“As you’re optimising your business for profit, you want your CAC payback period to get better and better”.
Remco Marcelis, co-founder and CEO of Standard Ledger
Whatever your product or platform, as a startup or growing business, the most important thing you need to be able to do is win new customers. Every business will have a different approach, whether that’s relying on salespeople to hound your leads or a killer social media machine that brings buyers straight to you.
One way to measure the effectiveness of these operations is Customer Acquisition Cost (CAC), which breaks down this secret sauce into a dollar cost.
CAC is often described as a debt incurred at the start of the customer’s life, which must be repaid. The key question is how long it takes to clear the debt.
In e-commerce, many companies are able to completely cover the CAC in a single order, given of course that many customers will only ever make a single order. Boosting Average Order Value (AOV) along with improving customer retention are two core areas to focus on in order to maintain high gross margins.
In the SaaS industry, where subscription pricing models predominate, you can calculate the payback by dividing CAC by the Monthly Recurring Revenue (MRR) per customer.
For a platform with a subscription pricing model, CAC payback might be in the range of 3-6 months if you’re in the consumer space, whereas 12-18 months is more common in B2B SaaS.
A general rule of thumb for SaaS is that the lower your Annual Contract Value (ACV), the faster the payback period is, says Remco Marcelis, co-founder and CEO of Standard Ledger, a full-service accounting and CFO firm dedicated to startups.
According to a 2023 report, a selection of B2B SaaS companies with an ACV below US$1,000 had a CAC payback time of 8 months, whereas SaaS companies with an ACV between US$25,000-50,000 had a CAC payback time of 16 months – quite a large variation.
Companies that have a CAC payback that is shorter than average may be doing something right, such as strong product-market fit or an effective sales and marketing operation, which can be sought after by investors.
Contrarily, a longer than average CAC payback time might be a red flag for potential investors.
Your CAC is also highly significant in relation to your balance sheet and your ability to grow your customer base at the pace you’d like.
“CAC payback is all about watching your cash go down and down [as you acquire customers], before it starts going back up,” says Marcelis.
“If you’re growing fast, you’re actually making this curve deeper and deeper. That’s why many companies look to raise investment when they’re in this fast growth stage. If you’re not careful, your company could fail,” says Marcelis. “It’s essential for founders to understand these dynamics.”
Marcelis works predominantly with B2B SaaS companies, where payback is typically around 12-18 months.
However, the payback period typically varies for a B2B SaaS across different client segments. Enterprise tends to have longer sales cycles, and even higher onboarding costs, meaning that the payback period is usually longer.
In the small business segment the ACV and the sales and onboarding support are usually simpler, meaning a shorter payback period.
As a business grows and moves up the value chain, winning larger and larger contracts, its CAC payback can lengthen, notes Marcelis.
A SaaS business can try to defray some of these costs by charging an enterprise customer for an implementation project, he adds.
Do You Even Know Your CAC Payback?
While businesses spend a lot of energy optimising their customer acquisition processes and reducing the overall payback time, the first step for many businesses is to be able to accurately measure or quantify this metric.
Common errors when estimating CAC payback include looking at it on a revenue basis, when it should be adjusted for gross margin, or ignoring areas of spend that are part of your CAC.
Accounting for the cost of offering a freemium service or a free trial is essential, as well as other costs such as onboarding.
On the operational side, a startup’s accounting and CRM systems need to be set up and synced in order to track spending on customer acquisition efforts, says Marcelis, who notes that this is also true for many other business metrics. Most accounting systems don’t have information such as user numbers.
Business costs, such as the CRM itself, also need to be broken down and relevant portions included in the calculation of CAC, he says.
If you look online, you’ll find there are different ways to model CAC payback, including whether you base your calculations on overall averages, or if you break down users into cohorts.
Standard Ledger offers a metric guide for startups, which highlights the differences between blended CAC and paid CAC, which illustrates the effectiveness of your paid advertising efforts, and whether it's profitable.
