I wanted to share how we decreased our CAC-Payback from 25 to 12 months over three quarters.
Why is CAC-Payback Important? Every decent VC will ask about your CAC-Payback during the funding process. After ARR, YoY Growth, and Churn this will probably be the number 4 metric they will want to know. I am happy to elaborate on why it is those 4 metrics at a later time.
Shortly explaining CAC-Payback before moving on: It measures how long it takes to recoup the money you spent to acquire a customer (CAC) with the revenue you get from that customer. Its a fancy-SaaS way of saying “ROI”. Some measure it in months, others in years.
The reason why VCs ask about CAC-Payback is to understand the efficiency of your Sales and Marketing engine. That engine will determine how much you can grow with the funds you have.
In a simple example, if you want to grow your ARR by 2m USD (churn aside) and you have a payback of 12 months (or 1 year), that means that you need to invest 2m USD in order to pay for 2m USD ARR growth. If your payback is 18 months (or 1.5 years) you will need to spend 3m USD to grow 2m USD ARR.
Seeing this from the company’s perspective, having raised 3m USD, you could use that money to grow 2m USD ARR (18 months payback), or by improving your payback you could instead grow by 3m USD ARR (12 months payback). This is a big difference.
It is important to not get mixed up with cash collection in this line of thought. You might be able to collect the full year up front, but your payback will still be the same. Cash collection really is only a measure of how quickly you can re-invest that money. E.g. if you collect the full 2m USD upfront from the customers you just acquired, you could deploy all that cash again for the next quarter. And again, it makes a difference if you grew 2m USD by spending 3m USD because you will mostly only be able to get that 2m USD from customers, which now will only yield 1.3m USD in growth.
All of the above is just a long story for saying that CAC-Payback is important. And lowering it can get you a real advantage. So, how to improve it?
Step one is measuring it. We developed some really sophisticated ways of doing this even down to a Rep-level. But for starters, you only need to know your CAC, which is mostly 90% of your Sales and Marketing cost for a given quarter, and the ARR/MRR you acquired in that quarter. If you divide CAC by the MRR you will get a payback number in months, if you divide it by ARR the payback number will be in years. (Yes, I know that's super obvious, but I can see how someone might easily get mixed up here.)
Ideally, that number is somewhere in the 12–15 months range. If it's not, it can also be absolutely okay if your churn is low enough. More on that later. But in any case, if it’s in the 20ies, you probably want to improve that.
Step two is about understanding where your payback inefficiencies are. To figure this out you will need to split you CAC into dimensions that make sense for your business. I am happy to elaborate on the details of doing this later.
We split it by inbound/outbound and by regions. Now, we split it by Rep, paid channel (google, facebook, etc.), and even on campaign-level. Other companies might split by product, or based on partner channels, etc. The ways to look at this are plenty.
Once you have this in place, you will likely see big differences between your CAC-Paybacks. If your blended payback is 18, your split payback might show you that one region or channel is super efficient, and others are not. You might have had a gut feeling about this being the case, but being able to quantify that difference will make it easier for you to make decisions.
In our case, we saw that the US was much more inefficient than EMEA. Which makes sense. NYC is more expensive than CPH or BER. Plus, we saw the US as a strategic opportunity, so we were prepared to pay a bit of a premium.
We also found that our outbound team was extremely efficient, and our marketing team, at that point, was not. Again, paying a premium for marketing makes sense, that team does more than “only” creating MQLs. But a 2x “premium” was, at least for our taste, too much.
Step three then really is a matter of shifting budget. Again, it can be absolutely okay to pay a higher payback for some initiatives. Sometimes that even is necessary when you scale aggressively. But in all other cases, you want to start funding the efficient channels/regions/products more and take those funds away from the channels/regions/products that are the least efficient.
Doing this will shift your blended CAC-Payback towards the CAC-Payback of the initiative that you decided to increase funding for.
All of this is obviously a bit harder than the excel-sheet logic above. Some initiatives that are super efficient can’t be easily scaled. Organic/direct traffic on your website leading to high-quality inbounds is a hard thing to scale for example. Also, slashing the underperforming teams will have repercussions. Back then we were with our backs against the wall and we had to be pretty ruthless to survive as a business. While we survived and thrived afterward, people don't easily forget what happened.
The above really is a CAC-Payback analysis-based approach to improving your payback. Next, I want to also mention another way we got it down that dramatically.
I previously wrote about the BDR/SDR to AE ratio here. Our thought back then went along those lines and resulted in an understanding of how to increase the efficiency of the sales team.
The fundamental question here was, how many opportunities (or SQLs) does an AE need to hit the target that we set for her? And we realized that we were far from it. Looking back I almost get embarrassed, but back then this was not an obvious thing. And I sadly see a bunch of teams that still make that mistake.
Once we understood how many opportunities an AE needed, we realized that we actually only had about half the opportunities to sufficiently feed the AE team. In more complicated words, we did not fully utilize the AE resources. And that led us to make the decision to reduce the AE team to match our opportunity production.
Those freed-up funds were given to the team that was most efficient in producing opportunities. That increased the number of opportunities, which led to an increased need for AEs. We eventually solved this circle calculation by building a revenue model. More on that later.
In essence, we used a bunch of common sense to solve this. The tools we used were a CAC-Payback analysis of the Sales and Marketing teams and we thought about the capacity of an AE. Then we shifted budget towards the highest performing teams.
There is a whole lot of detail that I omitted in the above because it would just drag this article out even longer. Happy to help anyone who wants to dig deeper.