What is Customer Acquisition Cost? Why It’s Important and How to Calculate it (with Examples)

Why is customer acquisition cost important?

CAC answers, “How much do you spend to acquire a new customer?”

CAC forms a part of the CAC Ratio and SaaS magic number formulas that calculate this efficiency. For example, if you spend $1 on sales and marketing to acquire $0.25 of new ARR in a quarter from a new customer, you are making back your CAC within one year.

However, this calculation doesn’t take COGS and the majority of your operational expenses into account. Thus, you are not actually breaking even for a lot longer.  

This makes higher CACs less desirable and places emphasis on reducing churn rates and increasing renewals. The more renewals, the higher your company’s LTV and the more upsells and cross-sells you can generate to increase ARR without raising CAC.

As a result of the exclusions from this calculation, although useful in SaaS metrics-based planning, CAC alone cannot be relied on for new ARR planning.

How CAC relates to LTV

CAC is crucial to measuring sustainability of your customer acquisition strategy. However, on its own, CAC doesn’t offer comprehensive insight into your company’s marketing and sales efficiency. It’s only when you compare CAC to your LTV that you can conclusively determine the ROI of your marketing and sales efforts.  

LTV:CAC measures how customer acquisition costs compare to the lifetime value those clients provide. It is a very important metric as investors will often consider the LTV:CAC before investing in a SaaS company. In addition to other factors, investors want to know the value of your customers, not just the costs associated with acquiring them. Consider the two hypothetical companies below:  

If you’re just looking at CAC, Company A would seem to be much better off than Company B. However, by comparing each company’s CAC to their LTV, it’s becomes very apparent that Company B’s go to market (GTM) strategy is far more sustainable. For every $1,000 it spends to acquire a customer, it’s getting $5,000 in LTV. That’s 5x its CAC, whereas Company A is only getting 2x its CAC in LTV.

In short, while CAC helps you understand how much it costs to acquire customers in terms of sales and marketing, the LTV:CAC ratio gives you a quick picture of the ROI your marketing and sales teams deliver.

Connecting CAC to your growth strategy

The ratio between CAC and LTV can be very useful when assessing growth sustainability. However, CAC payback periods can impact this assessment as well. The CAC payback period is a measure of how quickly you recover the money you spend acquiring customers.

Short payback periods mean your company quickly regenerates the money spent on customer acquisition and doesn’t have to rely on raising funds to cover general expenses. As a result, your company may be more appealing to investors focused on cash returns.

Here are some examples of how growth strategies can affect your perception of CAC and its importance:

• Company A wants to grow at any cost -- It invests in high-volume marketing channels. CAC is not a major concern.
• Company B wants to optimize valuation -- It invests in only the best LTV:CAC channels. The lower the CAC, the better. Payback periods, unless extreme, are not too important.
• Company C is prioritizing for better cash flow -- It invests in the fastest payback channels and makes keeping CAC low a priority. Although important, LTV is not what they optimize for first.

How to calculate the cost of customer acquisition

Use this formula to calculate CAC:

It’s common for SaaS companies to calculate their CAC by dividing total marketing and sales spend for the previous year by the total number of customers acquired in the same year. while this isn't consistent with the formula above, it still provides a good approximation of CAC over the longer period. However, for any period shorter than one year, such as a month or quarter, we recommend using the above equation to get a value that most accurately reflects your CAC.  

‍Note: If your company is selling multiple market segments, it's better to report your CAC for each market segment. To blend them obscures important differences that could otherwise provide important insights into your business. For example, let’s assume your company sells to two market segments, Small and medium businesses (SMB) and Mid-Market and that they incur the following CAC.

• CAC for SMB segment based on customers acquired = $1,200
• CAC for Mid-Market based on customers acquired = $12,000

In this situation, reporting the "blended” CAC for both segments ($6,600) isn’t helpful because it doesn’t come close to representing either segment’s CAC. If your business operates in different market segments, the only meaningful way to report CAC is with separate values for each market segment.

Does CAC include salaries?

Yes, the marketing and sales expenses portion of the CAC formula includes the wages and salaries of employees involved in marketing or selling to new customers.  

On top of the marketing and sales salaries, other costs you must account for are:  

• Advertising costs.  
• Sales commissions and bonuses.
• Software costs, including all the tools your teams use to market or sell your service or product.
• Costs for professional services such as paid partnerships or outsourced projects related to marketing or sales.
• Any additional overhead.

