Acquiring Customers Ain't Cheap

It costs SaaS companies $1.07 in sales and marketing expense to acquire $1.00 in annual contract revenue.

So says excellent research on the experience of SaaS companies, prepared by David Skok along with Pacific Crest Securities.

The SaaS companies included in their survey spent, on average, $1.07 on sales and marketing to win a customer that would be worth $1 in annual contract value.

Some might react with horror at that news.  “To grow a SaaS business to $100 million in annual contract value, I need to spend $107 million to acquire customers!!”

Not me. 

Spending $1 to earn $3 is a good thing

That ratio - $1.07 in customer acquisition costs (CAC) delivers $1 in annual contract value (ACV) - is great news.

Here’s what that number means.  If a SaaS business wisely invests $100 million in customer acquisition costs, they’ll earn nearly all of it back from customer revenue in the first year. 

And if they can hold onto those customers for a second year, they’ll earn another $100 million in revenue, and in the third year, another $100 million. 

In other words, the first $100 million in CAC earns nearly $300 million in contract revenues over three years.

With that kind of return, the SaaS company should put as much money into CAC as it can get its hands on.

Before folks bombard me with objections, let me be clear on a couple of points.  For one, I’ve made an assumption that the money spent on sales and marketing to acquire customers is spent efficiently.  (Call me if you need help with that.)

And second, for the sake of making a point, I’ve omitted the cost of retaining an existing customer.  The Skok survey shows that companies will pay 12 cents annually to retain an existing contract worth $1.00.    Factoring that in, the cost to acquire $300 million in contract value over three years is closer to $131 million.  Still not too shabby.

SaaS is a "pay now, collect later" model

So with such an impressive return, why the resistance to spending on customer acquisition?

It may come from a couple sources.

Perhaps there’s some misunderstanding about the SaaS business model.  SaaS companies spend money on customer acquisition in the present in order to generate revenue over the life of the customer.  (See "SaaS customer acquisition:  Feed it or starve it?")  It may take 2 or 3 years to recover the sales and marketing costs.  (If you need more than 3 years to recover CAC, let’s talk.) 

That’s a lot different than the traditional on-premises business model that charges large up-front fees for software, plus on-going maintenance fees.  In that scheme, companies might allocate 4, 5, perhaps 6 percent of annual revenues to marketing. 

Effective sales and marketing costs money

There might also be a misperception about how much sales and marketing really costs.  Companies should expect to pay well if they want it done well.  

  • It costs money to design and maintain an effective website.  
  • It costs money to prepare compelling content.  
  • It costs money to design an effective customer acquisition plan.  
  • And it costs money to execute effective search engine marketing and social media campaigns.  

The experts who do this work don’t do it for free.

Of course, companies should take advantage of newer sales and marketing tactics, like social media and inbound marketing.  These can get them in front of prospective customers much less expensively and more effectively than they could have done several years ago.

And for some solutions, building a viral component into their product can be a powerful way to gain customers. 

But even with greater efficiency, customer acquisition still isn’t cheap.

SaaS companies pay a lot for excellent developers and UX designers.  They should expect to pay a lot for excellent sales and marketing people too.

There’s a reason that sales and marketing expenses at even well-established SaaS companies account for their single largest on-going expense.  Workday’s sales and marketing expenses, for example, represented 56 percent of their annual revenue according to their most recent annual financials.

Instead of looking at customer acquisition costs as an expensive burden, people should be looking at them as an investment.  And with returns of 200, 300, maybe 400 percent, a fairly lucrative investment at that.