Customer Acquisition Cost (CAC) and Customer Lifetime Value (CLV) are two essential metrics for any SaaS company. CAC is the amount a company spends to convert any lead into a customer. In contrast, CLV is the income a company expects to generate from its customer over the life of the service provided. A customer might mean different depending upon the nature of any business. The ratio of CLV to CAC is an extremely important KPI that should be tracked by a SaaS company.
CAC and CLV are critical for any Software as a Service (SaaS) company. The reason why many SaaS companies fail is that they overspend on acquiring customers. For a SaaS company to be successful, the cost to buy a customer should be lesser than what is earned from their service lifetime (CAC < CLV). The knowledge of CAC is also essential for any business when it analyzes its marketing return on investment (ROI). It can help the company learn about cheaper channels that convert better.
It is believed that companies in the SaaS industry spend way more to acquire customers than to retain the existing ones. They spend all of their resources to attract new customers. It is because the acquisition is easier than retention. But, they do not focus on limiting their churn rate to the minimum. It means that your company will deteriorate over some time and is destined to fail.
The business can resolve the issue of profitability by either reducing the amount it spends on acquiring customers (CAC) or increasing the customers’ earnings over the time they avail of the service (CLV).
We can only improve CLV if we know the components that are used in its calculation. Customer Lifetime Value is calculated with the following formula:
CLV = Average Revenue per user × Gross Margin × Lifetime.
To calculate Gross Margin
GP Margin = (Revenue – COGS) / Revenue
A company can improve its gross margin by reducing the cost of sales or the cost of goods sold or keeping it stable. To be able to reduce COGS, a company must display efficiency in service operations through financial analysis. It should have a robust mentoring and alerts infrastructure. When a company mentors the two discussed SaaS metrics, it will know its business’s health. Therefore, it can take the necessary steps to improve the profitability of its business. A reduction in COGS will also increase revenue. The revenue a company can realize will directly depend upon how low is the cost of goods sold.
However, to improve CLV, a business should work on enhancing a customer’s lifetime and average revenue per user. It can grow the lifetime value by investing in customer service to lower its churn rate. In other words, it must reduce the annual rate at which people unsubscribe to its service.
A company can only enhance Average revenue per user (ARPU) by coming up with ways to make your existing customers buy more. The company should focus on upselling its service to its customers. It can be done by offering either discounts or coupons on upgrades.
Together, CAC and CLV metrics depict a prototypical return on investment a company receives from an acquired customer. It helps the company look into the efficiency of its customer acquisition process. It further emphasizes how valuable a customer can be to a company over his or her average lifetime.
By monitoring CCA and CLV ratios, a SaaS company will be able to identify its profitability across the customer base. It would facilitate them in taking steps to maintain or push profitability upwards.
If a company wants to grow exponentially, it will have to invest in customer acquisition to increase the number of customers acquired. It will lower the cost per customer. So, making investments in customer acquisition is critical. Through the implications and explanation of these ratios, a company must realize that CAC and investment levels are sustainable for long-term business viability and value creation. It would hopefully make CLV to CAC a very critical KPI to track.
An ideal CLV to CAC ratio is not too low because it indicates that a brand is spending a lot on acquiring customers that are not worth it. A rate of 1:1 means that the company is getting the same amount it has spent grabbing these customers. So, there will not be any profit for the taking.
On the other hand, the ratio should not be very high. It’s because optically, it indicates that a brand is not spending enough compared to its customers’ worth. An ideal CLV to CAC ratio, which the SaaS companies should be encouraged to keep is 3:1. It would highlight that the customers are satisfied with the given premium quality service.
Alongside CLV and CAC, the payback period is an interesting KPI. It’s because it will reflect how long it will take for a business to recover its acquisition costs from any customer. If a company’s customers are churning before the payback period, it will incur a loss on that individual customer.
To conclude, a SaaS company should keep a close look at the CLV to the CAC ratio. We at Oak Business Consultant have worked on different cases regarding SaaS businesses. We faced some great challenges and took them head-on by providing well-thought-out expert detailed services to these clients. To check out our case studies applicable to the SaaS business, visit https://oakbusinessconsultant.com/case-studies/.