CAC payback period – an introduction
You must spend money to make money. Understanding your customer acquisition cost (CAC) payback period provides insight into how quickly your customers contribute to profit after the initial cost of converting the prospect into a customer, which includes sales, marketing and onboarding costs.
What is CAC payback period?
CAC payback period is the time taken to recover the cost of acquiring a new customer, typically measured in months. Recovery is based on gross margin earned from your customer. The period depends on the level of gross margin your customer generates as well as the initial value of CAC.
A start-up can generate an attractively low CAC for a product or service but offset by a low gross margin resulting in an unappealing high payback period. So, determining the payback period alongside CAC gives more depth to marketing and sales performance.
Why is CAC payback period so important?
The shorter the payback period, the sooner you can recover acquisition costs and turn a profit. Measuring the metric and understanding your specific drivers are key to improving your payback period. Can gross margin be improved? Can CAC be reduced? Both will shorten the payback period so it’s important to know these drivers.
The longer the payback period, the more pressure is put on capital requirements. Therefore, shortening your payback period will free up capital sooner and be more attractive to potential investors.
What’s a good CAC payback period?
Generally, the benchmark for a new business to recover CAC is 12 months or less – a payback period at this level is deemed good business health. Achieving near five months or less is an indication of high performance, specifically in the SaaS sector.
What does CAC payback period look like?
How do you calculate CAC payback period?
The formula to calculate CAC payback period is:
CAC payback period = CAC / (ARPA x gross margin)
Where ARPA is average revenue per account.
CAC payback period worked example
CAC payback period is demonstrated in the table below, the same service purchased by customers from different acquisition channels.
In this example, web marketing delivers the more attractive payback period at 6 months, driven by the smaller customer acquisition cost. However, both are good and fall within the 12 months benchmark.
Conclusion
Understanding CAC payback period helps measure the efficiency of your sales, marketing and servicing strategy. In general, the shorter the period the better the strategy. Also, the shorter the period, the less impact on working capital which is especially important for fast-growth businesses. CAC payback period is therefore less a one-size-fits-all metric and should be viewed along with industry benchmarks and long-term strategy.
Knowing your payback period can help develop improvements and effectively deploy capital in all of your marketing efforts.
