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

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Boosting growth is a top priority for both new and established SaaS companies, but at what cost? The most common metric used to assess growth efficiency is customer acquisition cost (CAC).

What is customer acquisition cost? Customer acquisition cost, or CAC, is the amount of money a company spends on marketing and sales to acquire a new customer. Companies can compare their average CAC with the average lifetime value (LTV) of their customers using the LTV:CAC ratio to help them determine the sustainability of their growth-related marketing and sales expenses.

Here’s everything you need to know about calculating and improving CAC, and how your company’s CAC compares to SaaS benchmarks.

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Why is customer acquisition cost important?

CAC answers, “How much do you spend to acquire a new customer?” It also answers, “How much do you spend for $1 of new ARR?” It plays a key part in determining how efficiently your company adds new ARR.

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.

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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:  

Table showing CAC & LTV of two companies – A & B

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 $10,000 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.

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

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

  • CAC measures how much money is spent on sales and marketing to either acquire a new customer or generate $1 of new ARR.  
  • 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 quickly your gross margin pays for CAC.  

The formula to calculate your CAC ratio is:  

CAC Ratio equals Current period's new annual contract value multiplied by current period's gross margin divided by previous period's marketing and sales costs
Formula to calculate CAC Ratio. (Current period’s new ACV x Current period’s gross margin) / Previous period’s sales & marketing costs

A CAC ratio of 1 means you break even on gross expenses and sales and marketing expenses within one year. Note that the CAC ratio accounts for gross expenses while the Magic Number accounts for just sales and marketing expenses, making it a more versatile metric.

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 a major concern.

How to calculate the cost of customer acquisition

Use this formula to calculate CAC:

Formula for calculating CAC. CAC equals marketing expenses and sales spend divided by the number of new customers acquired.
Formula for calculating CAC that answers, "How much do you spend to acquire a new customer?"

You could use any time period in this formula – a previous quarter, previous month, previous four months, or previous year. While it’s common to use the previous quarter, standardizing the calculation in this way doesn’t make sense because different SaaS companies have different sales cycles. At Drivetrain, we recommend using whatever period corresponds to your average sales cycle to get a value that accurately reflects your CAC.

As mentioned before, in addition to calculating how much it costs your business to acquire new customers, you can also use the CAC formula to calculate how much money is spent on sales and marketing to generate $1 of new ARR.To do this, you simply change the denominator in the equation above from the number of new customers acquired to the amount of New ARR generated:

Formula for calculating CAC based on New ARR generated. CAC equals total marketing and sales spending during a previous period divided by the new ARR generated as a direct result of that spend.
Formula for calculating CAC that answers, "How much do you spend for $1 of new ARR?"

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.

Examples of CAC calculation

Although the overall CAC formula is simple, keeping track of customer acquisition-related expenses across marketing and sales departments can be challenging. In addition, twin-engine SaaS companies will receive less than satisfactory results calculating CAC on a per customer basis. In these cases, it’s better to calculate CAC at different levels or by market segment.  

Here are three examples of a CAC calculation.

Calculating CAC by market segment

Here’s how you can calculate CAC for a company operating in two markets, selling to both SMB and mid-market companies.

Example calculation of CAC calculated for two market segments.

  • Company A spent $240,000 on a sales and marketing campaign targeting SMB customers in Q1 2022
  • Company A’s average sales cycle length is 3 months
  • It spent $500,000 on a sales and marketing campaign targeting mid-market customers in Q1 2022
  • The company generated $100,000 in new ARR in Q2 2022 as a direct result of its SMB campaign
  • It generated $250,000 in new ARR in Q2 2022 as a direct result of its mid-market campaign
Example calculation of CAC calculated for two market segments. Company A spent 240,000 dollars on a sales and marketing campaign targeting SMB customers and 500,000 dollars on a sales and marketing campaign targeting mid-market customers. The company generated 100,000 dollars in new ARR during this period as a direct result of its SMB campaign and 250,000 dollars in new ARR during the same period as a direct result of its mid-market campaign. CAC for the SMB segment is 2 dollars and 40 cents (240,000 dollars divided by 100,000 dollars).
CAC for its mid-market segment is two dollars (500,000 dollars divided by 250,000 dollars)

Calculating CAC for specific marketing activities

The best way to calculate CAC at the marketing level is to do so for each individual marketing channel. This compartmentalization offers more insight into which channels perform better than simply looking at marketing expenses and subsequent acquisitions as a whole.

Let’s look at the following example:

Example calculation of CAC calculated for a specific marketing activity.

  • Company A spent $24,000 on a quarterly Google Ads campaign and paid a Google Ads expert $24,000 to manage the campaign.  
  • The company acquired 1,000 new customers as a direct result of this campaign.
Example calculation of CAC calculated for a specific marketing activity: Company A spent 24,000 dollars on a Google Ads campaign and paid a Google Ads expert 24,000 dollars to manage the campaign. As a direct result of the campaign, the company acquired 1,000 new customers. The CAC for this marketing channel is 48,000 dollars (the ad spend plus the cost to hire an expert) divided by 1,000 (the number of customers acquired. The total CAC equals 48 dollars.

Note that at the marketing level, you should include only the direct costs of each marketing campaign and the salaries associated with running that channel. For instance, the salary we have considered above reflects the money paid to a resource managing the Google Ads campaign.  

Calculating CAC for a specific product line

When calculating CAC for a product line, all the marketing and sales department salaries and costs must be included in your calculation:

Example calculation of CAC calculated for a product line.

Company B sells access to a content management system.  

  • Annual salaries for marketing and sales teams plus related costs = $1,000,000
  • New customers acquired during the same year = 10,000
Example calculation of CAC calculated for a product line: Company B spent 1M dollars in annual salaries for its marketing and sales team for the product line plus related costs and acquired 1,000 new customers during the same year. The CAC for this product line is 100 dollars, calculated by dividing 1M dollars in spend by the 10,000 new customers acquired.

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.

Median CAC of technology companies with less than $250 million in annual revenue (Source)

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:

Average CAC of SaaS companies at different funding stages based on their ARR (Source)

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.

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.

Curious about how Drivetrain can simplify how you analyze and manage customer acquisition?
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FAQs

What is customer acquisition cost?

Customer acquisition cost is the amount of money a company spends on marketing and sales to acquire a new customer. It can also be defined as the amount of money a company spends to generate $1 of new ARR.

What are the types of customer acquisition cost?

Numerous types of expenses fall under customer acquisition cost, including:  

  • Advertising costs  
  • Sales commissions and bonuses
  • Software costs
  • Professional services costs
  • Additional overhead
What is an example of customer acquisition cost calculation?

If Company A spends $1M a year on its marketing and sales department expenses and acquires 10,000 new customers as a result, then CAC is:  

CAC = $1M / 10,000 = $100

Alternatively, if the company spends $1M a year on marketing and sales and acquires $1M in new ARR, then CAC is:  

CAC = $1M / $1M = $1

What is a typical CAC for a SaaS company?

As you would expect, CAC varies widely in the SaaS industry. However, in a graph published on Nathan Latka’s B2B SaaS Blog, you can get a good idea of average CAC of SaaS companies at different funding stages based on their ARR.

What is considered a good CAC?

There is no single “good” CAC that applies to SaaS companies across the board. However, according to a 2020 Gartner High Tech CEO Benchmarks report, the median CAC recorded by companies with less than $250 million ARR was $27,000.