How do I move my software product upmarket? You need to understand the differences between your current customer base and the one you want to have.
BSMS 9: How to forecast revenue with CAC, ARPU and churn
What are the different ways to calculate Customer Acquisition Cost? How are metrics different for revenue planning and more short-term management?
Customer Acquisition Cost (CAC) can be calculated a few different ways based on the purpose. For financial forecasting and valuation purposes, CAC as a profitability number should be all-inclusive. On the other hand, for the purposes of strategic and tactical marketing management, CAC might not include salaries and instead focus on discretionary spend.
Knowing what your CAC number really means is important to help make better sense of other numbers like Months to Recover CAC (MRC) and Lifetime Value (LTV).
LTV relies on your churn assumptions, which can often be overestimated if not careful, which can negatively impact your projections.
Welcome to episode nine of B2B SaaS Marketing Snacks. Today's a little bit different. Stijn is in Germany with one of our clients and we're a little bit asynchronous. So I sent him a question, had him respond. And he sent the response back. And today we talked about CAC (customer acquisition cost) and the best ways to calculate that. And then also some of the metrics that revolve around that for calculating marketing's impact on the business. So here it is.
All right, Stijn. Here's a question for you. So once companies start investing in marketing, it isn't long before they ask questions about the best ways to calculate marketing's impact on the business. And one of the first calculations we look to for this is CAC or your cost to acquire customer, customer acquisition cost. But there are a bunch of different ways you can calculate CAC based on your goals and what variables you want to include or exclude. And so it can pretty quickly become a complicated metric and topic in general. So I would love to get your thoughts and your approach to calculating CAC and in your opinion, a few other good calculations for applying revenue metrics to the marketing function, the marketing's impact on the business. And then also maybe how you can use CAC together with the revenue waterfall model to forecast how marketing impacts the bottom line and helps you create budgets, calculate ROI, and set targets for funnel figures.
What is it actually mean for marketing? customer acquisition cost, of course implies all the costs that go into acquiring a customer for a business. And when you're in the marketing team and you're the marketing leader and you influence a big part of that, not everything, not the sales cost, but there are probably other costs involved like paying the rent for your building that houses your marketing team and your sales team. So there's this question, does your customer acquisition cost have to be all encompassing, including sales and marketing costs and a little bit of overhead from the rest of the cost of running the business? Or if it's more appropriate to use your direct spend the things that you can every day to calculate your customer acquisition cost. I think you need to do both, but both have very different purposes. You need to have an all up customer acquisition cost as a business to allow you to do revenue planning, profitability planning, to have a conversation with your investors about what will it take for your business to become profitable?
customer acquisition costs are a big part of another calculation that is often referred to as the months to recover the customer acquisition cost, which allows you to say, "Hey, if I get a new customer, this is how long it takes for the revenue that that customer will generate to make up for that initial investment." MRC months to recover CAC is an acronym that sometimes is used, and that is often based on LTV (Lifetime Value of a Customer). So if you know what the lifetime value of a customer it means you have made some assumptions on how long customers stay with you based on churn data and what they spent on average trend, the ARPU (Average Revenue Per Unit) where units could be a customer, could be an account, could be a user, could be a device. But those two metrics, the ARPU, the average revenue per unit and the Churn, how long those units, those customers stay with you give you the LTV, the lifetime value of a Customer that can be either done in revenue.
Sometimes it's already calculated as a profitability number, which means someone made some assumptions around the cost to service these customers. And thus then going to include this auto number that we started to talk about CAC customer acquisition cost that is part of the cost to service them. We also need to get the customer then you need to service them. So those often get combined to calculate profitability. So if you do all this for your investors to get your all up business plan together, then customer acquisition costs usually should include your marketing cost, your sales cost, your team, the people spend, the benefits, the salaries, et cetera. And of course, discrete marketing spent. That's helpful, right? For business planning if you want to raise money, if you have to report to your board of directors, all those require you to do it like that.
