đ Navigating the Challenges of Rising Customer Acquisition Costs: A Deep Dive
No doubt the business environment has shifted. According to Insights Partners, growth recently peaked back in 2021. The top companies among a 300 company survey showed that Sub-$10M companies grew 132% and dropped to 90% in 2022. Data hasn't come out for 2023 but I'd bet it fell below 90% for the top performing quartile. Companies are acquiring lower bookings and with that, fewer new customers.
In the face of this, sales & marketing expenses have remained flat as a percentage of revenue. But what's alarming is the soaring Customer Acquisition Costs (CAC) as a percentage of revenue. Another related metric that's creeping into untenable territory is the payback period.
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Recently, I engaged in a thought-provoking discussion with a fellow professional determined to unravel the complexities of CAC and to drive efficiencies.We started with a simple MECE (Mutually Exclusive, Collectively Exhaustive) exercise to scrutinize the landscape and craft actionable hypotheses.
Paid subscribers will receive a template from the discussion. Use it for yourself as you work with your stakeholders to reshape your CAC and Payback Period.
đŻ Objective: Decreasing CAC and Achieving a Reasonable Payback Period
The first step involved is to break down as many of the components of CAC. Think of it as a 'factoring' exercise reminiscent of school math â breaking down a number into its prime factors.
In grade school we learned that you could factor or partition a number. The goal is to break a larger problem into its base components.
Here is the CAC and Payback formulas:
CAC = (Total Sales & Marketing Expense) / Number of Customers Acquired
Payback Period = CAC / (Average Revenue Per Customer * Gross Margin)
Let's delve into the key pillars:
Sales & Marketing Expense
Number of New Customers Acquired
Average Revenue per Customer
Gross Margin
âśď¸ Total Sales & Marketing Expense
Unquestionably, a substantial chunk resides in Salaries & Wages. However, a nuanced approach includes considerations for tech spend, overhead/burden (including benefits), and travel & expenditures. When contemplating cost-cutting measures, caution is paramount. Trimming sales costs through reduced headcount or altering commission structures entails a delicate balance. Cut too deep and you may hurt culture. No one wants to work at a company that feels like a sinking ship. Also, fewer reps could also mean fewer acquired customers. This will increase CAC as number of customers is on the denominator.
Similarly, pruning marketing expenses demands a strategic approach. Identifying and minimizing channels with the lowest Return on Investment (ROI) is crucial. Yet, broad-stroke cost-cutting could harm overall business health, necessitating careful consideration. When the CFO says to cut 20% of ad budget it doesn't mean you should cut 20% from every budget indiscriminately. It means you should start with the lowest performing channels and work your way up.
âśď¸ Number of New Customers Acquired
At the GTM2023 Pavilion conference I sat in a presentation that showed flat Sales & Marketing expenses over the last several quarters. Contrasted against it was the upward trajectory of CAC.
Why?
It's simple. We're winning fewer new customers. Budgets have tightened up. If this is true for many companies, then if there is growth to be had where will it come from?
Expansion is the only answer left. Quite a few of the startups I've talked to sell to mostly other SaaS startups. This is a shrinking customer base. Many of these companies are struggling themselves and are cutting back their spending.
âśď¸ Average Revenue per Customer
The drivers behind this metric are twofold: pricing and quantity. Volume can be further broken down by license count or estimated consumption depending on your pricing model. One lever for growth with your existing customer base is to raise prices. You'll have a bit of air cover given the inflation situation of the last year. It'll also have a downside effect of increasing losses for new customer pipeline. For this scenario what I would do is to maintain the new increased pricing but offer a discount to bring the new customer back to last year's pricing. It's a bit of a parlor trick but over time customers will start to adjust to the new pricing.
Pay attention to what your competitors are doing. If they raise prices before you do then you have ample ammunition to raise in turn or to go on the attack
âśď¸ Gross Margin
Delving into Gross Margin means getting into revenue and Cost of Goods Sold (COGS) factors. This is where collaboration with Financial Planning & Analysis (FP&A) becomes pivotal. Each element can be further factored, offering a granular view of the financial landscape. As a revenue operator this is a metric that's largely outside their control.
For SaaS companies CS expenses impact Gross Margin. Automation the CS function as much as possible or improving the account capacity of a CSM could be within the RevOps strategic remit.
đ Putting It Into Practice: Creating a Framework for Improvement
Now, armed with insights, the next step is translating these findings into a practical framework. As a revenue operations team, assembling a comprehensive spreadsheet with columns with the following labels:
Category (Sales/Marketing Expense, Customers, etc.)
Sub-factor levels (wages, tech spend, etc.)
Actual KPI (calculation over the last year)
Improvement Factors
Projected KPI
GTM Initiatives
Calculating Improvement Factors involves assigning negative percentages to cost-related items and positive percentages to other factors. This approach provides a realistic perspective on the potential impact of strategic initiatives.
The final column is where hypotheses and initiatives take shape. What actionable steps can be taken to bring about these improvements? Hiring enablement, pricing adjustments, shifts in messaging, or revisiting hiring profiles are just a few examples.
Fostering Conversations with Leadership: Realism and Improvement Potential
The beauty of this approach lies in its ability to stimulate meaningful conversations with leadership. What improvements are realistic, and what positive changes can be driven? This framework serves as a powerful tool for aligning strategies with business objectives and fostering a collaborative environment.
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