I send out revenue metrics of a new SaaS company each day to my list and many times founders reply with great questions.
This week, John who runs Port Engine asked a question I think a lot of founders struggle with so I thought I’d address publicly:
John was asking how to calculate his customer acquisition cost after reading countless articles online, studying models, and finding no concrete definition.
Measurements are meant to be instruments, not absolutes. There is not specific definition for CAC however you’ll calculate it differently depending on what question you’re trying to answer.
Is our Google, FB, Linkedin adspend working?
Are we being too aggressive with our sales person commission structure?
How do we measure effectiveness of our content marketing and SEO team?
I’ve interviewed over 2000 B2B SaaS CEO’s on my podcast, The Top Entrepreneurs, and I’ve recognized 4 common patterns that come up in terms of how founders measure CAC.
They follow this quadrant structure:
4 most common ways SaaS teams calculate CAC
Lets assume your metrics from last month look like this:
New Customers Paid Channels: 1000
New Customers Organic/Inbound/Freemium/No-Touch: 3000
Total New Customers Last Month: 4000
Sales and Marketing Expenses only: $70,000
Total Expenses: $150,000
With this same set of data, 4 different founders could calculate 4 very different CAC’s:
Quad 1: $70,000/4000 = $17.5
Quad 2: $150,000/4000= $37.5
Quad 3: $70,000/1000 = $70
Quad 4: $150,000/1000 = $150
$17.5 and $150 is the difference between doubling burn to drive profitable growth, or pulling back as you hunt for new, cheaper channels.
So which equation should you use?
How to Figure Out Which CAC Equation You Should Use and When
Quadrant 1, upper left:
This is how founders measure when they are hiring their first few SDR’s, AE’s and are not quite sure how to sort customers based off which ones came from a sales person versus which ones came organically. In this case, they calculate CAC by: (Adspend+Salaries)/All new customers.
Example: $70,000/4000 = $17.5
This quadrant typically produces your cheapest CAC. Your actual CAC is likely more but you’re not quite sure yet how to measure/quantify it. This is a fine place to start.
What if you’re not great at measuring which expenses tie back to sales. Thats where Quad 2 comes in.
Quadrant 2, upper right:
Founders who use this calculation typically feel that all expenses directly tie back to sales. Engineer salaries speed up roadmap which helps land new customers. They host customer lunches at their office so rent helps land new customers.
This calculation is actually the easiest: Take all your expenses last month and divide all new customers into it.
Ex: $100,000/4000= $37.5
This is great, but what if you have tons of inbound organic new customers that cost you very little to get? Use quadrant 3 instead.
Quadrant 3, lower left:
Founders who rely on large inbound organic channels typically use this calculation. If they included all new customers in their CAC calculation it would lead to an unuseful, very low number.
Ex: 4000 new customers every month, 3000 come from freemium plan or mousetrap tool like WebsiteGrader (for Hubspot), or CodeWars (for Qualified.io). If S&M expenses totaled $70k last month, not so smart founders might calculate CAC by doing $70,000/4000= $17.5
But remember, you’re calculating CAC to try and assess paid channels where you spent the $70,000 last month. A more accurate read on your CAC would be to take $70,000/1000 (only customers who came from paid channels) = $70
So far we’ve gone from a low of $17.5 to get a new customer, up to $70. What if you want to stress test your model and get worse case scenario (most expensive CAC). Thats where Quad 4 is useful.
Quadrant 4, lower right:
This calculation will always give you your most expensive CAC. Teams who use this calculation think:
“I wonder what worse case CAC scenario is… Lets just take all our expenses, and only new customers from paid channels and see what the result is.”
For example: $150,000/1000 = $150
You’d use this information to establish a ceiling on what your CAC is. The floor would be Quad 1. Depending on what you want to measure, you’d pivot between Quad 2 and 3.
As you can see, CAC fluctuates significantly from a low of $17.5 to a high of $150 depending on what calculation you use.
I’d encourage you to calculate them all and then use the right one appropriately depending on which question you’re trying to answer about your business.