When it comes to business, nothing is free. You have to spend money to make money, and you have to take a variety of scenarios into consideration. It’s the same thing with SaaS businesses. The most crucial tactical financial decision that SaaS operators make is in acquiring customers. These expenses are better known as Customer Acquisition Costs or CAC.
It costs a lot of money to fill your pipeline with prospective customers. So, before potential clients become long-term paying customers and start to repay acquisition costs, it can be assumed that the company is net negative on this. This is where the company needs to focus on an essential profitability metric known as the CAC Payback Period.
In this article, not only are we going to cover what a CAC Payback Period is, but we will also show you how to calculate it, also show you why it’s essential for businesses along with scenario building.
The Definition Of A CAC Payback Period With Scenario Building
CAC or Customer Acquisition Cost Payback Period refers to the number of months it would take for a company to make a return on their investment of acquiring new customers. We can assume that it is a break-even point and a great way of knowing how much money a company needs to keep growing.
For example, if a customer is acquired for $450 and makes a monthly contribution of $30 a month, or $360 a year, the payback period would be around 15 months ($450/$30 = 15).
However, we must ensure that this CAC Payback Period is as short as possible so that our company has a more profitable future ahead of it.
Shorter CAC payback periods entail two things for a business:
- Quicker growth
- A fraction of the working capital
Why scenario building CAC Payback Period is Important
The payback period displays an acquisition strategy’s efficiency. And as we said earlier, the shorter the payback period is, the better the financial position of a company can be. This involves understanding the acquisition efficiency so that we know how acquiring various types of customers can affect our finances and how our ongoing acquisition strategies can be sustainable in the foreseeable future. The primary objective of every business from the start is to maintain a constantly expanding cash inflow: the more the accurate payback method, the sooner you’ll get the money to begin reinvesting.
How to Calculate CAC Payback Period
Now that you’re aware of the importance of a payback period let’s consider how you can calculate it.
The formula for an individual customer is:
CAC Payback Period = CAC / (MRR – ACS)
MRR: Monthly Recurring Revenue
ACS: Average Cost of Service
You should divide the CAC of a customer by the overall revenue that they contribute and under a year (then multiply the monthly subscription rate by 12)
Let’s take a what-if scenario by using the values from the example above; let’s assume that acquiring a customer costs around $450 in sales and marketing. That customer contributes about $30 a month, or $360 a year. As such, that customer’s payback period would amount to exactly 15 months.
Payback Period for customer X = $450 / $360 = 15 months
You can also calculate the average payback period for several customers that you have secured over a set period, like a month or quarter. This will inform you about the number of quarters required to earn your acquisition spend back.
The second way to calculate the payback period is:
The payback period for customer acquisition in the 2nd quarter = Marketing and sales spend in the first quarter / [2nd Quarter Revenue – 1st Quarter Revenue]
Then divide the number by 4 to get the number of years it will take to get the original cash outflow back.
Let’s take another what-if scenario using the second CAC payback period calculation method. Let’s assume that the total marketing and sales spend (such as marketing campaigns, paid acquisition, and also the salaries for the marketing and sales team members) equals to $8,000 in the first quarter. The revenue generated in the first quarter is $3,000, and the income from the second quarter is $4,600.
The payback period formula that we’re going to use here includes the first quarter’s marketing and sales spend divided by the difference from the first quarter to the second quarter, which is ($4,600-3,000 = $1,600)
Payback period = $8,000 / $1,600 = 5 quarters / 4 = 1.25 years.
The payback period would, therefore, be 5 quarters or 1.25 years.
Payback periods that are longer than ideal inform you that you need to make improvements in those areas that might affect the payback. A payback period’s length is dependent on the following two metrics:
- Customer monetization: the size of a customer’s payback increment in their monthly CAC depends on how many customers you can monetize. You can develop individual plans, charge your customers a single flat rate, or scale the pricing based on a value metric’s usage. Any payment plan you make for your customers affects the payback period’s length.
- Customer acquisition costs: subscription-focused firms consider the risk of having CAC upfront paid and then have it replenished as the customers continue to pay their monthly subscription fee over time. The more the upfront CAC, the more it will take to pay the investment back after a particular passage of time.
How to Reduce or Speed up CAC Payback with scenario building
To help increase your company’s profitability or help it do more than just break even, carefully use scenario building and apply the following strategies:
1. Use the Best Practices of PLG Companies
According to several reports, product-led growth (PLG) companies are known for having a smaller CAC payback than those with conventional sales and marketing-driven go-to-market models. That’s because PLG companies have lesser sales and marketing costs as their bottom-up business model relies on their products to attract, convert, and then upsell consumers.
That’s why it’s best to apply the best practices of PLG companies throughout your sales funnel to realize the product-led growth’s efficiency. You should set your mind on delivering delight and value through superior user experience to make powerful referral opportunities and network effects.
2. Enhance Sales Funnel Conversion Rates with scenario building
Look into your sales funnel and inquire how well it is converting your prospects into paying customers. This could have a significant impact on a company’s payback period.
Let’s assume that a company closes over 80 prospects a month for $80 each. And while using the same marketing spend, you close over 120 prospects within a month at the same rate.
This means that you’ve increased your revenue by $3,200 (120-80 x $80) and have ultimately lowered your CAC Payback Period, given that the cost of acquiring customers was the same. Now, you’ve converted more of your customers, which is exactly what you had hoped for.
3. Don’t Forget About Customer Retention.
Besides focusing on acquiring users, you should also pay attention to the consumer retention metric as well. This is the kind of metric that companies used to count customers and keep track of their activities. You need to keep this tip in mind as acquiring new customers is more expensive than keeping an existing one. To boost your company’s retention rate, you’re going to have to build a very intriguing and engaging app that can retain your customers. But besides that, you should also offer your consumers a great experience.
By applying proper customer retention strategies, you can boost your budding company’s visibility more, causing it to spread more members of your target audience by word-of-mouth, leaving positive comments on your app’s product page or review section, and build a proper community around that app. These strategies will give your company more notoriety, but they’ll also help push your CAC down.
4. Optimize Customer Touchpoints
Inspect the number of touchpoints that your prospects are going through before they’re converted into long-term paying customers.
A touchpoint is an important stage in the overall buying journey for customers. That helps them acquire a particular product or service. The only issue with this strategy is that every touchpoint costs money. And some touchpoints convert customers better than others.
So we recommend adding fewer touchpoints in the process, to make it more financially feasible for you. However, you need to look into those touchpoints that are unnecessary and focus on those touchpoints that are effective. In converting prospects into customers. Removing touchpoints that don’t bring any revenue can have a considerable impact on your CAC Payback Period.
All in all, a faster or shorter CAC Payback Period improves your business’s profitability. And now that you are aware of how to calculate CAC Payback Period, you should think about the best way to get a faster payback on your customer acquisition investment. This lays the groundwork for the company’s future performance. Besides that, you also need to contribute time and money towards more efficient growth levers to boost revenue.