Not to be confused with the, perhaps, better-known KPI with a similar name, customer acquisition cost (CAC), the CAC ratio is a critical metric for SaaS businesses.
Sales and lead qualification teams (SDRs or BDRs), long sales cycles, live events with a flashy booth and all the swag, building a new category from the ground-up, or building a brand that can win market share from existing leaders, running a partner program, paid advertising, content marketing, social media, PR, and the marketing and sales technologies that make it all work — you get the picture.
It takes a lot of time, effort, and resources to drive new and expansion bookings.
Are you getting out more than you're putting in? Is the business growing enough to justify your sales and marketing spend? Is the business growing fast enough to confirm your tactics are working?
There’s only one way to know for sure: look at your customer acquisition cost (CAC) ratio.
What's the customer acquisition cost ratio (CAC ratio)?
CAC ratio tells you how long it takes to effectively pay back your acquisition costs with the revenue generated from your sales and marketing efforts.
Why is CAC ratio an important SaaS metric?
The CAC ratio measures the efficiency of your sales and marketing programs.
For example, if you're spending too much on sales and marketing, you run the risk of taking too long to pay back your customer acquisition costs, and that can eat up your startup's runway.
If churn is also high, your EBITDA margin will suffer too. An efficient CAC ratio, on the other hand, gives you the green-light to invest more into sales and marketing to accelerate revenue growth.
Calculate Your CAC Ratio
Here is the CAC ratio formula:
(Gross Margin Q2 – Gross Margin Q1) × 4 __________________________________ | = | CAC Ratio |
Q2 Sales and Marketing Expenses | | |
Notice the numerator is expressed as an annualized number, and there are a few reasons for this:
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.
Products sold by most SaaS companies tend to have annual contracts and it makes sense for our metric to align with this time period.
Let’s walk through a CAC ratio calculation 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-15 | Aug-15 |
Revenue | | |
Monthly Subscriptions | $23,500 | $24,00 |
Total Revenue | $23,500 | $24,000 |
| | |
COGS: Hosting | 50 | 50 |
Total COGS | 50 | 50 |
Gross Margin | $23,450 | $23,950 |
| | |
Sales and Marketing | | |
Pay Per Click | $1,000 | $1,000 |
Print Ads | $3,000 | $3,000 |
Sales Rep Salary | $6,000 | $6,000 |
Total Sales and Marketing | $10,000 | $10,000 |
Above, we can see that the business increased its gross margin $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 CAC ratio:
(Annualized Incremental Gross Margin: $6,000) ______________________________________ | = | 60% |
(Total Sales and Marketing: $10,000) | | |
How do we interpret this data?
In one year, the new customers acquired from the new marketing campaign will have paid for 60% of the sales and marketing costs that month.
Inverted CAC Ratio
It can also be useful to flip the numerator and denominator to see a different result.
Doing so yields the Inverted CAC Ratio:
(Total Sales and Marketing: $10,000) _______________________________________ | = | 1.67 |
(Annualized Incremental Gross Income: $6,000) | | 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 bookings. Directly matching the revenue earned with respective sales and marketing spend can be challenging and time consuming, so simplifying it as we've shown here serves as a helpful proxy.
Related Reading: How to Increase the Efficiency of SaaS Customer Acquisition Cost (CAC)
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