How to reduce your CAC payback period and accelerate growth
What is the CAC payback period?
The SaaS business is asymmetric by nature. Acquiring new customers is comes with a single (relatively) large upfront investment. But when you close a sale you don’t immediately get your investment back and see a profit. All you’ve earned is the chance for. The time period passing by until you reach the break even point is called the CAC payback period.
Why does it matter?
Technically the CAC payback tells you how many months it takes until your initial investment is recovered. But that’s not the interesting part. Because what it really does is showing you the risk of pre-recovery churn, how fast you will grow and how much money you need to do so. And together they determine your acquisition efficiency.
But let’s go slow. Why does it display your churn risk? It’s highly unlikely that your customers will stay with you forever. The risk for churn simply increases over time. So while it hurts when a profitable customer says goodbye the churn that really hurts is of a customer that has not achieved profitability yet. Because you are not only loosing future revenues but a part of your, possibly huge, investment. The longer it takes to recover your CAC the higher is the risk that it does never happen.
Tom Tunguz, venture capitalist at Redpoint, points out the deep impact of the CAC payback period on a company‘s growth. As you are taking an upfront investment your money is tied. It becomes working capital and can’t be used elsewhere. Most prominently it can’t be reinvested into further growth. In the worst case scenario, responsible for countless failures, you run out of money.
But a short CAC payback period will let you grow like a snowball. Because you generate higher working capital turnovers and as a result you can reinvest more often in a given amount of time.
CAC payback calculation
The CAC payback period is calculated from 3 components: Customer acquisition costs, recurring revenues and costs of service. So the formula translates to:
This calculation definitely has it’s place and helps you get a quick overview. But it does not help you to improve it. That’s why Patrick Campbell recommends to calculate CAC payback periods for different kinds of customers (e.g. SMB vs. Enterprise) and different acquisition channels because you might have widely different results.
It’s a start but i’d like to encourage you to go even deeper – on account level. Because that’s where you find the data treasure. Who are the customers with an excellent CAC payback period, who are slow ones and what they each have in common. Market segmentation by CAC payback period. Focusing on the customers who help you grow as fast as possible. On an aggregated level you simply won’t see it.
David Skok defines a viable business with a CAC payback period <12 months. In the example above this target would be accomplished. But it also shows a broad disparity between individual accounts. The highly profitable customers cover for the non-profitable ones. Outliers should only exist in the other direction. What if the money would have been invested in more customers like Nr. 1?
CAC payback period vs. LTV to CAC ratio
There are not only revenues recurring in the SaaS world but also the question whether a company should track the CAC payback period or the LTV to CAC ratio. The answer is both. Because even though they are closely connected in the big picture they refer to different key aspects of your business. The CAC payback period refers to liquidity and growth, the LTV to CAC ratio to profitability.
The CAC payback period tells you how fast you’ll recover your investment and reinvest in growth. The LTV to CAC on the other hand tells you how much return on investment you’ve made in the long run.
If you’ve got an awesome CAC payback period but your (average) customer lifetime has the same length there is little to celebrate. Similarly if you generate high LTV to CAC ratios because your customer stay with your forever but you run out of money because it takes too long to reach the break even point. Your mission is to optimize both. But the LTV to CAC ratio will be the subject for another time.
How to reduce your CAC payback period
Growth and liquidity are 2 of the 3 key financial aspects of your SaaS business (the third is profitability). And you should treat it accordingly. This is not a one-time initiative and also nothing that’s only been done on rainy days. In my personal view reducing the CAC payback period should be specific job task or even a whole job role. A growth efficiency controller maybe.
However, the calculation of the CAC payback period consists of 3 components –acquisition costs, service costs and revenues. As they also each contain several processes and tasks there are more than a dozen angles for improvement. Their relevance will naturally vary in every company. Let’s go!
