Annual Planning Imperative: CAC Ratios
How to calculate the budget you need to hit the new revenue targets
It’s planning season already! CFOs are running models and executive teams are meeting to discuss vision, strategic themes, and growth levers. It’s the most important time of the year to get ahead of the planning curve. Otherwise, you risk finalizing a budget and plan the team can’t execute. There are three urgent imperatives for C-Suite leaders:
REPORTING: Get your own reporting in order so you can see performance, trends, what’s working, and where to invest
CAC RATIOS: Calculate your Cost of Acquisition (CAC) ratio so you can forecast what money you need to reach next year’s revenue plan at today’s conversion rates
ASSUMPTIONS: Participate in the financial plan to set reasonable assumptions on variables in the model]
CAC Ratios Help You Plan Your Budget Needs
Last week at SaaStr, I invited Ray Rike, Founder and CEO of Benchmarkit, to share his insights on the State of the SaaS market with an elite group of CMOs. One of the centerpieces of the presentation was his work on CAC Ratios. He described the two most important CAC Ratios at the CEO/CFO level to see the cost of acquisition across Sales, Marketing, and Customer Success. He likes to use two different ratios - one that blends new name and expansion ARR and one that’s just focused on new ARR. These two ratios can help you find a budget range, and may vary based on how much New ARR you want to bring in vs. Expansion ARR. These CAC ratios are more effective than payback period because they allow you to calculate a direct budget ($25M New ARR at a 1.5 CAC ratio requires $37.5M GTM Budget):
As the Economy Has Declined, the Cost to Aquire Has Increased
Ray’s insights for the CMO brunch shared some of the dismal declines in growth for both private and public companies. Not surprisingly, the cost to acquire customers over the last few years has increased amidst less buying overall, longer sales cycles and smaller deal sizes. This impact has hit the lowest quartile of companies the hardest, but it’s costing everyone more:
Ray went on to show that overall the cost to acquire new customers, while higher than new + expansion, has stabilized year over year. This wasn’t as surprising to me given the focus on efficiency and the pull-back of bigger spends on net new, as people “shored up the base”
Ray broke out the CAC ratios by contract value size - and showed how bigger deals cost more, especially in the “messy middle” of $50-100K.
CMOs Need Marketing CAC Ratios or Risk Fluffiness
While a Go-to-Market CAC ratio is fantastic for the CEO and CFO, Marketers need to drill down into their own components to ask for the right budget. In the past, many marketers have tried to use marketing budget as a percent of revenue as their target (Should the marketing budget be 6%, 10%, or 15% of revenue? Should we be 20% or 30% of Sales and Marketing Budget? DEPENDS!) Many moons ago, I did an expensive benchmark with IDC to get comparable spend/revenue benchmarks, only to have the CEO say, “Yeah, but we’re different.” Budget benchmarks can be misleading because of how significant different strategies, models, profit orientations, or CEO philosophies can be. A CAC ratio, on the other hand, lets you calculate the COST TO WIN THE REVENUE based on your own real-world realities. Ray recommends tracking three Marketing CAC ratios:
Time Periods Are CRITICAL for Calculations and Assumption Metrics
Ray generally recommends people run their metric in 5-quarter or 9-quarter increments to see longer-term trends. This is great. Also, if I were in a CMO seat this year, I might also run a model with the last 2 quarters. The market changes have caused fluctuating conversion rates, fluctuating contract values, and fluctuating time-to-close. Longer-term trends aren’t as reliable as this quarter's and last quarter’s metrics, unfortunately. One of the biggest issues I’ve seen in corporate planning is where assumptions are made for Q1 that are radically different than the reality of Q4 (Sales will close at a 29% conversion rate even though Q4 they were at 17%.) Things don’t magically improve on the first fiscal day.
Get Ahead of Model Assumptions
As a junior marketing leader, I wasn’t very involved with finance in planning the model. I got my budget and tried to do the best with what I was given. These days, I’m DEEP in the models. I want to make sure that the model has variables across the year for adjusting conversion rates and breakouts of new and expansion revenue (which perform differently). I want to make sure we account for seasonality swings, big annual inflection points, and don’t model on weird quirks from last year; I want to make sure we get as realistic as possible so sales and marketing have a chance at success together and we can edit the model as the metrics change. Be suspicious of averages in the model assumptions. I’ve seen issues like “new revenue closes at 30% and expansion at 70%; let’s assume a 50% close rate for the year.” Or, the average close rate for the whole year was 25%, let’s use that— but last quarter was 13%. It’s okay if we want to see it increase each quarter and provide relief on the budget, but let’s not base the starting plan on an unrealistic average.
Pros and Cons of Benchmarks
Benchmarks seem like the holy grail - fiiinnnally, we can see if we’re on track. But, they can be very misleading because of how many different factors are at play: company size, average sales prices, sales model, regional focus, number of product lines, growth rate, efficiency, total revenue, customer profile and more. The best path is to agree on how you will measure, get your own metrics right and start moving them in the right direction.
More Benchmarks with Ray
I can’t get enough of Ray’s work. I follow his SaaS Barometer Newsletter religiously and dip into his Metrics that Measure Up Podcast and SaaS Metrics Palooza (October 8th-9th), amongst his many different outlets. He takes a few clients a year to help create their metrics framework (maybe you can snag him). And we’re talking about teaming up to get deeper on marketing benchmarks, which I’d love! I couldn’t be more thankful to him for helping educate us all on the key metrics for success.
“Plans are nothing; planning is everything.” ― Dwight D. Eisenhower
Carilu Dietrich is a former CMO, most notably the head of marketing that took Atlassian public. She currently advises CEOs and CMOs of high-growth tech companies. Carilu helps leaders operationalize the chaos of scale, see around corners, and improve marketing and company performance.
Hi Liz, I believe it does. Sales and Marketing - yes. CS though - I think that's debatable and that depends on the structure of the business.
Does sales, marketing and CS expenses include headcount salaries?