What is a typical CAC for SaaS companies?

According to Gartner High Tech CEO Benchmarks, the median CAC for tech companies with less than $250 million ARR is $27,000.

However, the answer to, “What is a good CAC?” is far more nuanced than simply comparing your company’s CAC to the benchmarked median. Instead, consider the ratio between CAC and LTV:  

• Companies with less than $10 million ARR raised spend between $560 and $770 to acquire a customer worth $1,000 a year.
• Companies with less than $100 million ARR spend between $440 and $1,290 to acquire a customer worth $1,000 a year.

Below is a graph from Nathan Latka’s B2B SaaS blog that plots more than 1,000 SaaS companies and what they pay at different ARR scales to acquire new customers:

How to improve your CAC

Here are the three best ways of improving your CAC:  

1. Reduce buying friction -- Eliminate obstacles that slow down customer acquisition by offering quick onboarding, free trials, and fair market prices.
2. Leverage customer data  -- Use the data in your customer relationship management (CRM) system to track your customers’ onboarding journeys and touchpoints to optimize your marketing and sales team performance.
3. Champion transparency --  Provide transparent pricing, clear product roadmaps, and smooth customer service workflows to reduce disputes and optimize the customer experience.

What is the difference between CAC, LTV:CAC, the CAC ratio, and the Bessemer CAC ratio?

CAC, LTV:CAC, the CAC ratio, and the Bessemer CAC ratio are completely different metrics.  

• CAC measures how much money is spent on sales and marketing to acquire a new customer.
• LTV:CAC compares the lifetime value of your company’s customers to the amount of money spent on acquiring each new customer.
• The CAC ratio measures how much money is spent on sales and marketing to generate $1 of new ARR.  
• The Bessemer CAC ratio measures how quickly your gross margin pays for CAC.  

While the differences between CAC, CAC ratio, and LTV:CAC are pretty straightforward, when you stir the Bessemer CAC ratio into the mix, it's easy to get confused about which CAC ratio you might actually be looking at and what the value really means. So, let's take a quick look at the difference between these two metrics.

Here is the formula for the CAC ratio, which you would use to calculate how much you spend on sales and marketing to generate $1 of new ARR. You'll probably notice that this is essentially the same as the CAC formula above but with a different value in the denominator. For the CAC ratio, you swap out the number of new customers acquired with the amount of new ARR generated:

The CAC ratio is a sales and marketing efficiency metric because it tells you how much you're spending to generate new ARR. However, it's also very useful for planning purposes. For example, you can also use the CAC ratio to determine how much you'll need to budget for sales and marketing to hit your ARR target. To do this, you would benchmark your CAC ratio against other companies similar to yours, then multiply the benchmark by your ARR target to determine how much you can expect to spend in sales and marketing to achieve it.  

In contrast to the CAC ratio, Bessemer's CAC ratio is related more closely with the Magic Number:  

A Bessemer CAC ratio of 1.0 means you break even on gross expenses and sales and marketing expenses within one year. As one of the first metrics established by Bessemer Venture Partners as a way to measure sales and marketing efficiency, it has since been replaced by the CAC ratio, which measures this efficiency more directly. While Bessemer Venture Partners appears to have abandoned this metric, we have included it here to provide the most comprehensive information possible on the subject of CAC and CAC ratio.

How Drivetrain simplifies customer acquisition analysis

Drivetrain simplifies the process of analyzing CAC by providing SaaS companies with the following features:

• Easy metrics tracking multi-data source consolidation – When calculating CAC, your sales and marketing spend is likely in one system while your revenue data is in a completely different one. Combining these datasets to calculate CAC every quarter or month is cumbersome and error-prone. Automating data sourcing and having all your important metrics lets you focus more time on forward-looking analysis. It can also help your company switch to KPI-based SaaS financial planning instead of relying on arduous SaaS planning on Excel.
• Better cost control – Continuously monitoring your working capital and budget through dimensional analysis allows you to compute CAC at various market cuts. As a result, your CAC calculations will be faster to make and more accurate.

Striking a balance between growth and marketing expenses is essential to sustainably scale your SaaS company and boost revenue. Tracking CAC in relation to LTV) is one way to monitor and adjust your business strategies to maintain this balance.