What Is The CAC Payback Period?
The payback period for customer acquisition costs (CAC) means the time taken by a company to recover the expenses incurred to acquire or onboard new customers.
The CAC payback period is a crucial financial metric that helps companies evaluate the success of their customer acquisition efforts.
Why A Short CAC Payback Period Matters; Check Out The Gold Standard
A short CAC payback period means quickly retrieving the money a SaaS company has spent on customer acquisition, indicating a favourable business environment. However, a relatively long payback period may indicate potential challenges regarding business growth and cash flow.
Overall, various factors such as competition, market fluctuations, pricing and customer churn can impact a SaaS company’s CAC payback period and stretch the time it would have usually taken.
As most SaaS companies use a subscription-based revenue model to retain customers for the long haul, it lowers the CAC and reduces promotional expenses, thus shortening the payback period.
According to Dhruvil Sanghvi, founder and CEO of SaaS logistics startup LogiNext, any timeframe below 12 months is considered a good CAC payback period. And six months are regarded as the industry’s gold standard.
On the other hand, if a SaaS company’s CAC payback period exceeds 24 months, it is deemed too high. This means the company is spending too much money on acquiring customers but not earning enough to offset these costs. For instance, if a customer’s lifetime value (LTV) or a company’s gross profit margin is too low, it will lead to a long payback period, he said.
“The CAC payback period is more dependent on the gross profit margin you make from a customer, not the revenue. Suppose you sell software, and the gross profit margin is extremely low. In that case, you can’t spend too much on the CAC and the payback will take longer,” explained Sanghvi.
For context, revenue is the income earned from selling a company’s products and services, while gross profit is the money left after deducting the cost of goods (COGS) and other direct costs (variable) from total revenue.
How The CAC Payback Period Is Calculated
Before we delve into CAC payback period calculation, let us first understand how CAC is calculated. To calculate CAC or customer acquisition costs, SaaS company X must get the expenditure details of the money spent on customer acquisition methods like advertisements, content creation, marketing and the overhead expenses incurred by these departments.
If X company’s average CAC is $200, the company will then be able to calculate the CAC payback period, by simply dividing it by its monthly recurring revenue (MRR), which is $20.
The formula to calculate the CAC payback period:
CAC Payback Period = CAC / MRR
CAC Payback Period = $200 / $20
CAC Payback Period = 10 months
The CAC Payback Period is 10 months. This means that the company will take 10 months to recover the $200 spent on acquiring each new customer through the revenue generated from that customer’s $20 monthly payments.
However, it is important to note that if a customer leaves the service before the 10-month mark, the company will incur losses.
Why CAC Payback Period Is Not A Foolproof Approach
The CAC payback period has two major limitations:
- It does not take into account the time value of money, the fact that a specific sum today is worth more than the same amount in the future. So, a CAC payback period of 12 months will be longer if we factor in inflation.
- This metric also ignores customer churn. Churn indicates how frequently customers leave a company and stop using its products or services. If the churn is high, even a higher-than-average CAC payback period won’t be good in the long run. For instance, if customers leave in droves, the recovered capital cannot be reinvested for business growth. Plus, the CAC may increase considerably to combat churn, which means things may no longer be sustainable.
What SaaS Players Spend On Customer Acquisition
SaaS companies cater to all types of businesses, big, medium and small, and the CAC varies based on target audiences. Here is a quick look at the estimated customer acquisition costs as per Sanghvi:
- Small and medium businesses/SMBs: Many SaaS companies focus on small and medium-sized businesses (SMBs) and annually charge between $1K and $10K for their services. Their customer acquisition costs are also lower, typically ranging from $5K to $10K. The average CAC for SMB-focussed SaaS companies is around $5K. Zoho and Freshworks are good examples of SMB-focussed SaaS players.
- Mid-market companies: Mid-market businesses are also serviced by SaaS players. Here, annual charges vary between $10K and $100K, and the average CAC is around $30K.
- Enterprises: These are the most lucrative customers, often paying the highest subscription fees. But they also incur maximum CAC, typically from $50K to $100K. Interestingly, Sanghvi’s LogiNext has catered to enterprise customers from Day 1.
How SaaS Startups Can Improve CAC Payback Period In The Initial Days
It will be difficult for a SaaS startup to estimate the CAC payback period in the early days. For one, the SaaS player is still learning and growing, which means a constantly fluctuating business scenario and uncertainties about customer onboarding. Nevertheless, it is essential to leverage this metric from an early stage to assess the company’s performance and make necessary changes.
Once a SaaS company has operated for 24 months or reached $1 Mn in revenue, the CAC payback period begins to stabilise. It is the ideal time for the company to optimise the payback period.
When starting out, many SaaS companies aim to reduce customer acquisition costs to improve the payback period. However, this may disrupt their growth cycles at times. Instead, they can use the same CAC investment to attract a larger customer base by increasing the average/annual contract value (ACV). Alternatively, revisiting pricing strategies can also play a key role.
Interestingly, the CAC payback period is correlated with both ACV and ARR (annual recurring revenue.
Another way to improve the CAC payback period is to shift your focus from mid-market to enterprise customers. After all, the effort and resources needed to acquire mid-market businesses are similar to those required for engaging with enterprise clients.
But as the product/service matures, the talent pool grows and brand recognition gets a boost, servicing large players becomes more feasible. This, in turn, leads to a considerable reduction in the CAC payback period.
