In this first article of our series on the common pitfalls in planning that SaaS companies encounter, we cover customer acquisition cost (CAC) and how this important metric often fails to accurately represent a company's true spend for each new customer it gains. Our goal for this series is to bring greater awareness to this and other pitfalls in planning to help SaaS companies recognize and avoid them to develop a more reliable plan for predictable growth.
Winning new customers isn’t cheap, and for SaaS businesses, customer acquisition cost (CAC) is a critical concern because these costs are recouped over time. Thus, the higher your CAC, the more working capital you have locked up throughout the CAC payback period.
CAC is the amount of money your company spends on marketing and sales to acquire a new customer. Knowing your CAC will help you understand the costs associated with winning each new customer and, to the extent you can reduce it, the more working capital you have to work with and the more favorable you’ll look to potential investors.
The pitfall you need to watch out for
Theoretically, your CAC represents the true cost of customer acquisition in terms of your sales and marketing spend. However, how you define your sales and marketing costs for the purposes of this calculation has a big impact on your results, which can in turn have an even bigger impact on your planning.
The pitfall in planning is that if you’re not “fully loading” your CAC with all of the expenses of gaining a new customer, your CAC is going to be artificially low, which makes it look like your sales efficiency is higher than it really is.
This bias can affect your planning in some pretty serious ways. For example, you’re probably considering your CAC when figuring out your sales and marketing budgets. If your CAC is artificially low because you failed to fully load all your sales and marketing expenses into the calculation, you may decide that you need less budget than what you really need for your marketing team to generate the leads your sales team needs to meet their quotas, which means your company may not meet its targets.
What to include in a “fully-loaded” CAC
Let’s take a quick look at the CAC calculation:
The equation itself seems simple enough, right? What’s not so simple, though, is what you include in the total sales and marketing spend, and a lot of SaaS companies are getting this wrong. The problem is not with the formula. Rather, it’s in how they’re defining their expenses.
Common expenses included in CAC
There are a few expenses that most every SaaS business considers in their CAC calculation, including:
- Marketing and advertising costs, including the cost of all marketing and advertising campaigns, such as paid search, display advertising, social media advertising, email marketing, content marketing, and other promotions aimed at acquiring new customers.
- Sales and marketing team salaries and commissions, including salaries, commissions, bonuses, and other incentives for those directly involved in sales but also to marketing managers, content creators, graphic designers, and other marketing professionals as well.
- Overhead expenses associated with customer acquisition, such as office rent, utilities, office supplies, software licenses, and other expenses related to the sales and marketing function.
- Technology and infrastructure costs, including the cost of the software and hardware infrastructure used to acquire new customers, such as the cost of hosting, bandwidth, development, maintenance, and upgrades of the SaaS platform.
Other expenses you might not think of as CAC
Here are a few others that a SaaS company may or may not be including that they probably should:
- Costs for professional services such as paid partnerships or outsourced projects related to marketing or sales.
- Rewards and recognition given to teams involved in customer acquisition, which in addition to sales and marketing teams, can also include customer success teams and product teams focused on PLG efforts.
- Server and infrastructure costs incurred on free trials plus the costs associated with software tools for analyzing the data or running experiments for them.
- Onboarding and training costs associated with supporting freemium users (discussed in more detail below).
In addition to the types of costs listed above, there are also other, more nuanced expenses that you may need to include depending on your business model.
Freemium subscription models & product-led growth activities
For companies that offer freemium subscriptions and/or use a product led growth model, it can be hard to know how to account for all the marketing costs associated with getting people to subscribe to a free tier of their service. This is because they’re not paying customers yet, so it’s hard to connect those expenses to customer acquisition. However, they should be.
The freemium model exists to entice new, prospective customers, which is a form of lead generation. Therefore, the marketing costs associated with getting people to sign up for that free tier along with the freemium hosting costs is all a part of the cost of customer acquisition. The costs associated with your customer success (CS) team’s efforts to convert those freemium accounts to paid subscriptions is also part of your CAC.
A good rule of thumb
There will necessarily be some judgment calls with regard to some expenses where the connection to customer acquisition is less clear or harder to quantify. One of the most common gray areas here is with regard to CS teams.
