How to defeat high customer acquisition costs
Acquiring new customers is a crucial part for any SaaS business. According to research 89% of business executives see it as the top priority for growth. But new customers (rarely) come for free. Where there’s acquisition, there’s acquisition costs. Most SaaS businesses track it as one of their key metrics on an aggregated level but do not engage them on a level granular enough to improve them at full scale.
As funds are limited at any stage in the lifecycle of a SaaS business spending too much on acquiring new customers can quickly put an end to all growth. Without deeper knowledge about how much you spend on what and where high customer acquisition costs are the inevitable consequence. Here’s how to defeat them:
What are customer acquisition costs?
Let’s first start with determining for sure what we are talking about. The customer acquisition costs include all expenses related to acquiring a new customer. They are often simply considered as your marketing and sales costs. But that may not be accurate.
Because not all your marketing and sales resources must run into acquiring new customers. At the same time it’s not uncommon that the customer service team takes care of the customer during a trial. So before you can calculate your true customer acquisition related costs you need to be clear about your acquisition process and your resources. So the accurate formula is:
Some examples for acquisition-related costs:
- Marketing: Wages, ads, events, software
- Sales: Wages, commissions, travel expenses, software
- Customer service: Trial support, software
But what’s more important is to understand what your CAC really are beyond numbers and formulas. Customer acquisition costs are an investment you have to take to start a revenue stream delivering returns and eventually generating profit.
Why are they so important for SaaS businesses?
Because of the asymmetric nature of the subscription business model. Acquiring customers is basically a big one-time investment. But you don’t get repaid immediately. While you are getting paid back month by month the risk of churn steadily increases. If the customer churns before you got repaid you are loosing money. High customer acquisition costs increase the risk for that to happen.
But there is more. The revenues generated have to cover your other non-acquisition related costs, your expenses taken on unsucessful acquisitions and the gaps left from churned customers. Keeping your customer acquisition costs (relatively) low must be a priority for any SaaS business. Acquiring new customers at all costs is the road to extinction.
How much can you spend?
Without context the customer acquisition costs will tell you little about the health of your business. That changes when you put them in relation to your customer lifetime value and the CAC payback period. The LTV to CAC ratio obviously has to be greater than 1 or you are going out of business.
The CAC payback period will tell you how long it takes to recover your investment and reach the break even point. If it takes too long you will run out of money even when the projected LTV to CAC ratio will eventually be greater than 1. But what’s more likely is that your customers will churn before.
David Skok defines a viable business with a LTV to CAC ratio of 3:1 and a CAC payback period of <12 months and these are great benchmarks to follow. The higher your LTV to CAC ratio gets and the faster you get your CAC paid back the faster you can reinvest and the faster you will eventually grow.
Customer acquisition cost analytics
Determining your CAC frequently is important to quickly check the health of your business. But it does not give you the insights you need to improve it. More specifically it does not give you answers on the questions below:
- How much money do we spend on non-buyers?
- Where do we leak money?
- How much do we spend on non-revenue generating activities?
- How much do we spend on acquiring a specific customer?
And as we all know: You can’t improve what you can’t measure. In order to improve your customer acquisition costs we need to break them down and improve them on every level.
1. Types of costs
First you need to know how you spend your money. The standard calculation will only show you how much money you’ve spent on marketing, sales and customer service. But you need more details. You need to distinguish between the types of cost within your sales funnel and organization.
Sunken vs. success costs
In a perfect world you would have a 100% conversion rate from leads to customers. Because you attract only the right leads who sign up with your right away. The next best thing would be to increase your spendings on successful acquisitions while decreasing your spendings on unsuccessful acquisitions. Remember, your successfully acquired customers have to repay your entire investment. Taking non-buyers and quick churners out of your sales funnel will greatly improve the the ratio.
Overhead vs. real acquisition costs
It’s very unlikely that your acquisition forces spend all their time with actual acquisition. They will be busy inserting and updating data, create reports and other stuff. Some overhead work will always be necessary and you can’t get it to zero. But you certainly can increase the time spent on actual acquisition and maybe cut down on your software expenses.
Collective vs. individual costs
If your marketing team produces content like blog posts or e-books it does not matter how many people will read it in terms of costs. The more leads you produce the lower the costs per lead will become. Exactly the opposite is the time your sales reps spend with a single customers in calls, meetings etc. They don’t scale, they add up. Your goal is to increase the level of collective costs.
2. Funnel stages
After you’ve determined the spendings on each type of your costs you can break them down onto the stages of your sales funnel in the next step. You may also go the other way round. Determine the costs per stage first and assign the cost types afterwards. Let’s check it out with a simplified example:
Costs per lead
There is an ongoing debate whether inbound or outbound marketing is cheaper. The correct answer: It depends. It depends on your business model respectively your acquisition strategy. There is a big difference between selling a 10$ per month self service product or enterprise software for 10k+ per month. It also depends on the tools and methods you are using.
As determined earlier judging your CAC is only possible when you put them in relation to your LTV and your CAC payback period. The same obviously applies for all the parts of the whole (funnel stage). As you’ve probably more than one lead source in place it absolutely makes sense to evaluate the costs per lead per channel. You could even go further and calculate the your acquisition costs per channel.
Costs per qualified lead
If your lead qualification process is fully automated then you can qualify an unlimited amount of leads. If it requires manual work your costs will skyrocket when you’ve generated tons of low quality leads and have to qualify them individually. This may be the most crucial part of your sales funnel that can easily exhaust and waste your resources.
