Using CAC:LTV to Grow Your SaaS Business
SaaS companies have a critical advantage that makes them appealing, compared to other types of companies and startups: the ability to scale. However, there are a few problems SaaS companies inevitably face. First, forecasting growth is exceptionally difficult, especially if you don’t fully understand the variables. Second, maintaining a proper balance of costs and revenue is vital if you want to succeed long-term.
One of the best ways to get closer to achieving both these goals is using the CAC:LTV ratio.
The Importance of the CAC:LTV Ratio
In case you aren’t familiar, CAC stands for “customer acquisition cost,” and LTV stands for “customer lifetime value.” This ratio essentially measures the lifetime value of a customer against the costs you paid to acquire that customer. It’s a convenient way to better understand the true value of your customer acquisition strategies (like sales, marketing, and advertising), and project your future course of growth at the same time.
If this ratio is too small, or negative, it could mean you’re spending too much on customer acquisition, that you aren’t spending in the right way, or that you aren’t investing heavily enough in customer retention. Either way, it means your SaaS growth will be unsustainable or interrupted.
Let’s look at each of these variables independently.
Calculating Lifetime Value (LTV)
First, we’ll look at customer lifetime value (LTV). This is a measure of how much value each of your customers will bring your business, once they sign up for your service.
You can study this by answering these questions:
- How much is the cost of an average monthly subscription? How much is the average customer paying each month? Depending on the types of products you sell, you may need to work out the averages here. For example, if you have various cohorts of buyers, such as small businesses, mid-market companies and enterprises, you’ll need to take a blended average as well as a cohort average. For example, your cohort averages may be:
- Small Business: $50/mo
- Mid-Market: $500/mo
- Enterprise: $1,000/mo
In this example, your blended average would be $517, but relying on a blended average can be misleading, which is why we recommend focusing on your cohort averages.
- What is your logo churn rate? You’ll also need to calculate your monthly churn rate. In other words, how many customers do you lose during the year? For example, let’s say you maintain 10,000 customers, but 300 customers each year unsubscribe from your service, this represents a logo churn rate of 3 percent.
- What is your revenue churn rate? In the example above, logo churn, this can be misleading for companies that focus on serving small businesses as well as enterprise. If a small business churns, it should not be weighted equally with an enterprise account churning, which is where revenue churn comes into play. To calculate revenue churn, take your churned MRR and divide it by your previous months’ MRR.
- Net negative revenue churn: In some cases, SaaS companies that are performing exceptionally well can experience net negative revenue churn. This occurs when the expansion revenue (upsells, cross-sells) from existing customers more than make up the lost revenue from customer churning. You can find this number by taking your churned MRR subtracted by your expansion sales, divided by your MRR. If it’s negative, then you have reached net negative churn.
- What is the length of time an average customer remains subscribed? You can ballpark the average length of time a customer remains subscribed by inverting your churn rate. In other words, divide 1 by your churn rate; in this scenario, we’re dividing 1 by 0.03, which gives us a value of 33.333. We take this to mean the average customer will remain subscribed for 33 months before unsubscribing.
- What is the total revenue generated by an average customer? If the average customer subscribes for 33 months, and your product has an average monthly cost of $30, you can estimate the average lifetime revenue generated by a new customer to be $1,000.
- What is your gross margin? To measure gross margins in SaaS, add things such as hosting, support and credit card fees in as expenses to subtract from your revenue. A typical SaaS margin, before professional services, usually hovers in the 80-90% range, which is fantastic. For enterprise companies that have larger professional services components, often these gross margins are lower, typically in the 40-50% range.
Calculating Customer Acquisition Costs (CAC)
In some ways, calculating customer acquisition costs (CAC) is simpler. You’ll follow a basic formula to do this; divide the total costs of customer acquisition by the number of customers you acquired. So if you spent $100,000 on customer acquisition and you earned 10,000 new customers, your CAC would be $10 per customer.
However, you’ll need to make sure you include many different types of costs in this figure:
- Costs of materials or space. How much have you paid for the cost of raw materials, or for space you use to display your ads or marketing? For example, how much have you spent in advertising costs?
- Costs of third-party services. Do you enlist the help of a marketing or advertising agency? If so, how much are you paying for their services on a monthly basis?
- Costs of products. What products are your teams using to secure more sales? For example, if you use marketing analytics software, a customer relations management (CRM) platform, or other forms of tracking, you’ll need to incorporate those costs into your model.
- Staffing costs. Don’t forget to include staffing costs as well. Your full-time, part-time, and contract workers all cost money, and they’re putting in hours to acquire new customers.
Once you have a full monthly breakdown of your costs, you can figure out how many new product signups you received and combine this figure with your LTV to come up with your ratio.
CAC:LTV Ratio: What Is Ideal?
So what’s the bottom line here? What is the “ideal” CAC:LTV ratio?
As you might expect, it’s hard to make a general recommendation. Different business models should have different targets. For example, a business that expects higher customer churn may be perfectly fine with a CAC:LTV of 2:1, while a company that prioritizes long-term retention may want something closer to 4:1.
In most scenarios, the higher this ratio is, the better; it means you’ll get more total customer value for each dollar you spend on customer acquisition. However, a good goal to start with is achieving a ratio of 3:1, or generating at least $3 of lifetime value for every $1 you spend on marketing.
Furthermore, you should keep your payback period in mind, especially if you are a bootstrapped company.
Are you interested in learning your CAC:LTV ratio, or using data to achieve SaaS growth? If you’re interested in launching a demand generation strategy of your own, or if you have questions about our approach, contact OpGen Media today for a free consultation!