Part 4 of 9
CAC – Customer Acquisition Costs – are all of the expenses incurred during the marketing and sales cycle. These costs are the investment you make up-front and can be easy to underestimate. If you don’t measure it accurately, some of the other metrics become much less meaningful.
Many start-ups underestimate their customer acquisition costs and overestimate their sales projections. It is the main reason so many of them go broke – they simply run out of money. The same is true for services companies expanding into Cloud-based repeatable IP – they may have cash flow from their core business and they may have people and resources that can be shared across business groups, but if they aren’t measuring their customer acquisition costs properly, it will take much longer before their move to IP starts to pay for itself.
To properly calculate your CAC, you need to include all your costs, not just the direct costs for a campaign, such as Adwords, telemarketing and search engine optimization. You also need to include salaries for your sales and marketing people, an overhead allocation and the cost of broader-based marketing programs that may not be tied directly to a campaign. This total is then divided by the number of customers to calculate the customer acquisition costs:
CAC is an investment in gaining a new client, and the ROI is based on the amount of revenue that you generate from that client. CAC is typically measured against the length of a client relationship – the less you spend and the longer each subscriber stays with you, the more profitable you will become. Venture capitalists want to see the lifetime value of a client being at least 3x the CAC. In other words, if you spend $1,000 to gain a new subscriber, you should generate at least $3,000 in revenues over the lifetime of the subscription.
This standard is also expressed in another way – you should be able to recover your CAC in less than 12 months. Now think about that for a minute. VCs are saying you should be willing to spend up to one year of revenues to gain a new client, before you start collecting a dollar in subscriptions. Not to mention the other costs you have in running your business – rent and utilities, salaries and benefits for non-sales and marketing resources (administration, product development, support), hosting and infrastructure costs, etc. That is why driving CAC down as much as possible is a key consideration for SaaS vendors.
If you are just starting out with a new product, you won’t know what the lifetime value is, so you will need to make some assumptions. But this is also a good exercise to determine the sensitivity to longer term churn. Start out by looking at the return assuming a three-year lifecycle. If the numbers look bad, see how long the average lifetime has to be. The longer it is, the more likely it is that you are spending too much money on customer acquisition compared to the subscription value.
In the previous section we talked about the industry benchmark being 1:3. Clearly, being able to extend that to 1:4 or 1:5, will have a significant impact on your profitability. Some of the leading SaaS companies have ratios of 1:7.
The ratio can be improved in two ways: reducing the CAC (the initial investment in winning a client) and/or increasing the average revenues per client.
Reducing the CAC
Try to use:
- Viral marketing
- Inbound marketing and marketing automation
- Web-based, touchless sales conversions for non-complex products
- Freemium to drive users, as long as the product and sales process is self-service
- 15 or 30-day free trials
- Indirect channels that absorb the cost of sales and marketing
- Strategic partners and white label agreements.
- Field sales – keep human intervention in the sales process to a minimum
- Outbound marketing, which can be expensive and ineffective with many SaaS solutions.
Reducing the CAC is one half of the profit model – reducing the costs of onboarding a new client. As important is having a strategy to increase the revenues per client, which is also known as monetizing a client relationship. SaaS business models are very much a “land and expand” strategy, which is why so many vendors are happy to start with a small sale, with a clear strategy to increase the revenues over time. This has been the Salesforce.com model, and it has been very successful. There are two basic components to the long-term monetization – minimizing churn and selling more usage to your clients.
This is such a critical issue for subscription-based business that we are dedicating the next blog to this topic. “Churn” is the percentage of your users that do not continue with their subscription, for whatever reason. It is one of the most closely watched metrics by investors, and for good reason – it has a corrosive impact on long-term revenues.
Selling more usage
This is really the key to long-term success with a recurring revenue model. Every additional Dollar of subscription value that you can get from your clients adds to the recurring revenues. Selling an add-on is not a one-time revenue event, it will continue for as long as the subscription is maintained. More usage can come from a number of sources:
- Scalable pricing that encourages a user to move from silver to gold to platinum
- Building and cross-selling other modules
- Increasing the number of users
- Lead generation for other vendors, or white labeling other solutions to expand the product offering.
Previous blogs in this series
- Every SI should be an IP company
- Repeatable IP – strategic or opportunistic?
- Overcoming the cash flow chasm
- Minimizing churn
- How marketing changes
- Building the right sales organization
- Sales compensation
- Customer support
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