“I don’t spend anything on marketing. It’s all word of mouth.”
What this really means is: ‘I’m not spending money on ads to get customers.’
Whether you buy ads or not, getting customers is almost certainly costing you more than you think. Failing to understand and manage your Cost to Acquire a Customer (CAC) can be fatal for your business.
If you, your co-founder or anyone you pay, writes cold or warm emails, sales materials, landing pages, Facebook posts, blog posts, tweets, makes sales calls, answers questions, does demos, trials, and a million other things that lead people to become aware of what you have to offer and earn their trust, so that eventually someone uses and / or pays for your product or service… then… you incurred cost.
There’s always a cost to acquiring a customer.
I don’t care if you never paid actual money for any of this. Even if you and your co-founders don’t employ anyone or outsource a thing. Even if you do everything yourself – using ‘free’ software tools like WordPress and MailChimp, or whatever.
Every minute you spend doing anything that ultimately results in a user or a customer is a cost. Opportunity cost. Time you could alternatively have spent earning actual money. By consulting, or freelancing, or investing or in a job.
Better to be realistic and assign a notional monetary value to each hour of your time. Do the same for your co-founders and anyone else contributing (unpaid) to your business. Then, add on any direct expenses like staff, software, hosting, ads, blah. All those hours, all that cost. It’s all CAC.
On defining CAC, Tren Griffin of Microsoft says, “…to compute its CAC a business takes its entire cost of sales and marketing over a given period, including salaries and other headcount related expenses and divides it by the number of customers acquired during that period. If a business spent a total of $1,000 on sales and marketing in a month and acquired 100 customers in the same month CAC is $10.00.”
He goes on to point out that CAC and related subscription-business (including SaaS) terms are “not defined under generally accepted accounting principles (GAAP) and definitions may vary from company to company and over time. That GAAP is way behind the times on issues like defining CAC and customer churn is an understatement.”
Knowing your CAC along with LTV (Lifetime Value – the net present value of the profit stream of a customer) is fundamental to understanding how and why your business works (or doesn’t) and is the key to unlocking growth.
Rules of thumb have emerged regarding the “right” level of CAC in relation to LTV:
The bottom-line is that a business is not viable unless you make more from a customer than it costs you to acquire that customer. In a SaaS business, you need to make at least 3 times more from a customer that it does to acquire that customer, and you need to make back the cost of acquiring that customer in less than 12 months. The same principle holds for all businesses but the multiples and timescales may vary.
Tren does a great job of setting the context for what CAC is, why it’s critical for every business to calculate and use it.
Marc Andreessen once said: “Many entrepreneurs who build great products simply don’t have a good distribution strategy. Even worse is when they insist that they don’t need one, or call no distribution strategy a ‘viral marketing strategy’ … a16z is a sucker for people who have sales and marketing figured out.”
As Tren says, “Every business owner has customer acquisition cost (CAC). If that business owner does not know their CAC they are essentially the equivalent of a blindfolded poker player.”
As Brian Balfour explains, your company-average CAC is almost always useless as a guide to internal operations and decision-making. Instead we need to segment CAC since costs, conversion rates, and other factors will vary widely between them. Brian recommends segmenting by: 1) Customer type / attributes e.g. Personal, SME, Enterprise 2) Channel, e.g. Facebook ads, 3) Geographies and location, 4) Paid acquisition bidding method, e.g. Facebook oCPM, oCPC, oCPA, 5) Content category.
How to Measure CAC
Updata Partners have updated their framework for measuring SaaS performance. They argue that the 2 most important metrics are Gross Margin Payback Period (GMPP) and Return on Customer Acquisition Cost (rCAC). They offer here a framework with supporting spreadsheets to make this work for your SaaS business. Fascinating stuff.
When to Measure CAC
Patrick Campbell sets out a guide for which metrics (including CAC) are relevant for each stage of a SaaS startup. He cites research to show that 70% of startups fail because they try to size-up too early. Knowing which stage you’re at and applying the right metrics is critical. His advice on this is ultra specific and actionable.
Tips on Raising Seed from Uber’s CEO
Here are some excellent tips from Travis Kalanick (Uber co-founder & CEO) on raising a Seed round. EXCELLENT
The VC Scene in Europe & Israel in 2016
Gil Dibner offers a data-driven review of the European and Israeli VC scene. Among the highlights: 1) Dollar VC investment up 20% on 2015, 2) Israel, UK and Germany were the top three re dollar volume, 3) Fintech was the most frequently funded vertical, with 178 investments. Marketing was second with 109.
Series-B is the Hardest
Tomasz Tunguz explains why Series-Bs will be harder to raise than Seed and Series-A in 2017. He rounds out with why startups should not despair since “despite the vacillations of the market there’s near record-levels of capital out there to finance startups.”
Cryptocurrencies Keep on Truck’in
CoinDesk note how the 7 largest cryptocurrencies all grew substantially during 2016: Bitcoin, Ethereum, Ripple, Litecoin, Monero, Ethereum Classic and Dash. They foresee a bright 2017 for cryptocurrencies as one of the top-performing commodities available today.
Alternative Finance in 2017
Ryan Weeks at AltFi walks us through the likely 2017 developments in the alternative lending space: 1) Regulatory developments in the crowdfunding and authorisation fronts, 2) SME loan referrals, 3) Meet Marcus, Goldman Sachs’ expected entry into the unsecured consumer lending business, 4) Impact of Article 50 and the Trump era.
Exponential Computing Growth
In 1965 Gordon Earle Moore, co-founder of Intel, formulated what has become known as Moore’s Law where the number of chip components doubles exponentially over time. The law has since expanded in scope to cover the growth in computational speed and the rate of technology adoption. Peter J. Denning & Ted G. Lewis explore the mathematical basis for Moore’s Law and ask how much longer we can expect it to apply.
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