1. Customer acquisition costs
Let’s quickly remind ourselves how the customer acquisition costs are calculated. It’s adding up all acquisition related costs of marketing, sales and service divided by the number of customers achieved. There are 4 ways to improve it:
- Reduce spendings with a consistent number of new customers
- Acquire more (profitable) customers with consistend spendings
- Do both and acquire more (profitable) customers with less spendings
- Spend more and acquire better customers
Well, i guess you didn’t expect the last one. Because in an isolated view growing CAC would be a alarming. But if your CAC payback period goes down and your LTV to CAC ratio up in the same time you’ve greatly improve your customer acquisition cost efficiency. And that’s what really matters. Just think about it. Would you spend twice as much as before if you would generate 4 times the ACV? It would be hard to say no to it, wouldn’t it?
Market Segmentation
Selling to the right people is a key discipline for any SaaS business. Your acquisition efforts will produce 4 groups of people: Non-buyers, churners and low as well as highly profitable customers. That’s the nature of things. You won’t close 100% of your sales opportunities, you can’t reduce churn to zero, not all customers will shower you with money and without highly profitable customers you will go out of business.
But what matters is how much of your resources you spend on each category. That’s why market segmentation is such a crucial part. The fastest way to sink your business is trying to sell to everybody. Because not everybody needs your product. Spending your resources on bad leads and customers will not only make you loose money.
You will also miss out on highly profitable customers at the same time. Because we live in the age of now. No one’s gonna wait. You need to take a deep dive into your customer data, find out what each of the 4 groups have in common and redirect your acquisition efforts.
Reduce administrative work
A very serious issue in my point of view yet it seems to heavily lack of awareness. All the time your acquisition forces are spending on non-acquisition related work means loosing money. Of course, some overhead work is always necessessary. But according to studies sales reps spend up to 2/3 of their time with non-acquisition related tasks. That’s just insane.
Even if it’s not the case in your business it’s obvious that every working hour shifted from administrative work to acquisition will pay off. There are 3 ways to do it: Increase automatisation, reduce bureaucracy or decrease the number of “units”.
Let’s use updating the CRM data as an example. How can you reduce the time spent on it? The first way would be to adopt to a CRM that automatically sources, processes and tracks customer data. Processing data should always be reviewed in terms of their relevance and specifically if it’s done manually. Collecting and updating only data that is relevant for the acquisition process will boost your productivitity.
And finally comes the loop back to customer acquisition. The better you define your target group and the earlier you dismiss bad leads the less tasks will be performed on them. And less tasks means less data entries and updates.
Optimize software expenses
I’d like to keep this short for obvious reasons. The number of different apps companies use today is on the rise. Do you specifically know how much you spend on marketing and sales software (not running yours)? How many tools you have in place? How many of them are redundant, aren’t used at all and don’t deliver results but are paid for? All these costs are part of your CAC. At least you should include them because the only reason you have them is to help you acquiring customers.
Sales automatisation
For most SaaS businesses customer acquisition is a combined effort of generalized, automated and individual, manual steps within the sales funnel. If you are selling to enterprises the latter part will most likely be the dominant one. If you are following a PLG approach it’s the exact opposite. And in between these two extremes there are an infinite number of combinations.
But one thing is certain, everything you can automate and generalize will improve your efficiency. The most simple example for would be your FAQs. Everything that’s covered there no longer requires manual answering. Well, certainly that’s already pretty standard for SaaS businesses (and others too of course).
But there are more possibilities from onboarding to price calculators if you use dynamic pricing along a value metric. Another hot contender is your lead qualification. Individual, manual efforts are expensive so you should make sure they are taken on the right customer. Hello, market segmentation – once again. Do you begin to see a pattern?
Change your acquisition model
How much money you can spend on acquiring customers? Conversion rates aside the one thing that determines your entire acquisition strategy is your average ACV. The higher your ACV the more you can spend on acquiring customers. And the more you will have to. Because it requires more human touch which translates to personal 1:1 efforts.
It would be cool if your enterprise customer would simply perform a self-sign-up but you should not count on it ever to happen. The higher the prize, the harder you have to try. However, that does not mean there is no limit.
