How can you evaluate the success or failure of your sales and marketing campaigns? Are they worth the money you’re putting into them? Or is the payback period so long that you should shift tactics? There’s only one way to know for sure, and that’s by figuring out how long it takes to effectively pay back your costs with the money earned from the new sales generated by your sales and marketing efforts.
To do this, you’ll need to calculate and track your customer acquisition cost (CAC) ratio. Here’s how.
How to calculate your CAC Ratio
Here is the formula for calculating your CAC ratio:
([Gross Margin Q2 – Gross MarginQ1] × 4) / Sales and Marketing Expenses for period Q2
Notice the numerator is expressed as an annualized number. We do this for a couple of reasons. When analyzing a company, we often look at how the company is performing each year and therefore use the year as the period for comparison. Additionally, products sold by most SaaS companies tend to have annual contracts. Therefore, it makes sense for our metric to match this time period.
Let’s look at an example:
In August, SaaS Co., an online social networking platform for SaaS entrepreneurs, spent $1,000 on pay-per-click advertising, $3,000 for print advertisements, and $6,000 for one Sales Representative to reach out to the leads generated from the new marketing campaign. Through the outreach and marketing, SaaS Co. generated 100 new customers, all of which purchased annual subscriptions for $5/month. We also know that SaaS Co.’s product is fully developed and only costs $50/month for unlimited hosting. Here’s a breakdown of their key financials:SaaS Co.Jul-15Aug-15Revenue Monthly Subscription23,50024,000Total Revenue23,50024,000COGS: Hosting5050Total COGS5050Gross Margin23,45023,950Sales and Marketing Pay Per Click1,0001,000 Print Ads3,0003,000 Sales Rep Salary6,0006,000Total Sales and Marketing10,00010,000
From this, we can see that the business has an increase in the gross margin of $500, or $6,000 when annualized. We also know the total sales and marketing expenses were $10,000 for the month. Based on these numbers, we can calculate the following:
(Annualized Incremental Gross Margin: $6,000) / (Total Sales and Marketing: $10,000)=60% CAC Ratio
What does this mean? It means that the new customers acquired that month will recover 60% of the month’s sales and marketing efforts in one year. It can also be useful to flip the numerator and denominator to see a different result. Doing so yields the following:
(Total Sales and Marketing: $10,000) / (Annualized Incremental Gross Income: $6,000)=1.67 Inverted CAC Ratio (Payback Period)
The inverted CAC ratio tells us how many years—in this case, 1.67 years—it will take SaaS Co. to recover its initial investment in sales and marketing for August. At Lighter Capital, we use the inverted ratio most often because it gives us a faster way to review the amount of time it will take to recover a company’s investment in sales and marketing.
Note that in this example, we assumed that all new customers acquired in August were a direct result of sales and marketing efforts in August. However, most businesses have a lag time between the sales and marketing efforts and actual sales. Directly matching the revenue earned with respective sales and marketing spend can be challenging and time consuming, so simplifying it as shown above can serve as a helpful proxy.
Want More SaaS Metrics?
This guide explains the core metrics used to measure SaaS company success. Using simple examples, we’ll show you how to calculate each metric, and describe why specific indicators are important to investors.