One Number to Manage Your #SaaS Sales &Marketing Spend: The CAC ratio by Bessemer Ventures

Aug 26, 2015 | Publisher: manojranaweera | Category: Finance |  | Collection: Documents

One Number to Manage Your SaaS Sales &Marketing Spend: The CAC ratio A deep understanding of your Sales and Marketing investment is critical to the success of an OnDemand business, and requires the use of new metrics that were not part of the traditional software scorecard By Philippe Botteri Winter 2009 Release Philippe Botteri is a leader in the SaaS practice of Bessemer Venture Partners, a global investment group with offices in Silicon Valley, Boston, New York, Bangalore, Mumbai, and Tel Aviv and over $3B of assets under management. Bessemer has been focusing on SaaS and recurring revenue businesses for the past 15 years, investing in industry pioneers such as Verisign, Cyota, Postini and Trigo, and the firm has today a portfolio of more than a dozen active SaaS investments. Philippe was closely involved with the firm investments in Intego, Eloqua, Cornerstone OnDemand and Intacct. Before joining Bessemer, he spent close to 10 years with McKinsey & Company in Europe and the US and pioneered the firm's work with "on-demand" software. You can find out more about BVP's SaaS practice online at and read Philippe's Venture and Software blog at www.cracking-the- The Software-as-a-Service business model is fundamentally different from the traditional Enterprise Software model due to the recurring nature of the revenues and the upfront nature of the costs. While the profitability of such a model can be persuasively challenged, the Cable and Telecom industries showed that subscription businesses can be very profitable over time. The key to long term financial health resides in establishing a thoughtful balance between the costs required to acquire and support a new customer and the expected revenue streams. But for younger companies which don't have yet the history required to grasp all the elements of this complex equation, how should the sales and marketing investment be calibrated? Indeed, for SaaS companies, sales and marketing investments generate revenues not only for the coming year but through the entire lifetime of a customer and consequently, looking at the sales and marketing expenses in a standard US GAAP Profit&Loss format does not really help SaaS CEOs and CFOs understand if the time is right to scale their investment or instead focus on productivity improvement in other words, their P&L does not tell them if their business is beyond the "sales learning curve". This question is becoming even more pressing as the general economic environment is deteriorating fast and the cost of capital is skyrocketing. In the past year, we worked closely with our SaaS portfolio and looked at a dozen public SaaS companies to better understand the key drivers of value creation for an On-Demand business and developed a new framework to assess and benchmark sales and marketing effectiveness in the SaaS world the Customer Acquisition Cost or CAC ratio. This paper summarizes the key findings that our portfolio is now using with success. ******************** Bessemer Venture Partners Confidential 1 A new look at sales and marketing metrics: the Customer Acquisition Cost (CAC) ratio When a business invests in sales and marketing, the objective is not to generate revenues but to generate margin that will contribute to payment of the business expenses and hopefully generate a profit. This is even more important in the SaaS ecosystem where there is a large discrepancy between simple and easy to deploy applications with gross margin in the high 70's or low 80's (e.g., email marketing or CRM) and more complex applications requiring heavier support where gross margin can be in the mid to low 50's (e.g., ERP). The following exhibit highlights this variability for a select set of public SaaS businesses: Consequently, when thinking about defining a metric to benchmark the Sales and Marketing effectiveness across a diverse group of SaaS applications, Gross Margin seems to be more relevant than revenues. Gross Margin for select public SaaS companies (Q1 08) 81.3% 78.0% 76.2% 74.4% 73.2% 72.0% 68.4% 67.3% 66.6% 63.3% 58.8% 57.8% 55.3% Vocus Salesforce Constant Contact LivePerson Kenexa Taleo Concur DemandTec SumTotal SuccessFactors Ultimate Software NetSuite Using Gross Margin as the most relevant indicator of value creation, we have defined the Customer Acquisition Cost or CAC ratio. This single number is the key to determine your level of Sales and Marketing investment and is very simple to calculate by looking at a quarterly GAAP P&L: you just have to divide the annualized net Gross Margin added during a given quarter by the sales and marketing costs required to generate it (typically the Sales and Marketing costs of the quarter before). If you would like to calculate this ratio for the third quarter for example, the formula becomes: CAC Ratio (Q308) = [GM(Q308)-GM(Q208)]*4 Sales & Marketing Costs (Q208) The CAC ratio determines the payback time on your sales and marketing investment: a CAC ratio of 0.5 for example means that half of your investment is paid back per year, so it is a two year payback period. From a practical standpoint, this ratio can easily be derived by looking at any quarterly GAAP statement and therefore is very easy to benchmark for public companies. This formula needs to be adjusted, however, based on the time a given SaaS business requires to get a customer up and running. Typically, revenue and therefore gross margin recognition starts when the application goes live and the customer begins to use it. For most SaaS