By: William Short
If you are the owner or operator of a SaaS business, customer acquisition efficiency is a critical metric that can make or break your business. Efficient customer acquisition ensures that you are growing your customer base in a cost-effective manner, and with the market continuing to emphasize and value profitability and growth efficiency for SaaS businesses, customer acquisition plays a significant role in how your business is valued. Below, we explore the key indicators and strategies to help you determine if your SaaS business has efficient customer acquisition.
1) Calculate Customer Acquisition Cost (CAC)
The first step in evaluating the efficiency of your customer acquisition is calculating your Customer Acquisition Cost (CAC). CAC is the total cost incurred to acquire a single customer. To calculate, total your sales and marketing expenses over a specific period (let’s say a month) and divide that by the number of new customers acquired in the same period. The formula for CAC is:
CAC = (Total Sales and Marketing Expenses) / (Number of New Customers Acquired)
If your product requires a significant investment in onboarding and/or implementation, you should also consider factoring these costs into your total customer acquisition cost by adding them to your total sales and marketing expenses in the formula above. Often times, these costs can be offset by one-time implementation or service fees, but if they are not, they would be viewed as additional costs related to customer acquisition.
2) Analyze Customer Lifetime Value (CLV)
For customer acquisition to be efficient, it should result in customers providing a return over time on their initial customer acquisition cost. Customer Lifetime Value (CLV) represents the total gross profit a customer generates throughout their entire relationship with your business. Note that we are looking at total gross profit and not total revenue. It is common to see this metric calculated with revenue, but that is not a true representation of a customer’s ROI, and it is important to use gross profit when calculating CLV.
To determine if your customer acquisition is efficient, compare the CLV to your CAC (CLV:CAC). A CLV:CAC above zero means you are generating a profit/return on your customer acquisition spend. Healthy SaaS businesses operate with a CLV:CAC of at least 3:1, and a ratio below this suggests that customer acquisition efforts should be reevaluated.
3) Assess Churn Rate
Churn rate measures the percentage of customers who cancel their subscriptions during a specific period. A high churn rate can significantly impact the efficiency of your customer acquisition efforts because it results in a lower CLV, making it difficult to recoup customer acquisition costs and generate a return on your investment in customer acquisition. To ensure that you maximize your return on your customer acquisition investments, you should implement customer retention strategies to minimize churn and maximize customer lifetime value.
4) Analyze Payback Period
The Payback Period is the time it takes to recover the CAC from a newly acquired customer through their subscription payments. It is another essential metric for assessing customer acquisition efficiency because it gives you a sense of how expensive your CAC is relative to the price point of your product.
To calculate the Payback Period, divide the CAC by the Monthly Gross Margin per customer. The result will tell you how many months it takes to recoup your acquisition costs from each customer.
Payback Period = (CAC) / (Monthly Gross Margin per Customer)
It is best to look at your Payback Period for each monthly cohort of customers acquired. In other words, look at the CAC for the customers acquired in a one-month period and compare this to the average monthly gross margin for those same customers. If you track this each month, you will be able to quickly notice and address fluctuations in your Payback Period.
A shorter payback period indicates that your business is efficiently recovering customer acquisition costs, leading to a faster return on investment. In most cases, healthy SaaS businesses operate with a payback period of 12-months or less. If you are unable to reduce customer acquisition costs, and you have a Payback Period that is significantly above 12-months, you might need to reevaluate your pricing model and determine if an increase in pricing is a feasible solution to lowering the Payback Period.
5) Monitor Conversion Rates
Conversion rates at various stages of your sales funnel can provide valuable insights into the efficiency of your customer acquisition efforts. Here are some key conversion rate metrics to consider:
Lead-to-Customer Conversion Rate
This metric measures the percentage of leads that eventually become paying customers. Calculate it by dividing the number of new customers by the total number of leads in a specific period.
Lead-to-Customer Conversion Rate = (Number of New Customers) / (Total Number of Leads)
A high lead-to-customer conversion rate indicates that your lead nurturing and sales processes are effective, contributing to efficient customer acquisition.
Trial-to-Paid Conversion Rate
If your SaaS business offers free trials, you should track the conversion rate from trial users to paid customers. Calculate it by dividing the number of trial users who become paying customers by the total number of trial users.
Trial-to-Paid Conversion Rate = (Number of Trial Users Who Converted to Paid) / (Total Number of Trial Users)
A high trial-to-paid conversion rate suggests that you are targeting that right audience with your sales and marketing efforts, and your product is adding enough value to justify the cost to your customers.
6) Evaluate Sales and Marketing Efficiency
It is crucial to evaluate the efficiency of your sales and marketing processes. While each business has its own unique mix of sales and marketing channels and processes, but below are three metrics to consider. The right metrics for your business might be different, and it is important to identify the right KPIs for your specific business processes.
The SaaS magic number is an indicator that helps companies determine if their customer acquisition costs are well-aligned with their revenue growth rates and gives you a high-level understanding of sales efficiency. Monitoring this metric can help you determine when you should invest more or less in sales and marketing.
Magic Number = (Current Quarter ARR – Prior Quarter ARR) / (Prior Quarter Acquisition Spend)
A magic number of “1” indicates that your company will recoup its quarterly marketing spend in new revenue within 12 months of the expense. Most advisors will tell you that if your magic number is 0.75 or above, you should consider increasing your investment in sales and marketing. A magic number less than 0.75 indicates that sales and marketing efforts should be reevaluated and optimized before increasing your investment.
Return on Advertising Spend (ROAS)
For many SaaS businesses, online advertising is a meaningful source of new customers. If you run advertising campaigns, calculate the ROAS by dividing the revenue generated from ads by the advertising costs.
Tracking the ROAS by campaign or by advertising channel is key to identifying your most profitable channels. For example, if you are purchasing both Google and Facebook advertising, you should track your ROAS trends by each of these channels. Evaluating ROAS by channel can help drive your decision making on how to allocate your advertising budget between channels.
Sales velocity measures how quickly leads move through your sales funnel. A high sales velocity suggests that your sales process is efficient and can help you acquire customers more rapidly.
To calculate sales velocity, multiply the number of opportunities in your pipeline by the average deal value and the conversion rate. Then, divide the result by the length of your sales cycle.
Sales Velocity = [(Number of Opportunities) x (Average Deal Value) x (Conversion Rate)] / (Sales Cycle Length)
Determining whether your SaaS business has efficient customer acquisition involves analyzing a combination of quantitative metrics and qualitative assessments of your sales and marketing processes. By regularly monitoring CAC, CLV, conversion rates, churn rate, payback period, and the efficiency of your sales and marketing efforts, you can gain a comprehensive understanding of your customer acquisition efficiency.
Remember that customer acquisition efficiency is an ongoing effort. It is important to continuously refine your strategies and adapt to changing market dynamics to ensure that you not only acquire customers cost-effectively but also foster long-term customer relationships that drive sustainable growth for your SaaS business.