I lead the operations of a small technology Saas company from £0-£1M ARR. You can find my template for calculating every metric you might need here.

Customer acquisition cost on the face of it is quite a simple metric and calculation to understand and calculate.

The calculation is simply:

Total Sales & Marketing Expenses / number of customers acquired.

That means, you take the total expenses from Sales & Marketing and divide it by the number of customers you acquired to get the ‘per customer’ acquisition cost.

This is useful for a number of reasons:

Accessing Unit Economics of the Business
Understanding which channels are more and less successful

That simple calculation, however, will often lead you to the wrong conclusion and might be misleading. I’m going to use a worked example to help understand how to properly do this calculation and the different variations of the calculation you should look at to get a full view of your customer acquisition expense.

You can find that sheet here. This is an enterprise sales business with an HQ based in London, UK. They have an office in New York just for the sales and SDR staff. An average business spends £2,000 a month on the product and the LTV is around £60,000.

The Simple Way to Calculate CAC

According to the simple formula, you would take rows X and Y and add them, and divide by row Z. You can find the outcome of that on row D.

Lets look at December 2021.

In December, we can see that the Customer Acquisition Cost was extremely high. According to this calculation, the business was spending just shy of £50,000 for an average contact value of £24,000. Disaster. Call in the fire trucks.

However, if you look at the sales and marketing expenses, they radically increased in November. Almost tripling! In October, their CAC was just £22,000.

Clearly, we need to go a layer deeper.

Which Customers do Costs Relate to?

When you spend a dollar in marketing, what customer does that dollar help acquire? Well that’s a hard question. Consider a few Customers:

Customer A: Signs the Day after the marketing dollar is spent
Customer B: Signs the Week after the marketing dollar is spent
Customer C: Signs the Month after the marketing dollar is spent
Customer D: Signs the Year after the marketing dollar is spent
Customer E: Signs the Decade after the marketing dollar is spent

What does the dollar relate to? We will covert that in the next section.

Lagging Expenses: Which one of these customers does the spending affect?

If you are a consumer business, it might be the case that people often sign up right after seeing a marketing campaign. You could see return on that dollar the day after, or if not maybe the week after.

If you are a nation state, purchasing software to help identify insurgents in a military setting. It seems unlikely a marketing campaign would have impact on a client that signs the day after.

The solution is that we need to know the Sales Cycle Time of the business. If it takes a year to close a client, then perhaps it makes sense to take an average of the sales & marketing costs from the preceding year to their close.

In our business, it takes a year to close a new business. So for us, it would make sense to blend the S&M cost from the preceding year in order to get a fair assessment.

We’ve done that on row 27. This provides us a different picture of the business, it looks extremely good in terms of CAC in December.

Strangely, however, it now looks like up to November is was extremely bad. That brings into question the decision to rapidly increase costs in November. Is this business about to hit a brick wall?

Lesson 1: You need to lag your Customer Acquisition Costs according to your Sales Cycle Time.

CAC Exclusions: Are there any costs that we should leave out?

If you’ve looked at the spreadsheet, you will discover that November and the preceding month looks terrible because of November the previous year.

In the previous year, there was a large one off cost which was the full rebrand of the company, office renovation and website.

These are tricky costs to handle. Firstly, the logic of such projects doesn’t apply neatly to the Sales Cycle logic we used previously. A rebrand should have impact on the sales conversion rate for, hopefully, years to come.

Secondly, a rebrand impacts current customers as well as new customers. The cost is not purely acquisition costs, although I realise there is a degree to which that’s true of most marketing expenses.

Thirdly, it really messes up our data. We aren’t going to do another rebrand, so it’s almost impossible to get a picture of what is the actionable information I should use.

So what should we do?

I would argue in this case, that we should remove the costs entirely. We can’t make any decisions with this data in it.

I have removed it in Row 29. This makes much more sense – the CAC has been low since last December, which is why the management decided to increase spending.

Lesson 2: There might be individual costs you want to exclude from CAC calculations. Don’t use this to delude yourself though, keep one line with all the costs (a ‘Full Loaded CAC’) and one without (a CAC ‘with exclusions’).

‘Fully Loaded CAC’: Are there any other costs that we should include?

We have, like our friendly equation suggest, just taken the rows that say Sales & Marketing on them.

Are there any other costs that are involved in the acquisition of Customers? Have a look through your P&L and see if anything jumps out.

