If I could take it all CAC
A deep dive on customer acquisition cost and payback period
Customer Acquisition Cost is what you spend in sales and marketing costs to go out and get a net new customer.
CAC Payback Period is a derivative of Customer Acquisition Cost, and spits out the number of months it takes to breakeven on that new customer.
CAC Payback Period also incorporates the customer support and maintenance costs associated with getting the customer to stick around.
CAC Payback Period is important because it shows how efficient your GTM machine is. Investors care about it because you can’t trade a buck for eighty-five cents forever, and this indicates if you built a model that can get to profitability and keep growing.
I drew up a dummy P&L so we can try out a few CAC Payback Period formulas. The numbers we’ll use are in blue.
Below are the three most common ways to calculate CAC Payback.
Neither is inherently better - I’m providing options because you won’t always have all the components you need for one versus the other and might need to be flexible.
Sales and Marketing Expenses: S&M should be lagged according to the average sales cycle of the sales engine you’re measuring. The goal is to align the dollars you spent in the past to generate the sales you are finally seeing today. This is important if you are hiring really quickly. You don’t want the costs of new hires who haven’t sold anything yet (deadbeats!) to show up in the CAC Payback for today’s additions. Examples of lagging by segment:
Enterprise sales cycle of 180 days = 2 quarter S&M lag
Mid-Market sales cycle of 90 days = 1 quarter S&M lag
SMB sales cycle of 30 days = 0 quarter S&M lag
NOTE: I’m lagging everything by one quarter (or period) in my examples above; this is the most common way to do it
Cost of Goods Sold (COGS): This includes hosting costs, customer support, and customer success. It’s basically the ongoing costs you incur to keep your install base around. It’s taken from the period you are measuring, with no lag.
New ARR: This is the in-period additions to your topline, preferably measured in ARR. It is NOT your total MRR or ARR - just net new. Also, it is not your GAAP revenue, which is an accounting based measurement of topline.
Generally all of these figures are best measured on an aggregated trailing twelve month basis to smooth for seasonality. Most companies add more ARR in their fourth quarter than the rest of the year. This means your S&M will technically go back 5 quarters (or 15 months) if you are lagging by one quarter. Otherwise, looking at it monthly can result in a graph that looks like a heart EKG.
What’s “good” look like?
The median CAC payback period for private software companies is somewhere between 12 and 15 months depending on scale. Generally speaking, the smaller you are, the faster you need the money back, hence the need for a shorter CAC payback cycle.
Openview breaks CAC payback period into Annual Recurring Revenue (ARR) cohorts below. You can think of this as your Seed through Series C or D-ish benchmark.
It’s important to note that “good” varies significantly for larger, public companies who tend to focus their resources more heavily on a prolonged Enterprise sales cycle and have better access to capital. Clouded Judgement crunched the numbers on what CAC Payback looks like for companies making the jump to public. You can think of this as your +100M ARR benchmark. The median is 25 months and top quartile is in the high teens.
Can CAC Payback be too low?
Yes. It might indicate you are leaving money on the table and under investing in your go to market engine. The Mendoza Line for small private software companies is ~6 months and ~10 months for public software companies.
At these points you start to blur the line between highly effective and not spending enough to grab the market.
Are there differences in CAC Payback by Industry?
Absolutely. Wealth management and insurance companies might be willing to wait up to three years given their retention rates. Think about it - how often do you shop for car insurance or move your 401K?
On the other side of things you have mobile phone developers who know you’ll get frustrated playing Words with Friends once you lose to your grandmother and require something closer to 30 days to break even on their app.
You see similar trends even within the software sector. Consumption licensing models, especially data infrastructure companies with longer deployment cycles, are usually willing to wait a bit longer to break even than subscription licensing companies since they are embedded into the plumbing of the customer’s business. However, this may be up for debate in an economic downturn.
Anything else to watch out for?
Yes, there’s a nearly 100% chance that whatever CAC payback period a company self-reports is understated. Check to see if overhead (rent, office expenses, IT) and share based comp (often a massive non-cash charge for startups) are contemplated within S&M and COGS. Someone’s gotta foot the bill.
What I’ve Been Reading:
Young Money by Jack Raines is positioned at the intersection of funny stuff you think of (but don’t say) at work and smart stuff you read and repurpose in conversations with your boss. I’m enjoying @Jack_Raines irreverent attitude applied to well researched financial takes. It’s a healthy combo of LOLs and Aha moments for anyone who likes business. I read this piece last week while contemplating the meaning of life from a middle seat SFO —> BOS.
Quote I’ve Been Pondering:
“Yeah, maybe. But at least I won’t be unoriginal.”
-Matt Damon as Will Hunting - Good Will Hunting (1997)