KPI Series Part 3: Much-Needed Insight to Track Customer Acquisition Costs (CAC)
When tracking KPIs and double-clicking into a company’s performance planning and reporting, CAC tends to be at the forefront of the minds of investors and internal finance teams. Much like churn and contract values, CAC is an integral metric that should be monitored by businesses of all sizes across all industries, as it evaluates sales team efficiency and scalability. CAC represents all of the sales and marketing costs that a company spends at one-time to acquire new customers. This number is inclusive of all of the respective sales and marketing labor costs (e.g. salaries, payroll taxes, benefits, bonuses, commissions), as well as other indirect sales and marketing costs that are spent to acquire a customer (e.g. CRM software systems, events and conferences, marketing material, whitepapers, website etc.). By monitoring CAC, a company can make the necessary tweaks and operational adjustments to supercharge its sales and marketing team and/or enhance existing go-to-market processes to better align the number with benchmarks and expectations.
Help! I Need to Calculate CAC and I Am Drowning in Data and Uncertainty!
If you are feeling overwhelmed with the amount of detail you have at your hand and do not know what to do it with it to properly calculate CAC, you have come to the right place. Typically, CAC is stated as the total value of sales and marketing costs over a selected period, divided by the total new customers added over the same period of time. The two most common lengths of time used for the calculation of CAC are annual (LTM) and quarterly (90 days) periods.
In its simplest form, the sales and marketing costs included in the CAC calculation will include all of the expenses from each of the sales and marketing departments, as stated in the introduction to this article. We will refer to this methodology as “Quick CAC.” However, companies and investors can refine the calculation of CAC by classifying total sales and marketing costs by what spend is attributable to new customer acquisition vs. existing customer retention. Although this segmentation requires companies to track additional granularity on which costs are assigned to new vs. existing customers, it provides a more thorough and potentially more accurate representation of CAC. We will refer to this calculation as “Detailed CAC.” The below provides representative examples of the Quick CAC and Detailed CAC methodologies in practice:
More Detail for the Curious Mind: CAC Ratios and CAC Payback
Two other important metrics to consider to further refine KPIs and financial reporting are CAC ratios and the CAC payback period. These two items help business owners and investors understand how quickly (or slowly…) a company can recover initial customer acquisition costs. CAC payback period is typically stated on a specific timeframe basis (e.g. months, quarters, years), conveying how many periods it will take for the company to recoup its initial customer acquisition costs. Both of these metrics can be expressed with or without the impact of a company’s gross margin. By including the impact of gross margin in the calculation, the company adds conservatism and potentially more accuracy in representing how long it will take to recover CAC. This is often an area of dispute and lengthy discussion between industry professionals and companies. As a rule of thumb, it is good practice to calculate both revenue and gross margin breakeven CAC ratios and payback periods, and present the metric that the company and investors feel best positions the business to external parties. It is also a good practice to provide a rolling historical and projected view of each of these metrics (i.e. rolling quarterly and/or LTM basis) when reporting, as it can be a powerful display of a company’s trends and how the metrics have either improved or deteriorated over time. Two examples below provide further detail on CAC ratio and CAC payback period:
For CAC ratio and CAC payback period, different companies and investors possess a variety of potential targets they track towards. Depending on a company’s business model, customer base, retention, length of contracts and other key variables, CAC ratio and payback period benchmarks can vary. As a result, the benchmarks below certainly do not apply to every company, but can be useful for many to track against:
Concluding Thoughts: CAC Can Be Your Best Friend and Worst Enemy
Over the lifecycle of a business, the customer acquisition engine will ebb and flow, leading to changes in performance metrics. Through this all, it is important to maintain a consistent and vigilant approach to monitoring customer acquisition costs, as CAC affects cash flow and helps assess the long-term viability of go-to-market strategies. Adding other KPIs into the fold, such as CAC ratio and CAC payback period, will allow business owners and investors to increase their understanding of potential merits, shortfalls and risks in a company’s customer acquisition model. This clear line of sight provides a company with the agility and flexibility to improve the customer acquisition process and capitalize on available market opportunities.