applications, this configuration and deployment period takes about 3 months or a quarter, so we can approximate that the sales and marketing costs of a given quarter will generate incremental gross margin that will be recognized from a GAAP standpoint during the following quarter. However, for companies with a shorter implementation cycle (e.g., e-mail marketing) or a self provisioning service, the revenue can be recognized shortly after the signature of the contract and therefore the CAC ratio should be calculated with the sales and marketing costs of the same quarter, not the quarter before. Bessemer Venture Partners Confidential 2 Bessemer Venture Partners Confidential 3 If you have access to the Committed Monthly Recurring Revenue or CMRR1 metric for the SaaS business you are looking at, you can get an even more accurate CAC ratio. Similarly to the CMRR, we can define an equivalent metric for the Gross Margin: the Committed Monthly Recurring Gross Margin or CMRGM and use it to eliminate the implementation inaccuracy that exists in the previous formula. Using the CMRGM, the CAC ratio can then be defined as: CAC Ratio (Q308) = (CMRGM(Q308) - CMRGM(Q208))*12 Sales & Marketing Costs (Q308) ******************** Using the CAC ratio to set the pace of your sales and marketing investment Once the CAC ratio defined and measured, two questions need to be answered: What is the right benchmark level for the CAC ratio and is this benchmark different for public and private companies? The following section will dive deeper into these two points. As a start, we looked at the CAC ratio of since its 2004 IPO a key data point given the success of the company and we found that their ratio has been indeed within this 0.5- 1.0 range: CAC ratio since IPO (Delta GM annualized/ S&M costs for the previous quarter) - 0.20 0.40 0.60 0.80 1.00 1.20 1.40 Ju l-0 4 Oc t-0 4 Jan -05 Ap r-0 5 Ju l-0 5 Oc t-0 5 Jan -06 Ap r-0 6 Ju l-0 6 Oc t-0 6 Jan -07 Ap r-0 7 Ju l-0 7 Oc t-0 7 Jan -08 Ap r-0 8 One year return curve Two year return curve Getting back to the definition, a CAC ratio between 0.5 and 1.0 is equivalent to a marginal payback period of respectively 2 year and 1 year for a new customer. From our private investor experience, this timeframe seems reasonable as the lifetime of a customer is usually between 3 to 6 years. The other interesting element coming from this chart is that, while the CAC ratio presents 1 The CMRR can be defined as the recurring GAAP revenue recognized in a given month, plus the monthly recurring revenue contracted but not implemented (and therefore not recognized), less the GAAP revenue expected to churn (the customer already gave notice but the subscription might last a few more months and therefore the revenue is still recognized). You can learn more about CMRR by reading the white paper wrote by my colleague David Cowan: "Measuring Growth Businesses with Recurring Revenues". This article is available at or you can request a copy by sending a request to some variability over time (the quarters ending in April seem to have better ratios), there is not a clear improvement pattern over time. This tends to demonstrate that the benchmark ratio should be equal for public and private companies as scale does not really seem to matter, but we will dive deeper into this later question to see if this anecdotal evidence can be generalized. With the data in mind, we then performed a benchmark of the CAC ratio for a set of 13 SaaS companies for the quarter ending June 30th 2008. The following chart presents the result of our analysis and show a Median CAC ratio for the period of 0.54 CAC Ratio for Quarter Ending June 2008 0.00 0.20 0.40 0.60 0.80 1.00 1.20 1.40 1.60 1.80 KN XA CR M LP SN CT CT TL EO CN QR VO CS SF SF DM AN N SL RY UL TI SU MT Ticker C A C R at io Median: 0.54 Companies with Negative Ratio We expect these ratios to evolve and probably deteriorate in the coming quarters as these companies will likely need to adjust their sales and marketing expenses and cash flows to take into account the tougher macroeconomic environment, but this chart gives a good idea of where best performing companies are standing today. Based on these data points and on our experience working with private SaaS companies, the punch line is that a CAC ratio of a third (0.33) or less is challenging. This suggests that it takes the company at least three years to payback the initial customer acquisition costs, so the customer acquisition model is likely not contributing enough to cover the G&A and R&D expenses and generate a profit especially in the current environment where the cost of capital is very high and therefore any contribution more than three years out should be heavily discounted. In this case, the company should slam on the breaks and reduce the sales and marketing spending until it can improve the sales efficiency. At the other end, anything above one (1) means that the company should invest more money immediately and step on the gas as customers are profitable within the first year. However, the increase of the sales and marketing spend needs to be closely tied to the cash flow model of the company. In bullish capital markets where access to financing is relatively easy and cheap, increasing the spend is an easy decision to make and growth is heavily rewarded by high exit multiples. However, in the current climate, companies need to balance growth against cash flows and cost of capital and therefore the answer is more complex and depends on the cash available and the overall cash consumption of the company. If the CAC ratio is between 0.33 and 1.0, we would suggest keeping the same level of sales and