My number one candidate is the American office. This cost is entirely related to Customer Acquisition. There are a few others commonly missed areas.

Technology: CRMs, Sales Support Software, Database access etc. all need to be included in the fully loaded calculation.
Travel: Are your Sales Team jet setters? This needs to be included.
Events: Dinners, Conferences, Judo Classes – anything involved in Customer Acquisition should be included.

Why? Well the management has clearly decided that their CAC is good enough to rapidly scale the effort. They might get a nasty surprise if they actually were missing out a pile of costs. If they aren’t as effective as they thought, this might be an issue.

In my example, I’ve summed all the relevant rows into row 29 to give a revised ‘Fully Loaded’ CAC.

How do the numbers look now? Well they still look good, but not nearly as good as without including the extra costs. It has changed the figures meaningfully.

Lesson 3: Make sure you include all the relevant costs from each department involved in the acquisition to get an actual answer.

Channel CAC (Organic & Paid): Making judgements about CAC

There is another point to make about these costs. They are low. How could the fact this business is small affect our judgement of it?

What we have been calling CAC is actually a ‘blended CAC’. That is, we’ve blended together all of our Paid and Organic Channels into one metric.

Organic Channels are customers you have acquired through non-paid channels. Paid are customers that were acquired through a paid channel like advertising or marketing.

If you are particularly lucky, you might have a significant number of inbound requests of very keen leads who need almost no sales time to convince them to sign. If that is the case, what will the effect be on the overall CAC?

IT will cause you to severely overestimate your efficiency at paid selling. If you have a CAC of £10,000 and 9 of your last 10 customers were organic inbound leads, your paid acquisition might be as high as £100,000 per lead.

Therefore, its always good to separate out these channels to avoid any surprises. You should also be ware of human nature. The sales and marketing teams are likely to want to claim as many customers as possible as ‘paid’ acquisitions.

I have put together the final numbers we will look at on rows x to y. These are (from smallest to largest number):

CAC (with exclusions): Including all S&M (including overheads), without branding or other exclusions and lagged costs blended over 1 year.
CAC (‘Fully Loaded’): Including all S&M, Branding and Overhead costs blended over 1 year.
CAC Payback (with Exclusions)
CAC Payback (Fully Loaded)
LTV:CAC (with exclusions)
LTV:CAC (Fully Loaded)

The CAC Payback of the business (in October 2021) was 10 months with exclusions and 20 months without it. After the period of exclusions end, the CAC Payback is about 13 months. This benchmarks as on the edge of Good to Great.

LTV:CAC, which is a similar metric to CAC Payback is at 1:3.2 after the exclusions end in December 2021, which again benchmarks as good.

In all, this business is in fact benchmarking well, which suggests they were correct to increase their Sales & Marketing spend. However, it might be the case that they thought they were much better than they were, which is why they have gone too heavily into sales and marketing.

A few more examples:

If a company has extremely high CAC and doesn’t benchmark well, they shouldn’t increase spend and look to run experiments to find channels that work.
If a company is benchmarking as just OK, then they should look to slowly increase their spend.
The company benchmarks as ‘great’. They are probably spending too little.

The above are dependent on having looked at CAC channels, and assessing if any of these are driven by organic factors, instead of being driven by paid intentional channels.

Conclusion

As the final of this three part series, it’s worth noting again how different these angles look to each party that wants to assess them:

Optimistic Teams: Founders/Teams are often desperate for good news. What is seen as an ‘exclusion’ can be subjective. There might be times when they want to convince themselves too hard.
Machiavellian Teams: If you attribute some of your say, advertising spend, into a bucket with more long term branding – which you then exclude, you could find that manipulating the metrics rather easy.
Basic Teams: As we have seen above, it would be very easy to not include any overheads. That might be because the costs are hard to separate, or are not already coded under a separate line in your accounting software.
Investors: If the investors don’t do their proper due diligence, they are relying on the teams that present the information to give a balanced view. As you can see above, there are a pile of reasons why they might not.
Individual Promotion: A smart Marketer could present his efforts in customer acquisition as being very positive if he, for example, failed to analyse the CAC by channel and instead just reports a blended figure.

Understanding how to properly dissect a metric, is the other side of the coin to manipulating it. The best approach is for both the investors and the individuals in the teams to be well versed in this information.

If you need help with metrics, give me a shout at david@saasanalysts.com.