But what’s really matters is if there is an asymmetry between the projected ACV and the acquisition model. If your average ACV is 100$ annually you can’t afford operating with field sales. You have to reduce sales complexity to a level where new customers sign-up themselve or require a minium of individual effort.
2. Service costs
Long term success in SaaS is built on mutual benefitial and lasting relationships. Delivering a great customer experience is crucial and customer service is a vital part of it. The end of the story? A rhetorical question, of course. Because like everything else in your business model also the customer service is subject to the laws of efficiency.
Match customer service efforts with ACV
Hopefully your pricing strategy includes several tiers for different customer personas. But you should also think of support tiers. What does that mean? Customers who pay a premium price get premium support, customers who buy your basic product get basic support. Some SaaS companies even make it public like Getresponse.
If the customer buys the enterprise package they will get a dedicated account manager and receive additional consulting services. Alike customer acquisition there is no black and white in customer service either. Spend your resources according to your customers revenue contribution.
Get rid of bad-fit customers
It’s obviously not always easy to really limit your support. Even if you offer account managers, phone support etc. to your key account customers. Because a customer who gets only mail support may send you dozens a month. If this happens your service costs will quickly exceed your revenues. A negative monthly margin means that you will never recover your investment. Worse, every month the particular customers stay you will loose money. Make them go away.
But aren’t you supposed to get deliver an exceptional customer experience, get great customer revies, high nps scores and live happily ever after? Yes, you are supposed to wow your great fit customers. But there is a reason why those customers need so much support. They are a bad fit for your product.
So what you need to do is to have “the talk” with your customer where you point out the obvious truth. And the truth is that you are not meant to be together. Why would your customer deny it? Aim for a clean split with staying friends afterwards. You may even make a recommendation for an alternative.
Customer service automatisation
Alike customer acquisition your customer service is a mix of automated, generalized and personal, individualized efforts. Similarly it pays off increase the level of customer inquiries that can be handled automatically. In-app help, forums, FAQs and chatbots and more.
The time your customer service team saves can be reinvested into more valuable work. Because for many businesses the service forces are the main drivers behind upselling and retention.
3. Revenues
What’s the main difference between costs and revenues? Cost reductions are finite, revenues are not. Well, at least in theory. But nevertheless you can grow your revenues far beyond what you can save from cost reductions. At some point it simply becomes inefficient to aim for more and will waste your resources.
I like cost reductions and efficiency but honestly growth is much more fun. Surprisingly the monetization of the SaaS business model is widely underdeveloped. I’ve experienced little that goes beyond trying to acquire as much customers as possible. A whole lot of missed opportunities. But the most successful SaaS businesses in the world do not only have great products and excel at acquisiton. They are masters of monetization.
Increase your prices
Arguably the most underrated and underappreciated SaaS growth lever. Most SaaS business put little effort in their pricing. In fact most prices are a random choice based on competitor’s prices plus/minus a few percent.
The worst enemy of growth regarding prices are the „affordable“ ones aka having the cheapest offer. But your pricing always speaks to your audience. If you are cheaper then there must be a reason for. Would you expect high value from the cheapest offer? But people have pains they want to be solved for which they are willing to pay.
Another harmful practice is to improve the product but don’t change the price at all. It defies all logic. A better product delivers more value or at least it should do so. Why else would you work on it in the first place unless it’s a bug fiesta or a UX nightmare? The value of your product is always reflected by your customers willingness to pay. Until you raise your prices up to this level you are loosing money. It’s as simple as that.
Increasing your prices is the fastest way to add growth. Because it affects (at least) all your future acquisitions. If you raise them by 10% tomorrow every new acquisition will deliver 10% more revenues. Think about how this will turn out in the long run where you constantly add more value for your customers.
Create and seize upselling opportunities
Another fierce enemy of growth is the pricing strategy of „one simple price“. Similarly will do a pricng strategy based on the number of users. Because you don’t consider the value your customers get out of your product and their willingness to pay. They are ready to pay more but you simply do not charge them for.
