What is CAC?
Customer Acquisition Cost, or CAC, is the cost of acquiring a new customer in your business. The metric is used in a variety of industries but is perhaps most common in SaaS and other subscription businesses.
It is essential in many resource allocation decisions.
Why calculate CAC?
Having a deep understanding of the costs associated with acquiring a new customer will have massive implications on operational decisions in your business.
CAC and its sister metric, Customer Lifetime Value or CLV, help drive strategic business decisions about what to sell, who to sell it to, how to deploy capital to acquire customers and more.
How do I calculate CAC?
Here’s where it gets tricky. As with all SaaS metrics, there is no governing body that dictates how to calculate it. Unlike GAAP financials, no standards board provides guidance on exactly what gets included in the calculation of CAC and what doesn’t.
However, there are some best practices to observe, and there are some common mistakes we’ve seen people make over the years.
CAC Mistake #1: Including costs associated with existing customers.
A big thing to remember about CAC is that it should only account for the costs associated with acquiring NEW customers.
The costs associated with maintaining existing customers or growing their usage of your product should not be included.
At SaaSOptics, for example, we have a resource on our marketing team who is solely dedicated to current customers. We’ll call her Katie because her name is Katie.
If most of Katie’s time is being spent on the customer side, it doesn’t make sense to include Katie’s salary and other employment costs in the overall Sales and Marketing spend that gets factored into CAC.
Because the cost of having Katie on the team is not associated with acquiring NEW customers but rather the cost of maintaining and growing current customers, it would not be accurate to include her employment costs in the calculation.
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CAC Mistake # 2: Including only Sales and Marketing Expenses.
Another common mistake people make when calculating CAC is including only Sales and Marketing related expenses in their calculation.
In fact, most websites cite the formula for CAC as:
CAC = Sales and Marketing Expenses / Number of New Customers
But this is not entirely correct.
The formula should actually read:
CAC = Costs Associated with Acquiring a New Customer / Number of New Customers
The first formula for CAC paints an incomplete picture of the true costs associated with acquiring a new customer.
By including only Sales and Marketing expenses, you’re potentially leaving out other kinds of costs associated with acquiring the new customer.
Take, for example, a company that offers free trials or Proof of Concept of their software. That trial or PoC isn’t free. There are possibly server costs associated with hosting that customer’s trial and implementation/support costs associated with facilitating the trial.
To leave those costs out of your CAC calculation would mean painting an inaccurate picture of the actual cost of acquiring a new customer.
Other CAC Calculation Considerations
Small Teams Wearing Multiple Hats
Another consideration to take into account when calculating CAC is the nature of work at smaller companies and the tendency for employees to “wear multiple hats.”
For example, suppose you’re at a small SaaS company where your sales team is managing existing customers as well as closing new ones. In that case, you do not want to include 100% of that person’s associated costs into your CAC calculation.
Suppose a salesperson earns a $100,000 base salary, but their time is split 70/30 between chasing new customers and nurturing existing ones. In that case, it makes sense to allocate only $70K of the base salary rather than the full $100K to your cost of acquisition (for now, we are omitting the related variable comp and marketing costs for this rep’s deals).
A more explicit example of the above:
The rep above closed a deal for a new customer in January and earned a $2,000 commission.
Our analysis of Marketing costs to get this customer was $5,000. So the complete CAC for that 1 customer in Jan would include the following:
100,000 *0.7 = 70,000/12months = 5833 (portion of time spent on new customer acquisition in Jan) + 2000 (rep commission for this customer) + 5000 = 12833 total.
This is a cut-down example for clarity. Day-to-day, rather than figuring it out per customer, you would most likely lump all relevant costs together for January. and divide by the number of new customers in January.
While some acquisition costs are more straightforward, others are harder to attribute to a specific time period.
For example, say your sales team attends a trade show in January, but you expect to acquire customers from the leads generated there over the course of the year.
