As a SaaS startup, assessing the health of your business involves tracking and calculating overwhelming numbers, statistics and metrics. In this series on key SaaS metrics, our team walks you through the most common and helpful metrics to successfully grow your SaaS startup.
Traditionally, companies had to engage in shotgun style advertising and find methods to track consumers through the decision-making process. Luckily, this process has changed and many web-based companies can launch highly targeted campaigns and track consumers as they transition from initial leads to long-term customers. But, how can you evaluate the success or failure of your sales and marketing campaigns? Are they worth the money you’re putting into them? This is where the Customer Acquisition Cost (CAC) ratio metric comes in handy. In this article, we will cover the CAC ratio metric in more detail, how to measure it, and why it’s important for your business?
What is the CAC Ratio?
As the name implies, CAC is the cost of convincing a potential customer to buy your product or service. The Customer Acquisition Cost (CAC) ratio is simply a comparison of the sales and marketing expenses associated with gaining a new customer, and the increase in your gross margin pertaining to those new customers over a given period of time.
How to measure your CAC Ratio?
Since the SaaS industry started out with monthly pricing and payments, many of the early SaaS metrics were defined in monthly terms. While for some startups this undoubtedly remains true, for many others the real metric of the business is annual. That’s why the formula for calculating your CAC ratio below expresses the numerator as an annualized number.
To calculate your CAC ratio, divide the gross margin of the annualized new revenue that your company recorded during a given quarter by the sales and marketing costs:
([Gross Margin for Q2 – Gross Margin for Q1] x 4) / Sales & Marketing Expenses for Q2
Let’s look at an example. In August, SaaS Inc., had $50,000 in revenue from monthly subscriptions. Management decides to spend $15,000 in sales and marketing expenses (pay-per-click, print ads, and sales representatives). Through these efforts, SaaS Inc. generated 100 new customers, all of which purchased a discounted annual subscription for $10 per month. To keep things simple, we will assume that SaaS Inc. pays $500 per month for unlimited hosting. Aggregating all this information, we get the financial table below:
|August 2017||September 2017|
|Sales and Marketing|
|Pay Per Click||$5,000||$5,000|
|Sales Rep Salary||$6,000||$6,000|
|Total Sales and Marketing||$15,000||$15,000|
From the financial table above, we can see that SaaS Inc. had an increase in gross margin of $1,000 or $12,000 when annualized. Based on these numbers, the CAC ratio is 80%:
(Annualized Gross Margin of $12,000) / (Total Sales & Marketing Expenses of $15,000)
This means that the new 100 customers acquired will only recover 80% of the company’s sales and marketing effort in one year.
What the CAC Ratios means to you?
The CAC ratio metric is important to investors and companies. From an investor’s point of view, it helps analyze the scalability of your SaaS business. Investors can determine profitability by comparing how much money can be extracted from customers and the costs of extracting it.
On the other hand, your company’s marketing team is interested in this metric to measure the return on their advertising investments.
The CAC ratio is an important metric for understanding how long it will take you to recover your sales and marketing investments.