recover the CAC after the 5th month and become profitable from the 6th month.

The bare minimum of what a SaaS company should aim for is to recover CAC in under 12 months and retain a customer for longer than 12 months.

So in a few words, time to recover Customer Acquisition Cost < Customer Lifetime Duration, otherwise your company is not making profit.

One of the steps you can take to alleviate the negative cash flow effect is by collecting upfront payments for a period greater than the time you need to recover the CAC. In the example above SaaS XYZ can ask the client to pay every 6 months in advance.

Ideally, in order grow fast, SaaS companies should keep their CAC as low as possible. The faster CAC can be recovered, the more money can be re-spent on getting new customers. In turn, CAC affects a SaaS company’s profitability AND growth.

To increase your Contribution Margin and ergo your profitability there are three possible ways, 1) increase your MRR, 2) increase your Customer Lifetime Duration, and 3) lower your CAC. Increasing MRR and Customer Lifetime Duration will be discussed in a future post, but here are few steps you can take to lower your CAC.

Factors that increase CAC

Firstly, eliminating the causes that increase CAC will already help you lower it. Here are a few of those:

• Cold-calling – this method is still used but it has been shown to provide lower returns than other forms of cold outreach like cold emails
• Account executives focusing on prospecting – by dividing their efforts into tasks that are not their specialization they won’t be able to dedicate their time to the real money making tasks, from demoing the product to closing the sale
• A high number of human touches in the sales process – there are certain tasks in the funnel that can be semi or fully automated and by not doing so you’ll cost yourself conversions
• High competition / low differentiation – the more companies there are in the marketplace the harder it will be to get attention of the prospect and convert them into a customer
• Inexperienced sales staff – a lack of competency in sales experience can also influence your end numbers because they will be less efficient and usually have a higher lead to customer ratio

There are definitely other factors that increase CAC however I deem these to be the most detrimental.

Factors that decrease CAC

Conversely, there are steps you can take to decrease your CAC. You can lower it with one or more of the following approaches:

• Adopt cold-calling 2.0
• Make customer profiles
• Increase lead quality and relevance
• Automate as much of sales as possible
• Separate leads development and account management
• A/B test to optimize sales related activities

Here is the breakdown of each one:

Adopting cold-calling 2.0

In the new generation of outreach, cold calling has been shown to not be as effective as in previous generations, but it doesn’t mean that there isn’t a time and place for it, for example, when you understand through other channels that a certain company is highly interested in your product, it is best to just give them a call. However, as a first form of contact with a cold lead, there a fewer and fewer situations where cold calling seems to be the most effective.

The great news is that as one type of outreach goes out of fashion, new forms appear, and in this case it’s cold emailing which has two major advantages, one, you’re able to send multiple personalized emails at the same time, and two, you’re not obligating the recipient to answer right away, which means that you avoid disrupting their work flow.

The latest generation of cold outreach is being forced to go one step further by utilizing other channels like LinkedIn, Xing and other social media because email is also getting more competitive and noisy.

By implementing these strategies you’ll increase the chance of converting a prospect into a customer and consequently lower your CAC.

Making customer profiles

When doing you outreach you need to establish a customer profile so that you can increase personalization by customizing the main aspects of your email (email message, subject line, etc). Here are some factors to consider when creating your customer profile:

type of company (b2b or b2c) – companies that want to target other business or that go directly to consumer
number of employees – companies from SMBs to Enterprise level
target market – companies in a specific industry
By separating customer profiles you understand each prospect profoundly and you can personalize your messaging to maximize each interaction, which will lower your CAC.

Increasing lead quality and relevance

A lot of companies that rely on cold outreach need to create lists of prospects to target, which frequently ends up in them buying the cheapest leads from low quality vendors and getting mediocre results.

In our experience, this is not the best solution because reaching out to leads of bad quality equates to lower engagement with your emails, higher bounce rates, decreased domain health, and, in the long run, you’ll also pay more per conversion.

There are two main ways to attain higher quality data, one, you form an internal prospecting team whose only purpose is to provide you with quality leads, but the downside is the time and money spent on training the staff; second option it to partner up with a reliable vendor in the data research sector that can provide you with high-quality data enriched and/or verified by extensively trained humans and software. Even though the price per prospect might be higher, the deliverability of your campaigns will be too which will lower your CAC.

Automating as much of sales as possible

The first automatable task is that of prospecting and list building, which should be automated or outsourced whenever possible. Even though the customer profile might change depending on the market, it will remain the same within the same industry.

Reaching out to prospects can also be automated after the creation of email templates, by using software that enables you to send emails which are customized for each decision maker through dynamic placeholders.

Finally, objection handling and qualifying prospects can be automated but only once you understand the different possible replies of prospect, by creating specific templates for each response.

Through automating all of these stages of the sales development process you’re in a position to invest more time in tasks that cannot be automated which will provide you with more conversations, demos and closes per unit of time, consequently decreasing the CAC.

Separating leads development and account management

Generally speaking this process is only relevant for bigger sales teams that have the ability to separate into two departments, even though you can still accomplish this with only two people.

The purpose of dividing sales development and account management is to increase the productivity of team members by specializing in fewer tasks. Over time, this will result in the optimization of the process which would lead to a lower CAC.

A/B testing to optimize sales related activities

A/B testing should be an integral part of your process, especially regarding subject lines and email templates that require experimentation to find the highest performing copy.

However, this concept can also be extrapolated to other branches of the funnel, for example, to test if its better to schedule a call or demo, or to assess if the objection handling should be more or less aggressive, or to evaluate who are the best decision makers to target, or even to investigate if it’s superior to reach out first through email or LinkedIn.

Again, there are other steps you can take to decrease your CAC but these are the ones I recommend cause I’ve personally deployed them and seen their effects first hand.

Summary

In this article I examined the concept of Customer Acquisition Cost and its importance to SaaS companies, taking you from its effect on profitability to applying tactics that will lower it to increase revenue in your company. Here are the main takeaways from this post:

Customer Acquisition Cost (CAC) is the investment necessary to acquire one customer.

Customer Lifetime Value (CLV) relates to the amount of money one customer will make you while using your product

Contribution Margin (CM) is the difference between CAC and CLV which if positive will determine that you’re currently profitable

To maximize profitability your CAC should be as low as possible and your CLV as high as possible

How to lower CAC

Causes that increase CAC

• cold-calling
• account executives focusing on prospecting
• a high number of human touches in the sales process
• high competition / low differentiation
• inexperienced sales staff

Solutions to decrease CAC

• adopting cold-calling 2.0
• making customer profiles
• increasing lead quality and relevance
• automating as much of sales as possible
• separating leads development and account management
• A/B testing to optimize sales related activities

Keeping track of the KPIs that determine profitability and consequently the runway of a SaaS startup can be a challenge, but hopefully with the information presented in this post we’ve empowered you to optimize them, specifically your CAC, to generate you even more revenue.