Marketing strategies, sales teams, and non-stop advertising campaigns across different marketing channels: when you have a business, having someone buy from you seems like the ultimate goal. However, this doesn’t mean that any way of getting new customers is sustainable. While nothing can take away the thrill of closing a deal, some customer acquisition efforts can lead to unfavorable long-term results (such as an unsustainable CAC payback period).
No matter if you are a big established business or a startup that’s taking its first steps, you should have a clear idea of how much you are investing to acquire customers and how much time your business needs to win that back. In this article, I explore the significance of the CAC payback period, explain how to calculate it, and give you actionable steps that you can implement to reduce it.
What is the CAC Payback Period?
For business owners, every client that comes in feels like a small victory that deserves anything from a smile to a quick happy dance. However, when it comes to the numbers, there are scenarios where the overall cost associated with getting each of those clients is simply not realistic for your business. This is the problem that the CAC payback period addresses in the first place.
The concept of CAC ratio (customer acquisition cost) is the main element in this metric, as it represents the total costs incurred in marketing and sales efforts to attract and retain these customers. These expenses will take some time to recover; thus, the CAC payback period, which will express this time in “months to recover CAC”. Regardless of the CAC ratio alone, the payback period evaluates everything from the costs, the money that the client brings in, and how profitable the relationship between these two values is.
Why is the CAC Payback Period Important to Track?
The CAC payback period is a metric that helps companies assess how effective their marketing efforts are. If the payback period is dragging on, it's a sign that something's not working right. It could mean that the company needs to fine-tune its sales cycle, work on new marketing strategies, or find ways to boost customer retention. On the flip side, a shorter payback period means quicker ROI and a healthier bottom line.
In industries like Software-as-a-Service (SaaS), where upfront costs are considerable, understanding the CAC payback period and keeping track of how it changes as time goes by helps build a profitable strategy. This explains why different saas businesses and giants in the marketing software space, such as HubSpot, not only focus their efforts on reducing their CAC payback period as much as possible but also share substantial information that educates other companies to do the same.
How to Calculate Your Payback Period
If you want to calculate your CAC payback period, the first step is pretty clear: you need to know your cost of acquisition (CAC). Divide your total acquisition costs (including less obvious items such as sales team travel expenses and sales & marketing salaries) by the number of customers you managed to attract, over a specific time period. Now you have your cost of acquisition in-hand.
Here comes the fun part: calculating the CAC payback period. If take your CAC and divide it by the monthly or annual contribution margin, you will get the CAC payback period formula. And now you just need the result, which will indicate the number of months your business needs to get that investment back. In case you’ve forgotten, the contribution margin is (Revenue - Variable Costs) / Revenue.
Let's explore a clear example:
If your business has a cost of acquisition of $10,000 and the monthly contribution margin per customer is $1,000, your CAC payback period is 10 months. That means it'll take approximately 10 months to recover the costs of acquiring each customer through their generated profits. And what happens after the CAC payback period ends? Profit city, baby.
Remember, the longer the CAC payback period, the more patience is required to witness the spoils of your hard-fought sales efforts.
Unsolicited (but important) tip: If you want to get more accurate numbers when putting together these formulas, efficient accounting software can help you keep track of your business cash flow, making your life incredibly less complicated.
What is the Average CAC Payback Period?
The duration of the payback period can be highly unpredictable, however, achieving a CAC payback period of 12 months or less is generally considered favorable. However, it's important to note that this timeframe varies significantly based on factors such as industry, other metrics, company size, and even the annual contract value.
To gain insight into peer benchmarks, let's explore some examples. By examining public SaaS companies on Meritech Capital's Comparables Table, we can observe a wide disparity in CAC payback periods across sectors. For instance, Bill.com boasts a relatively short CAC payback period of 5.7 months, while Adobe exhibits a significantly longer one of 82.9 months (which kind of hurts to hear…). These variations highlight the need for businesses to understand industry-specific benchmarks and tailor their strategies accordingly.
When is it Okay to Have a Longer CAC Payback Period?
During the early stages of a company’s growth - pending the ability to survive with delayed cash flow - it's usually necessary to tolerate a more drawn-out payback period. Startups and emerging companies can often have longer CAC payback periods because they are prioritizing other metrics that indicate progress and potential, such as customer acquisition volume, customer churn, monthly recurring revenue (MRR), and brand recognition.
