How do you calculate CAC Payback?
In short, CAC payback is the amount of time it takes for a company to earn back the money it spent acquiring a customer. To calculate CAC payback, you simply divide the company's total customer acquisition costs by its monthly recurring revenue.
So, for example, let's say a company spends $100,000 on customer acquisition in a month and has a monthly recurring revenue of $10,000. In this case, the company's CAC payback would be 10 months.
CAC payback is important because it allows startups to track their progress in acquiring customers and to assess whether their customer acquisition efforts are sustainable in the long run. If a company has a CAC payback of 12 months or more, that means it could take more than a year for the company to earn back the money it spent acquiring a customer. This might not be sustainable in the long run. However, if a company has a CAC payback of 6 months or less, that means it's likely on track to acquire customers in a way that is sustainable and profitable.
Of course, there is no magic number when it comes to CAC payback. The amount of time it takes for a company to earn back its customer acquisition costs will vary depending on the business and its specific circumstances. However, tracking CAC payback is still a helpful way to assess whether a startup is on track to acquire customers profitably.
The CAC payback period is the amount of time it takes for a company to recover the costs of acquiring a new customer. A long CAC payback period indicates that the company spends more on customer acquisition than it receives in revenue. A low CAC payback period, on the other hand, indicates that the company is quickly recovering its acquisition costs and may be able to spend more to acquire new customers. Calculating the CAC payback period is, therefore, critical for determining the effectiveness of a company's sales and marketing efforts.
The CAC payback period is calculated by dividing a period's total sales and marketing expenses by the net new monthly recurring revenue (MRR) acquired in that same period multiplied by the gross margin. The gross margin is the difference between revenue and cost of goods sold. This formula is used to determine how long it will take the company to recover its expenses and begin making a profit from the customer.
CAC Payback Period Formula = Period Sales & Marketing Expenses / (Period Net New MRR Acquired * Gross Margin)
It is important to note that the CAC payback period formula is not fixed and can change depending on the size, industry, and target audience of the company. As a result, it is critical to benchmark against the industry to determine the average CAC payback period and strive to meet or exceed it.
Profit margin maximization and lowering the CAC payback period are critical goals for any business. However, doing so can be difficult, and traditional sales and marketing-driven go-to-market models can be costly. Enter best practices for Product-Led Growth (PLG), a strategy that can significantly reduce the CAC payback time. PLG firms prioritize product acquisition, conversion, and upselling, resulting in shorter CAC payback periods. Such businesses reduce their sales and marketing costs by emphasizing stickiness, user experience, and virality.
But how can businesses put PLG best practices into action? The key is to reduce paid advertising by leveraging virality and word-of-mouth. A seamless user experience can generate powerful network effects and referrals, resulting in lower marketing costs. While conducting website content audits, optimizing the mobile experience, sign-up flow, buyer resources, and chatbot can improve clarity and persuasion.
Upselling and cross-selling are also effective methods of shortening the CAC payback period. Businesses can improve their selling opportunities by expanding their current customers. Furthermore, focusing on inputs such as CAC and retention rather than outputs such as lifetime value can provide businesses with the tools they need to reduce the CAC payback period. Retention, in particular, is a powerful predictor of CAC payback.
Businesses should experiment with CAC optimization, PLG best practices, funnel efficiencies, and upselling and cross-selling opportunities to reduce CAC payback time. Those that implement these strategies not only reduce their CAC payback time but also strengthen their company in the long run.
It is essential to benchmark against industry standards in order to understand how your company stacks up against competitors and to identify improvement areas. A CAC payback period of 12 months is regarded as excellent, but it is important to remember that the optimal payback period varies depending on a company's go-to-market strategy, customer type, and industry. For example, enterprise-level companies with complex sales cycles may have a longer payback period than product-led businesses that target businesses of all sizes using a self-service freemium model.
To determine the best-in-class CAC payback period for your company, it is essential to benchmark against industry peers. OpenView's 2021 Financial and Operating Benchmarks Report provides peer benchmarks that businesses can use to monitor the optimal ranges for best-in-class CAC payback as their businesses mature. It is essential to remember, however, that CAC payback should not be evaluated in isolation. In order to determine if the implied CAC payback will be realized, retention rates and net dollar retention must also be considered.
Moreover, businesses should examine the trend of the numbers over time to gain a clear understanding of what is occurring and to remain vigilant regarding efficiency, especially as the company grows. As a business grows, its markets saturate, and its competition increases, it is common for its efficiency to decline. In addition to adding new team members as you scale, adding new operational costs (don't forget to include rent for your sales and marketing teams!) can also affect the payback period for your CAC. The key to successfully riding these waves is anticipating them (so that no one panics) and being consistent with measurement so that you can quickly identify and address growth challenges. Internally, benchmarking against comparable companies will provide insights into the effectiveness of the sales and marketing organization, while incorporating an appropriate level of intellectual integrity for board and investor reporting.
CAC payback has pros and cons, like any business metric. CAC payback shows how well a company acquires and retains customers. A company can fix customer acquisition inefficiencies by tracking the CAC payback period. It can also help companies set and track realistic goals. CAC payback can also be used to evaluate a company's performance against industry benchmarks to improve sales and marketing strategies.
CAC payback as a performance metric has drawbacks as well. The biggest drawback is that it ignores customer lifetime value. Consequently, it only considers a customer's revenue during the payback period and not afterward. Thus, a company may prioritize new customers over existing ones, which can increase churn and hurt long-term growth. For companies with longer sales cycles or more complex sales processes, CAC payback may be difficult to calculate.
In conclusion, CAC payback can be used to evaluate a company's customer acquisition process, but it should not be used alone. To ensure holistic customer acquisition and long-term growth, companies should also consider customer retention rates and customer lifetime value. Businesses can better understand their customer acquisition process and allocate resources for sustainable growth by using multiple metrics.
CAC payback is an important metric for startups to track because it allows them to assess whether their customer acquisition efforts are sustainable in the long run. If your company's CAC payback is 12 months or more, that means it could take more than a year for you to earn back the money you spent acquiring a customer. This might not be sustainable in the long run. However, if your company's CAC payback is 6 months or less, that means you're likely on track to acquire customers in a way that is sustainable and profitable. So keep an eye on your CAC payback! It just might be the key to your startup's success. And if you're still thinking, what the heck is CAC??? Checkout this Glossary entry!