SaaS Barometer Newsletter: Saturday, January 27th
How much does it cost to acquire one dollar of ARR? ?What if you changed the question to ask it across three different ARR growth categories:
The above questions are the reason why the "CAC Ratio" is my favorite SaaS metric!
The CAC Ratio was created to answer the following question(s):
"How much Sales and Marketing expenses were incurred to generate $xx,xxx,xxx of new ARR last year or last quarter?”
Knowing the above makes answering the below question much easier.
"How much Sales and Marketing investment do we need to generate $xx,xxx,xxx of new logo ARR and/or existing customer expansion ARR next year or next quarter?”
A good place to start is to understand historically how much Sales and Marketing expense was incurred in the pursuit of acquiring new ARR from both new and existing customers which is where the Blended CAC Ratio comes into play.
The Blended CAC Ratio is a good starting point to answer the first question that includes the combination of ARR from new logo customers plus ARR from existing customer expansion.
Below are the latest Benchmarkit Blended CAC Ratio benchmarks:
But what about how much does it cost to acquire one dollar ($1) of new ARR from a new logo?
This is where the New CAC Ratio comes into play.
With the difficulty of acquiring new customers in 2023, understanding the unit economics of the investment required to acquire a dollar ($1) of new ARR is critical to determining how much budget to allocate to the pursuit of new customer ARR acquisition in 2024 and beyond. ?
Below are the New CAC Ratio benchmarks, segmented by ACV from recent Benchmarkit research:
Over the past few years, and especially in 2022 and 2023, expansion ARR from existing customers has become a larger contributor to ARR growth than ever before. Traditionally there was a rule of thumb that 70% of total new ARR comes from new customers and 30% comes from existing customers. That benchmark has changed dramatically and the below chart from the Battery Ventures State of the OpenCloud 2023” report highlights today’s reality by company size:
With the growing dependency on existing customer expansion ARR, it is time to move beyond the common belief that “expansion ARR is much less expensive than new logo ARR” by measuring the cost to acquire one dollar ($1) of expansion ARR from existing customers.
Introducing the Expansion CAC Ratio:
The CAC Ratio results can vary based on several other factors including;
?? Annual Contract Value (ACV)
The highest correlation to CAC Ratio, especially New CAC Ratio is the average annual contract value. ?As could be expected, larger contract values have a longer sales cycle, involve more people on both the selling and buying side, and as such require more investment to acquire those customers and the associated ARR.
It is very important to only use benchmarks for Customer Acquisition Cost metrics, including the CAC Ratio that are segmented by contract value as they miss relevance.
?? Market and Customer Segment
Different market segments (Enterprise vs SMB) and region of the world will typically have different CAC Ratios. ?This is even more important to understand when first entering a new market and not having a repeatable customer acquisition motion and process validated
?? Customer Acquisition Motion
Product-Led Growth companies will typically see much lower initial Customer Acquisition Costs.
It is important to clearly define when "NEW LOGO" ARR begins/ends and when “EXPANSION” ARR begins and what costs factor into CAC. ?In PLG companies, some level of product costs may actually be customer acquisition costs.
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One strategy is to measure New CAC Ratio in a PLG company using the total ARR generated over the first year versus the value of the contract.
?? Pricing Model
How do you determine the actual costs to acquire a new customer measured against the "contract value" if the initial agreement commitment is much lower than the expected revenue in a Usage-Based Pricing Model?
One strategy is to measure New CAC Ratio in a Usage-Based Pricing model using the total ARR generated over a period of time equal to the deploy + ramp time frame
?? Product(s)
If you have multiple products with different ACVs it is a best practice to try and understand the New CAC Ratio by product
TIME PERIOD IMPACT:
??♀???♂? One of the more common questions about calculating CAC Ratio is what time periods to use for the Sales and Marketing Expenses and for the New ARR?
The SaaS Metrics Standards Board recommends using “Sales Cycle Length” to guide the decision of which time periods to use.
For the most common sales cycle length of ~ 90 days it is recommended to use the Sales and Marketing expenses from the previous quarter and the New ARR from the current quarter using the below formula:
*CQ = Current Quarter
Companies with longer than a ~ 90 day sales cycle will sometimes use the Marketing expenses from the quarter most aligned to the start of the sales cycle and the Sales expenses from the quarter preceding the Closed-Won ARR.
As an example, if the Sales Cycle is 180 days, use the Marketing Expenses from (Current Quarter - 2) and the Sales expenses from (Current Quarter - 1). ?Basically, this says if the deal closes in Q4 use the below formula:
?? DO NOT LET PRECISION GET IN THE WAY OF GOOD ENOUGH!
The more precise one tries to become in calculating the New CAC Ratio - the more complex the New CAC Ratio can become and the result is often giving up and not calculating New and Expansion CAC Ratio
?? How often should the CAC Ratio be calculated?
?? CAC Ratio is best measured using a rolling 3/6/12 month period to smooth out any specific month's anomalies. Alternatively, for sales cycles > 60 days, measuring CAC Ratio quarterly and annually is typically often enough.
ALLOCATION OF SALES AND MARKETING EXPENSES TO NEW LOGO VS EXPANSION ARR:
?? One of the most common questions about calculating New CAC Ratio vs Expansion CAC Ratio is how to allocate Sales and Marketing expenses (and Customer Success if involved in expansion ARR) to the pursuit of new logo ARR versus existing customer expansion ARR
?? NO PERFECT ANSWER - but two concepts for consideration ??
1?? Conduct a simple “time allocation” survey with all of resources that are involved in pursuit of new logos and/or existing customer expansion and use a basic average percentage allocation:
In the spirit of “just get started” the above is not precise, but unless you have dedicated resources for new and for expansion, it is a good place to start - and getting started is the ??
2?? As a company scales meaningfully, which suggests >$50M ARR it may make sense to start dedicating resources specifically to the pursuit of expansion ARR in Sales and Marketing. This will make the allocation of many expenses easier, but the reality is that some resources will always have a level of responsibility across acquisition and expansion activities and/or some activities are actually applicable to both new and expansion programs.
CAC RATIO SUMMARY:
The CAC Ratio is the Swiss Army Knife of Customer Acquisition Cost efficiency insights for both new acquisition and existing customer expansion.
? The SaaS Magic Number includes too many variables, including new ARR, expansion ARR, churned ARR, down-sell ARR to understand the “efficiency” of acquiring new & expansion ARR
?? CAC Payback Period is a good metric - but it has many different calculations and does little to nothing to explain the efficiency of acquiring a dollar of ARR from new and/or existing customers and adds NO value when trying to budget for future periods ARR goals
?? Pursuit of perfection or mathematical precision should not get in way of understanding the cost of acquiring new customer ARR