The Common Mistake Made When Calculating Cost of Acquisition (CAC) and How To Fix It
Most SaaS businesses understand the Cost of Acquisition (CAC) metric is one of the critical metrics to pay attention to. If you are not aware, CAC measures the cost the company expends to gain a new customer. Most measure this by taking the sum of "Total Marketing and Sales Expenses" and dividing it by the number of new customers acquired:
CAC = (Total Marketing + Sales Expenses) / # of new customers gained
Because this equation is too generalized, it could lead you to believe your CAC is either lower or higher than it truly is. This ultimately leads to operational decisions based on inaccurate data, which could ultimately impair your business. Take these steps to accurately calculate your true CAC.
1) Do not include new acquisition of free trials
CAC is the calculation of the cost to acquire a paying customer, not just any customer. Including any customer accounts that are on a free trial or free subscription should still be considered leads rather than customers.
2) Consider your sales cycle
Most companies that sell to other businesses typically have long sales cycles, usually lasting longer than a month. By including the total monthly marketing & sales expenses for the month's new customers, the equation does not account for the costs associated with that customer prior to becoming a paying customer. Similarly, the equation could be including costs during the month not associated with the paying customer at all.
To resolve this challenge, determine how marketing and sales expenses are spread over the period of obtaining the new paying customer. If the sales cycle is 3 months, you may determine the total cost are evenly spread by 1/3 each month. Then adjust the calculation accordingly.
3) Determine what marketing and sales expenses to include
Most of the time we think of marketing and sales expenses as only including the cost of ads and commissions paid to the sales team. However, there are other costs to consider.
Most sales departments have project management or CRM programs. The cost for usage of these programs and any other program the team uses should be included.
Most sales departments also have someone managing the sales team. All or at least a portion of the salary of that individual should be included.
Any overhead expenses related to the sales team should also be included. Example of these expenses include any rent, leasing, or fixed assets used by the sales team.
At the end of the day, any SaaS business should manage its metrics and CAC is certainly an important one. But what type of data you’re using to determine the company’s CAC is key.
Chris Royer is the Founder and CEO of SaaS Accounting & Consulting. He uses his 15 years of public and private accounting experience to help both early and mid-stage SaaS companies see the financial story in their own business and achieve financial success with strategic growth strategies.