Whether and how to allocate costs associated with your customer success teams really depends on how you define the role of your CS team in your company. If your CS team is working 100% on getting renewals, and they’re not responsible for any expansion quota, then you probably wouldn’t add any CS expenses to your CAC. On the other hand, if their role involves getting existing customers to upgrade or buy more licenses or, as earlier suggested, getting freemium users to convert to a paid subscription, then the costs associated with those activities should be included in your CAC.
Where it becomes much less clear is when you have costs that are shared among different teams. For example, you might have a software program (e.g. Salesforce) that’s shared between your customer success team, which works with existing customers, and your sales team, which works to win new customers. So, how much of the cost for that software do you allocate to the sales team as part of the CAC?
When questions like this arise, a good rule of thumb is to ask yourself, if you were building the company with your own money (bootstrapped) rather than VC money, would you include that cost in the CAC computation?
How to make accounting for CAC easier
Depending on how your accounting system is set up, specifically the cost centers you have established, you may find it difficult to properly allocate all the true expenses associated with CAC.
One way to make accounting for your CAC easier is to break out your sales and marketing teams into specific cost centers in your ERP system so that any costs tagged to that particular department gets included in your CAC. For example, let’s say Employee A works on customer acquisition and Employee B is in the same group or team but works on cultivating existing relationships. In this case, you would tag Employee A's salary to the business unit that you assign CAC to in your ERP but not Employee B’s salary.
The benefits of fully loading your CAC
Clearly, fully loading your CAC is a safer way to plan. However, your investors or board may want you to calculate your CAC in a different way, excluding some of the expenses you think should be included or possibly even using a slightly different formula. If so, we recommend calculating a fully loaded CAC for your use internally in addition to calculating your CAC in the way your investors or board wants to see it done. That way, you can satisfy their requirements while still avoiding the pitfalls in planning that we’ve described here and the unpleasant surprises they can create.
A fully loaded CAC is particularly useful when benchmarking because it’s conservative. Consider that benchmarking companies, investors, and your peers might include fewer costs in their CAC calculations. By using the most conservative number, you can be confident that you’ll always perform better than the CAC benchmarks you find.
For example, let’s say that for your peer group of companies, the median CAC as published by a reputable benchmarking company like RevOpsSquared is $5,000, and the 75th percentile is $4,900. However, RevOpsSquared's CAC formula excludes PLG costs in its calculation. If your company’s fully-loaded CAC is $5,000 with the PLG costs included, you know that you’re definitely performing better than the 50th percentile and probably closer to the 75th percentile for this metric!
On the flip side, if you don’t fully load your CAC, there might be some other benchmark survey or a VC who expects PLG costs to be included in the CAC calculation. And, if you’re not including it, your CAC is going to be biased low. By fully accounting for all the true costs of acquiring new customers, you can be fully confident that you’re not inadvertently misleading potential investors with regard to this important metric.
There is no downside to having the most accurate number as possible for your planning. By fully loading your CAC, you’re being honest to yourself and the company and can derive greater insight from value-added planning practices like benchmarking. Benchmarks can be a powerful tool for driving growth in your SaaS business, but the benefits you get from it are only as good as the results you’re comparing to them.
Drivetrain makes tracking your CAC easier
When calculating CAC, your sales and marketing spend is likely in one system while your revenue data is in a completely different one. Drivetrain’s ability to integrate with all the systems SaaS companies need to pull data from for financial planning and analysis (FP&A) means that you no longer have to manually consolidate your data. That work is automated in Drivetrain, so you can focus on looking at how your CAC is impacting your business and working to find efficiencies that can help reduce it.
Drivetrain also gives you better cost control, continuously monitoring your working capital and budget through dimensional analyses that allow you to compute CAC at various market cuts or splitting your CAC into new CAC and expansion CAC if needed. As a result, your CAC calculations will be easier, faster, and more accurate. CAC ratios are easier to calculate, too, giving you deeper insights into how much you are spending to generate new ARR.
One of the biggest advantages that Drivetrain can provide is a single source of truth. With Drivetrain, you can avoid the pitfall of obscuring the true cost of customer acquisition by ensuring that everyone internally is on the same page with using a fully-loaded CAC for FP&A, while still allowing you to calculate and report CAC in whatever other ways your board or investors might want.