However, as a business matures and establishes a considerable base of customers, polishing the acquisition process to new levels of profitability becomes the main priority. Once the gross margin is considerable and new customers are not the ultimate goal, new needs such as mastering customer retention, optimizing marketing costs, and upgrading both cross-selling and upselling opportunities enter the scene.
During this secondary stage, metrics such as the CAC payback period, Customer Lifetime Value, and Customer Acquisition Cost (LTV/CAC) gain the number one priority medal. Clients are already coming in so it’s time to implement new systems (such as ERP), look at high-level metrics, keep a closer look at the MRR (monthly recurrent revenue), and focus on understanding if the processes are efficient enough to benefit the business in the long term.
How to Reduce Your SaaS Payback Period
Let’s say that you understood the importance of CAC payback period calculation and decided to explore this new concept. You follow all the steps and calculate your current CAC payback period… only to discover that it is higher than it should be. Before you decide to tear up your marketing costs by their roots or stop all the paid marketing campaigns you are running, let’s explore what you can do about it.
Focus on the Least Expensive (and Most Efficient) Marketing Channels
Not every platform is worth the effort. And the only way to find out if you are losing your time fighting the algorithm in vain is to look at the numbers; more specifically, by looking at your conversion rate, average CAC, and dollars spent. Analyze the marketing channels that are bringing in new customers and which marketing efforts need a quick switch.
Conduct a thorough marketing audit to identify the acquisition sources and sales efforts that yield the highest return on investment, over a material time span. Get your marketing team to double down on these channels, optimize marketing campaigns, and reallocate resources from other platforms that are not showing the same outcome.
Increase Customer Touchpoints
According to SalesForce, 96% of customers say excellent customer service builds trust. And trust is what leads to strong relationships that can avoid a higher churn rate in the long term. Use customer feedback to improve your customer retention rate as much as you can, by ensuring that you are delivering ongoing value and providing an enjoyable experience.
When businesses prioritize customer retention and consistently go the extra mile, clients feel excited to return and even take someone else with them. Just like Sam Walton said, “Exceed your customer’s expectations. If you do, they’ll come back over and over.”
Satisfied customers become brand advocates that complement your sales team by spreading positive word-of-mouth and contributing to the company's growth and customer lifetime value (LTV) without spending another dime.
Experiment with Pricing Models
Spending a considerable amount of resources to convince new customers that your offer is valuable affects your CAC ratio negatively. This is where pricing strategies can help you. Different pricing models can make the difference between someone not being convinced to buy and believing in your product as a wise investment.
By aligning your SaaS pricing strategy with your ideal customer’s preferences, you can foster longer customer relationships, close better deals and ultimately increase overall revenue. Monitor the impact of pricing experiments closely, and create new pricing models based on what shows the best results.
Differentiate from Competitors
If you want to avoid high customer churn and the longer CAC payback period that comes with it, you will need to show both current and new customers why they should choose you over your competitors. The best way to give this clear message is to build a brand that no one can ignore.
It doesn’t matter if you are an early-stage online business, a saas startup, or a big company: a strong, consistent brand always pays off.
Focus on defining your brand pillars and creating marketing campaigns that go along with those standards. Prioritize outstanding customer service and personalized experiences to establish a stellar reputation. Above all, invest in building a robust brand through consistent messaging, visual identity, and shared values. A strong brand engenders trust, facilitates cross-selling, sets you apart from competitors in front of new customers, and shortens your CAC payback period.
Expand to Higher-Value Customer Segments
Diversifying your customer base in the SaaS industry can be an effective way to tap into new revenue streams, increase your gross margin, and also improve a bad CAC payback period. By identifying and targeting higher-value customer segments, SaaS companies can unlock additional sources of monthly recurring revenue (MRR) and ultimately reach a shorter CAC payback period.
Identify untapped higher-value customer segments in your current niche and find out what they’re looking for - if you can offer that, it’s on. Once you have that new customer in mind, it is time to get creative: experiment with tailored marketing strategies and targeted campaigns to capture their attention and onboard them as valuable new customers.
Time to Act
Now you have the tools you need to understand how your CAC payback period works and what you can do to improve it. However, it is essential to remember that, especially when it comes to businesses, theory is only a starting point.
Innovative marketing campaigns, new pricing models, and retention strategies that leave customer churn in the past: these are all resources, not one-size-fits-all solutions. You will need to track many KPIs and experiment across different areas within your business before finding out what works for your current CAC payback period depending on your clients, business stage, and even long-term goals. No one said that having a business, let alone a profitable one, was easy: but with the right resources, it can be an exciting journey.
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