Want a Bigger Marketing Budget? Optimize Your LTV to CAC Ratio
Almost every head of marketing, whether they are a CMO, VP, or Director of Marketing is thirsty for a larger marketing budget. With more money to spend, marketing can (theoretically) drive more growth.
But all too often marketing budgets are set without much rhyme or reason – there tends to be a huge correlation to how many sales were made in the previous month or quarter, or worse yet they are set as a percentage of the company’s revenue. This is particularly common in product driven SaaS organizations. But for growth-oriented companies, these means of setting marketing budgets are simply not serving your growth agenda appropriately.
How much do SaaS Companies invest sales and marketing?
Take the chart below as an example. Based on a sampling of 300+ SaaS companies with greater than $2.5mm in revenue, the median sales and marketing spending as a percentage of revenue is 32%.
Does this mean all SaaS companies should simply set their sales and marketing budgets at 32% of their revenue? Absolutely not. There are a number of companies spending as much as 43% of their revenues on sales and marketing, with these companies achieving growth rates of 80%+.
While some of these companies may be spending so aggressively because they are heavily funded and are looking to capture market share, the companies that are the true darlings of the SaaS space are those that have such a strong ratio between the Lifetime Value (LTV) of their customers and their Customer Acquisition Cost (CAC) that they’ve built a compelling case to pour more dollars into their customer acquisition engines. They’ve built Ferraris and have a valid reason to believe that additional sales and marketing spending will keep their growth rates accelerating.
In your quest to obtain access to more financial resources, it’s the marketing leader’s job to educate the rest of the organization. And simply put, the idea of a “marketing budget” is outdated if growth is truly what you are after.
The Formulas Your SaaS Company Needs
Instead, you have two levers at your disposal – both of which can be optimized, and both of which are not typically considered areas of your business that marketing alone should own. The Lifetime Value (LTV) of your customer is impacted by many factors, including but not limited to:
- Sales selling to buyer personas that have the best chance of being successful with your product
- Product organizations delivering truly valuable features that make the product “sticky”
- Customer success teams working with your clients to make them successful after purchase
- Marketing developing pricing and packaging that pushes longer term contracts over month-to-month agreements.
Average Customer Lifetime = 1/churn rate (expressed in months or years)
Ex: 1 / 5% monthly churn = 20 month average customer lifetime
Average Revenue Per Account (in a given period) = Total revenue /total customers added
So for example, if last month you made $200,000 in revenue from 25 customers, your calculation would be $200,000/25 = $8,000.
And if customers stay with you for an average of 20 months, you multiply 20 x $8,000 and reach the lifetime value of $160,000. So the cost to acquire a customer (CAC) should be no more than $53k. ARPA = $200,000/25 = $8,000
In this example 20 months X $8,000 = $160,000 LTV
Just as there are many ways to extend your customers’ LTV, there are also a number of different strategies that you can employ to lower your Customer Acquisition Cost (CAC). Marketing can focus on more cost effective lead generation strategies like organic search, conversion optimization, and developing customer advocates. Sales teams can learn to more efficiently move prospects through the customer acquisition funnel and can do away with expensive events and client dinners in lieu of more cost effective inside sales techniques.
To calculate the cost it takes to acquire a customer, you simply divide the total sales & marketing spend by the number of customers added in a given period. So if you spent $100,000 in a year and acquired 10 customers during that time frame, your CAC would be $10,000.
As a general rule of thumb, a SaaS business with a LTV:CAC ratio of 3:1 is considered healthy – meaning you get $3 in customer revenue for every $1 you spend to acquire them. If you have this ratio or better, you have a customer acquisition engine that is performing well. It is important to mention that this is simply a benchmark – not a magic bullet. This ratio had held up well and provided a valid target at a number of companies I’ve worked with, but every company’s unique situation in terms of funding, growth rate, burn rate, and business goals should be considered. Never put all of your eggs in one basket by looking at any SaaS metric in isolation.
3:1 Ratio is Your Benchmark for a Higher Marketing Budget
With a ratio of better than 3:1, you have a strong argument for investing more money in customer acquisition programs if maxing out your growth potential is your objective. You can make a simple argument to the CEO by saying, “we know that for every $1 we spend to acquire a customer, we get $3 back in revenue.”
So it’s the job of the marketing leader to relentlessly look for ways, across the organization, to lower customer acquisition costs and extended the lifetime value of the customer. If you’re able to do so, you’re making a compelling case for marketing to be given access to whatever financial resources are available, whether you’re a funded or bootstrapped company.
In fact, a strong LTV:CAC ratio is one of the most important metrics you can show if you are trying to raise funding. In my opinion, perhaps the most valid reason a SaaS company should raise funding is if they have a very healthy LTV:CAC ratio and their growth is only limited by access to capital.
Gone are the days of marketing leaders waiting until after a big sales month to nervously ask for an increase in marketing budget. And gone are the days of the marketing leader advocating for marketing spending to represent a larger percentage of the company’s revenues. Relentless focus on increasing customer lifetime value and decreasing customer acquisition costs will blow the top off or your marketing budget (as it should!) indefinitely.
About the Author: Geoff Roberts is the Vice President of Marketing at Bizness Apps. Bizness apps is an app building platform used by small marketing and design agencies to build mobile apps for small business clients.