Building your tiers either on a value metric (e.g. the number of contacts) or different feature packages, which you can both also tie to a user (e.g. the number of contacts per user), will immediately create opportunities. Hubspot is a great example for a powerful pricing strategy because they are doing both – different feature packages and value metrics. Growth is about monetisation, not acquisition. Reviewing and reworking not only your prices but also your packages should be a frequently recurring task.
However, it’s one thing to create upselling opportunities and another thing to seize them. That’s why you need to have, similarly to your acquisition, a process in place that e.g. defines when a customer is ready. High growth companies realize up to 40% of their growth from upselling. Let that sink in if you are not sold yet.
Move upstream
Resolving a misfit between your ACV and your acquisition model respectively costs by increasing the level of self service is only one side of the medal. What happens if you simply can’t do it right now or ever? Because your product simply is complex and so is the buying process.
The answer lies in going the other way round and target larger customers. Instead of lowering your efforts you are rising your ACV level and move upstream. The natural way to do this is by choice and that’s obviously much healthier. Not every product is best suited for startups or following a PLG approach.
Annual contracts
„No binding. You can cancel at any time“. Another well-meant goodie for the ultimate customer experience that slows down your growth. Because you are saying no to instantly getting (most of) your customer acquisition costs back.
That’s the true reason why a lot of SaaS businesses offer a price reduction for annual payments. It’s an incentive for customers to repay their acquisition costs faster. Your target price should always be the annual one (monthly paid). So you don’t offer a price reduction for the annual but a penalty for the monthly payment.
Offer both and let your customers decide.The customers who are ready to commit will take the incentive. The others will remain on monthly payments.
Retention
Loosing revenues to churn is always painful. But the worst scenario is if it happens before you’ve recovered your customer acquisition costs. Because you don’t only loose future revenues but also (part) of your investment. If your customer pays and stays only for one month, considering a 12 month CAC payback period, you will loose 91.7% of your investment (again, offer monthly and annual payments).
Customer retention is the core of any subscription business. Because most of your revenues come after the initial sale. Your LTV to CAC ratio is what your business is built on. Yet it still plays second fiddle to customer acquisition despite the fact that it is about 9x cheaper to generate new revenues from retention than acquisition.
It’s a simple truth that you can’t grow as long as you leak piles of money every month. You need to put resources and processes in place to prevent churn.
Reduce sales cycles
The CAC payback period is not only determined by how long it takes, or more precisely for a SaaS business, how many single payments are necessary for, to recover your investment. Because there is also the time period over which you are spending your resources until the first payment starts. The longer it takes to monetize your investment the longer you will keep running dry on funds. Liquidity matters.
In entreprise sales it often takes several months until deals are closed. Nonetheless you should seek to reduce it. Even if you go from 9 to 8 months will be of great value because you have one month less to bridge. A long sales cycle does not necessarily mean lead to higher costs. The customer touchpoints may only be stretched out over a longer period or decisions are made slower because of friction.
This simplified example shows what would happen if you reduce your sales cycles from 5 to 3 months. In the first scenario the company’s funds are drained after 10 months. It would take another 6 months to get out of debt. In the second scenario the outflow of money stops after 11 months completely and generate positive cashflows after 13 months.
Summary
The CAC payback period is a key KPI measuring your growth efficiency. It determines how fast you can grow and how much money you need for. A fast recovery means that less capital is tied and the higher turnover allows you to reinvest into growth faster. Like a snowball rolling downhill.
An extented CAC payback period on the other slows down your growth and endangers your financial stability. Because the churn risk increases over time and so does the probability to loose a significant part of your investment.
As the calculation of the CAC payback features acquisition and service costs as well as recurring revenues you have 3 different angles to improve your performance. And due to its importance you should work on all of them.
Although there are more than a dozen ways to improve your CAC payback period the key discipline you need to master is your market segmentation. Because it determines how much you spend on acquisition, customer service and ultimately how much revenue you can generate. The less money you spend on non-buyers, churners and low profitable customers and the more you spend on highly profitable ones the faster you will grow.