marketing investment or reducing it based on the capital available and focusing on productivity improvement. The second question we wanted to address is whether scale affects the benchmark level of the CAC ratio. To answer this question, we looked at the two components of the ratio: the Gross Margin and the sales and marketing effectiveness. To identify the potential benefits of scale on Gross Margin, we looked at the median Gross Margin percentage during the three years before Bessemer Venture Partners Confidential 4 Bessemer Venture Partners Confidential 5 3-Year Average Gross Margin Pre-IPO 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% LP SN CR M VO CS SL RY CT CT KN XA SU MT DM AN TL EO N CN QR SF SF UL TI Ticker G ro ss M ar gi n Median: 69.8% and after the IPO2 for a set of 13 public SaaS companies. The results are presented on the charts below: 3-Year Average Gross Margin Post-IPO 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% VO CS CR M SL RY LP SN KN XA N TL EO DM AN SU MT SF SF UL TI CN QR CT CT Ticker G ro ss M ar gi n Median: 70.6% Surprisingly, while some companies have seen a leverage effect (like NetSuite or SuccessFactors), the median gross margin pre and post IPO are relatively close and therefore it does not seem that larger companies are reaping a significant advantage from their scale from this standpoint. Intuitively, one would think that with growth slowing down, the ratio of professional services to revenues would decrease, but these numbers show that this factor is compensated by increased data center costs and/or the need for more services to support existing customers. If we look at the sales and marketing side, our experience (confirmed by the Salesforce numbers presented above) tends to show that while companies improve their effectiveness through branding and climbing the sales learning curve further, these benefits are balanced by increasing competition and the need to go after segments that are more difficult to reach. Consequently, with the gross margin and the sales and marketing effectiveness not improving structurally with scale, we can conclude that the CAC ratio benchmarking exercise developed earlier in this section should apply to both public and private companies. Following this analysis, we have defined a simple set of rules that we have found helpful to better manage the sales and marketing investment of SaaS and recurring revenue businesses: If the CAC ratio is above or close to 1.0, invest more aggressively and accelerate growth if capital is available. If, not optimize the sales and marketing spend to stay at cash flow break even If your CAC ratio is lower than 0.33, it is time to slam on the breaks and focus on sales and marketing productivity improvement If the ratio is between 0.33 and 1.0, keep the same level of sales and marketing investment or reduce it based on the capital available and focus on productivity improvement ******************** 2 Detailed analysis provided in Appendix II: "Public SaaS Companies Benchmarking". Please email to receive a copy Refining the CAC Ratio The CAC ratio calculation can be further refined by considering the implementation services and revenues as part of the customer acquisition cost. Sales and Marketing investments cover the lifecycle of a customer till a contract is signed however, this does not mean that the customer is using the service yet and this is why US GAAP does not recognize the revenue at this point in time but only when the customer starts to use it. The next step is therefore to get the customer up and running on the service and this usually implies the need for professional services. To some extent, these services are part of the customer acquisition costs and therefore should be included in the calculation of the CAC ratio. As these services usually generate revenue, only the difference between this revenue and their cost should be accounted for. This leads to a refined formula for the CAC ratio: CAC Ratio (Q308) = [ CMRGM(Q308) CMRGM(Q208)] x 4 S&M Costs (Q208) [Pro. Serv. Rev. Pro. Serv. Costs] This ratio is usually more difficult to benchmark since few public companies provide a detailed breakdown of their professional services revenues and associated costs and since the revenue recognition policy for these services can differ widely (recognition can be upfront if the service is provided with a partner or it can be over the lifetime of the contract). We have been able to conduct this analysis for and the following exhibit shows the slight difference between the initial CAC ratio and this refined version: CAC ratio and Refined CAC Ratio since its 2004 IPO - 0.20 0.40 0.60 0.80 1.00 1.20 1.40 Jul -04 Oc t-0 4 Jan -05 Ap r-0 5 Jul -05 Oc t-0 5 Jan -06 Ap r-0 6 Jul -06 Oc t-0 6 Jan -07 Ap r-0 7 Jul -07 Oc t-0 7 Jan -08 Ap r-0 8 One year return curve Two year return curve Refined CAC Ratio CAC Ratio Finally, the CAC ratio can even be refined further by separating the account management cost from the sales expenses. This is possible if you are conducting this analysis for your business, but this data is not available for public companies and therefore very difficult to benchmark. We would recommend using it though if you are trying to define your customer lifetime value. ******************** Bessemer Venture Partners Confidential 6


About manojranaweera

Founder of UnifiedVU and Venture 9. Previously Founder and CEO of 

Help companies with digital and business transformation via process optimisation and system design, especially in the areas of bringing everything together for increased productivity and revenue growth.


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