CAC is also often discussed relative to the lifetime value (LTV) of customers, which is the total revenue you can expect to earn from an average customer (often calculated as average revenue per user divided by churn rate).
If your CAC is higher than your LTV then obviously your business is not on a sustainable footing. Often the CAC:LTV ratio is discussed, with benchmarks suggesting that for B2B SaaS an average ratio is in the range of 2-5 (e.g, for each dollar you spend on customer acquisition you get a return of $2-5), whereas a ratio in the range of 5-10+ is considered excellent; in consumer SaaS, an average ratio is 1-3, whereas 3-5+ is considered excellent.
When looking at CAC, many industry commentators stress the importance of considering variables such as churn.
While churn often speaks to more fundamental issues that need resolving such as customer satisfaction or pricing, it can also impact the average payback period.
If you have a CAC payback of 12 months, but a customer churns after 6 months, then you have an unpaid CAC debt that would extend the average payback period for remaining customers. Higher churn rates also reduce your LTV, and therefore affect your CAC:LTV ratio.
Optimising CAC is Essential – but External Factors may Dominate
The customer acquisition cost will be a key factor in determining how quickly you can scale and grow your customer base, and how effectively you can deploy capital into growth activities.
CAC payback usually becomes a focus for companies once they have established a product-market fit, and proven they can grow and retain customers, says Marcelis.
“Usually around the Series A stage, a business will shift from a ‘growth at all cost’ model to optimising a repeatable sales process and considering how much it really costs them to acquire customers,” he says.
Not only will investors want to know this metric when assessing a company, but it is essential to balance growth with capital preservation.
Companies ideally want to see CAC payback fall over time, says Marcelis. Once a company has established a strong market fit it should be easier to attract customers, with a lower ad spend, and the onboarding process should be streamlined and require minimal inputs.
It’s a common sentiment in the tech space. But it’s worth keeping in mind that your CAC could actually increase due to external factors outside of your control.
According to a 2023 report by OpenView, payback times worsened significantly from 2022 to 2023 for larger SaaS companies: for those with an annual recurring revenue (ARR) between US$20-50m, the median CAC payback period rose from 17 months in 2022 to 23 months the following year, reflecting closer scrutiny on expenditure by clients.
In e-commerce, customer acquisition costs are trending higher globally due to factors that include increased competition, limited channels available to reach customers, as well as increased privacy online making it harder to accurately target customers.
That was the experience of Gathera, a direct-to-consumer e-commerce store selling hydroponic grow kits and accessories which has been in business since 2018.
Co-founder Dilhan Wickremanayake says that the business was able to grow steadily, but in the last two years as overseas manufacturers and resellers such as Temu aggressively entered the Australian market, this has pushed up CAC costs while also having downward pressure on prices in some categories.
“When Temu launched in July last year, they basically just bought up all the Google ads. That pushed up our Google ad costs too."
That pushed up Gathera’s CAC by 10-20% virtually overnight.
Temu and other overseas resellers also changed consumer expectations around price, says Wickremanayake. Another factor was that some competitors had stocked up massively after Covid, and then had to discount aggressively to move their products, which affected some of Gathera’s categories.
“The low end of the market is getting absolutely smashed, you might make a small sale and make less than $5 [in net profits].”
Gathera has responded by designing a new generation of products that Wickremanayake believes will be more popular with buyers and provide greater differentiation from low-cost products and other competitors.
That includes offering larger size products, such as a 20 litre basin that can grow up to 18 plants and herbs and only needs to be watered once every three months, far bigger than competitors.
Global competitors who aren’t established in Australia struggle to compete on price when selling larger sized items, since they must pay for air freight from other geographic locations which is expensive, he notes.
“The overall trend in the market is lower prices but better value,” says Wickremanayake . “We have redeveloped all our products during the cost-of-living crisis, looking at what people didn’t like about our old products and redesigning them around the features that customers care about to make them better.”
Wicks says they plan to counterbalance the higher cost of acquiring customers via digital advertising by focusing more on growing their presence on social media and organic marketing, looking to tap into the natural enthusiasm for hydroponics or growing your own food at home.
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