The standards for a qualified lead should never be lowered in terms of increasing conversion rates. The further an unqualified lead moves up the sales funnel the more money you will waste.
Costs per conversion
If your business strategy involves high touch inside or even field sales you will pay a heavy price for bad lead qualification. Because you are carrying them through your entire sales funnel including the most expensive non scalable parts. But it gets worse.
Customers have all the choices in the world today. That means building up a backlog and „getting back at you“ rarely works out. Your prospects will be gone. If you have more prospects than you can handle in a reasonable amount of time then you have to decide which ones to prioritize and which ones will most likely be gone.
If you spend your resources with the wrong prospects you are loosing twice. Because you won’t get a return on your investment and because you are missing out on opportunities. The quality of leads and prospects is decisive.
3. Costs per account
If you are determined to take your customer acquisition costs to a whole new level you need to go even deeper – on account level. Because a successful signing does not mean you will get a return on your investment and make a profit. You’ve just earned the chance for.
If the customer churns before reaching the break even point you are loosing money. The same happens when an acquired customer generates negative monthly margins (service costs exceed revenues) but this is another story.
When you track your acquisition costs on account level you are also able to calculate the CAC payback period and the LTV on account level. That means you can evaluate the profitability of each and every customer. And the most important thing: It allows you to create customer persona profiles based on profitability and redirect your acquisition.
As soon as 1:1 efforts are taken the costs can be assigned to the respective account. Calculating account-based customer aquisition costs is highly recommendable for businesses with high touch inside and field sales. If you are following a PLG approach the efforts to determine the CAC on account level will most likely exceed the benefits.
How to defeat high customer acquisition costs
I saved the best for last. Because i am telling you now that you don’t have to get your CAC down. They may remain the same or even grow. Double, tripple, quadrupple – the sky is the limit. Pure insanity? Maybe. But hear me out first.
What your really need to improve is your CAC efficiency. That means getting the most out of every cent spent. After you’ve determined the CAC and their payback periods on account level you can rank and profile your customers. What you might discover is that a specific customer might cost twice as much to acquire but pay you back in half the time.
Don’t get me wrong. Increasing your CAC efficiency could very well lead to a reduction of your customer acquisition costs. But i can’t emphasize it enough – what matters are the LTV to CAC ratio and the payback period. These are the KPIs you need to improve.
The road to victory leads to tackle CAC efficiency form 3 angles:
- Spending less on non-buyers and more on profitable acquisitions
- Spending less on overhead and more on acquisition-related work
- Increasing automated and decrease manual work in the sales process
1. Market segmentation
This is the most powerful angle and should always be your top priority. Defining, targeting and acquiring your ideal customer. What is your ideal customer? From a growth point of view: The one who delivers the highest LTV to CAC ratio and the shortest payback period.
Your market segmentation affects everything that happens in your sales funnel. High customer acquisition costs are always, at least partially, the result of a weak market segmentation.The table below shows a CAC payback period of close to 12 months. Awesome? Could it be more awesome? Who are the customers you would like to have more of?
2. Overhead spendings
The more time your acquisition forces can spend on actual acquisition the better results you will get. Either way – with more customers or more per customer. That’s actually a big one. Research says that sales reps spend the vast majority of their time on non-selling activities. If you can reduce that by 20% you would already score big time.
Two ways to reduce the time spent on overhead work is to increase automatisation for processing data and completing tasks or to process less data and perform less tasks (or both). The latter one is directly related to your market segmentation. If you increase the quality of leads you will very likely decrease the number their number. As a result there will be less data to process and less tasks to perform.
3. Sales process
The more manual and individual inputs you have to take the higher your customer acquisition costs will be. According to David Skok the costs rise exponentially from the left to the right in the scheme below.
Source: For Entrepreneurs
Downgrading
If the costs rise exponentially by going one step further from left to right the exact opposite must be true for moving into the other direction. Reducing your customer acquisition costs exponentially is pretty tempting. But it’s not something you can simply do by pulling a switch. Because it will change your entire business. From strategy to organization and product design/development.
Automatisation
Before considering taking actions requiring such dramatic changes you should first look for improvements in your current acquisition model. Everything you can take from manual to automated and individual to collective will have an impact from low-touch inside sales to field sales with SE’s. FAQs, automated trials, chatbots etc. Most likely you already have some of these in place. But maybe you did not approach them from a CAC efficiency point of view.
Dissolve asymmetries
By going from the left to the right not only the CAC increase but also the projected ACV. The higher the prize, the more efforts can be taken. Perfectly logical. But what i’ve frequently ran into are asymmetries between the costs and the ACVs. If your acquisition model requires high touch inside sales but your ACV per account is 100€ it simply can’t work out. Your acquisition model and its costs must fit the revenue potential.
Conclusion
There is a good reason why customer acquisition costs are said to make or break your business. Continuously spending your limited resources on work with no and low returnswill quickly put an end to all your aspirations.
That’s why increasing your CAC efficiency must be a top priority at any stage of your business. But as you can’t improve what you can’t measure you need to install a system that allows you to track your customer acquisition costs on a granular level.
High CAC efficiency is the result of accurate market segmentation that shifts more resources to profitable acquisitions, reduced overhead work and a higher degree of automatisation within the sales process.