If you attributed the cost of the trade show in its entirety to January, your acquisition cost would seem disproportionately high compared to the number of new customers you acquired in January.
It would follow then that it makes more sense to amortize the conference’s cost over the course of the year so that it more accurately reflects the return on investment of attending the trade show.
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Why a CAC Policy is a Good Idea
Unlike other SaaS metrics such as ARR or MRR, CAC is a bit of an accounting project on its own requiring analysis and management judgment. You can’t simply plug a few inputs into a calculator and have it spit out your Customer Acquisition Cost.
Since there’s no governing body for SaaS metrics, there’s a lot of room for interpretation when calculating the metric.
This is why instituting a CAC Policy is a good idea. Like revenue recognition, calculating CAC has less to do with following a specific script and more to do with being clear and consistent in the way you define and calculate it.
A revenue recognition policy is a single document that summarizes your processes and methodologies used to recognize revenue. Your rev rec policy is where you establish the rules that govern the consistent application of the ASC-606 framework at your company.
A CAC policy would function in the same way. Your CAC policy is a single document that summarizes what goes into your Customer Acquisition Cost calculation and why. It also ensures the metric is being calculated the same way across the business.
Additionally, it serves as documentation to point back to if and when your investor asks you to elaborate on how CAC is calculated in your businesses.
It’s important to note that your CAC policy, like your rev rec policy, will evolve as the business evolves. What makes sense to include in the calculation today may not make sense in a year or two, so it’s a good idea to revisit the policy periodically.
What Should Be Included in CAC?
As we said before, the most important things to keep in mind when calculating CAC are:
- Only include the costs of acquiring NEW customers
- Include ALL costs of acquiring a new customer that you deem relevant, not just your sales and marketing spend
However, there’s still a lot of ambiguity about what should be included and what shouldn’t.
The simplest guidance here is to only include what makes sense for your particular business.
For example, some people include things like rent in their Customer Acquisition Cost. But this may not make sense for your business.
If only 1% of the team in the office is devoted to new customer acquisition, including more than 1% of the rent would overstate the rent portion of your CAC.
Worse still, what if your staffing level changes? You’ll need to make sure you update your CAC policy and calculations.
Given the overhead of maintaining the rent portion of the calculation and policy and the fact that you won’t be able to do much about the rent cost in any case (assuming you signed a lease), you are probably better off excluding it in this example.
An easy litmus test for this is to ask your investor. If your investor asks about rent, include it in your calculation. If they don’t, leave it out.
A Quick Note on Investors
You have a lot of leeway to calculate your Customer Acquisition Cost as you see fit in your business, but that doesn’t mean you should get too crazy.
It’s common to only include inputs that make you look good, but keep in mind that investors are very skeptical about CAC numbers that seem too good to be true.
Plus, if your CAC number isn’t an accurate representation of what’s going on in your business, it will be ineffective in helping you make critical operational decisions.
How To Successfully Use CAC as a Metric in Your Business
Just like Revenues and Customers, it’s always a good idea to segment Customer Acquisition Costs in your business.
No two types of customers are the same, so it’s essential to understand how expensive it is to bring on each customer type.
For example, there are generally higher costs associated with bringing on Enterprise customers, as sales cycles tend to be long and these customers are unlikely to agree to pre-written contract terms without some back and forth or getting their legal teams involved.
That isn’t to say that it’s not worth it to pursue Enterprise customers. Still, you have to be mindful of the Customer Lifetime Value or CLV in proportion to the costs associated with acquiring a customer in that segment.
Understanding how your CLV to CAC ratio differs from one segment to the next will significantly impact strategic decision-making.
Use your CLV to CAC ratio to dig around for operational insight. Ask yourself where you are spending money and how you can best deploy your resources for maximum payback.
These types of resource allocation exercises will pay off in spades.
Remember: CAC can be a large-scale accounting project and will require time and energy to perfect. However, every minute you spend figuring out how to calculate it in your business and gleaning operational insight from it–will be worth it.
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