But then when you think of the marketing team that you run every day, that you need to hold accountable to constant improvements and to optimize for more effective marketing, more efficient spend of marketing dollars. That broader CAC calculation is not that helpful because they don't influence most of those elements. They might influence them, but they definitely don't influence them on a short term time window. So what I usually want to have as well is the customer acquisition component that is made up of the discrete marketing spend that the team has control over on a weekly or monthly basis. Your Google Ads spend, the spend that you have with your vendors, things that you can easy dial up and down with a relative short lead time, right? If you include the salaries of your team and your customer acquisition cost, of course you can optimize your team and you should as a marketing leader, but you're not going to fire and hire people on a weekly or a monthly basis.
And for your monthly and short-term optimization, it's really helpful to have customer acquisition costs broken down in what I call the discretionary day to day, week to week, month to month spend and the part of the customer acquisition cost as more planned on an annual basis. That's I think an important notion, think of CAC in those two ways, the long-term, all-encompassing CAC that's helpful for investors and for board reports or for your business planning and the short-term CAC that is more focused on discrete marketing spent that you can use to manage your team on a day-to-day basis. Then there's another big question mark. When you want to turn this into what's often referred to as a revenue waterfall model. Some kind of spreadsheet where you show "if I get so many leads and they convert at this rate to MQL, and then we needed so many visitors to get to this number of leads."
And then of course, those MQLs will have conversion rates to opportunities and therefore convert to customers at a certain rate. Customers that spend a certain amount of money with you, right? An average contract value or ARPU, then you can calculate how many leads you need. How many visitors on the website you need, et cetera, to drive down the larger the number, the bottom line impact.
The main variable there that is really challenging often is the time that it takes to go from someone visiting your website, to becoming a lead, to becoming an MQL, to become an opportunity, and then ultimately becoming a customer, right? Because we said weeks, months, the conversion rates are typically relatively easy to get once you have good marketing automation and good data, and then getting the conversion rates with an average estimate based on your historic pipeline is pretty doable. But the time that it takes to go from a visitor or a lead to an actual customer, it's often a crap shoot, right? You ask your sales team, they will typically tell you, it goes faster than what you actually find in the data. If you think of pitching investors on to raise money, sometimes the deal speed is executive a little bit because it helps you with the valuation of the company.
And then when you do your own realistic planning as to how many leads do you need, how many MQLs to drive a certain amount of customers in a certain timeframe, then you have to be careful that you don't paint a too rosy picture, right? If it takes three, four months for a lead to become a customer, then if you put one month into your revenue projection model, you're going to be running behind a red number on your dashboard for a while.
So this is very important, right? Then once you do proper planning then this number is really going to look different when you have a different purpose. If you want to raise capital, you're driving a pre valuation. Maybe there are people looking different at this number than what you have to put a realistic marketing budget, a marketing plan together. The other part of this is the churn number, right?
That's another number that sometimes when I engage with customers and looks very different than the investor pitch than when you actually look at the real day to day business. SaaS company, B2B SaaS company get very high evaluations because churn numbers are typically low, especially when they service enterprise customers, churn numbers will be in the low single digits, right? There's one, two, three, 4% of churn on an annual basis, which means these customers theoretically stay with these businesses for 10, 15 years, right? Which drive huge lifetime values of these customers. The reality is that even if your churn numbers on a day to day, week to week, month to month basis are extremely low, the timeline that you can count on beyond five years is pretty hard to really prove, right? If you think of evolving, there might be an M&A transaction at some point in the future, your customers may get acquired by others.
So churn numbers that are very low drive these valuations of customers staying with you longer than six, seven, eight years. I always find them very suspect because businesses will just change so much over that course of time. So I think from a marketing revenue modeling perspective, when I see churn data that is so low to this huge offer for valuation and for investment conversations, I always bring them back a little bit. I like to put my churn numbers at a level that cancels these customers being with us for seven, eight years at the most. And then that's, I think, a healthy buffer to plan against.