What goes around…
Understanding your customer acquisition cost (CAC) unlocks a lot of valuable strategic tools and decisions for you. Along with your customer lifetime value (LTV) it allows you to understand the fundamental economics (and viability) of your business.
One important analysis you should undertake with your CAC is how long it takes a customer to pay back their cost of acquisition. If a customer costs you $10 to acquire, how long is it before you earn that $10 back again? This is a critical analysis because it will tell you how much capital you need in the business to hit your customer growth goals.
For some businesses, the payback is immediate because the customer makes a product purchase that is more than their CAC. However, for many subscription and recurring revenue businesses the payback period can be very long!
An example would be easier to follow
Good point. For example, let’s say that your CAC is $1,000 and you earn $100 per month from each customer. That means your payback period is 10 months, which is how long it takes you to earn $1,000 from that customer. Now, let’s assume you acquire 100 customers in January, so you spent $100,000 and made $10,000 from them so you have a $90,000 gap. You won’t get all of that $90,000 back entirely until October! If you continue to acquire 100 customers each month, you will quickly realize that you need to have a lot of capital on hand to be able to wait 10 months for your customer payback. In fact, your net cashflow will look like this:
Hence, in our example you will need a total of $450k in cash just to survive until October! However, after October the fact that you have paid back your January customers means that you will be generating enough cash to fund the acquisition of more customers, so your business will become cashflow positive (assuming no churn, which is a bad assumption).
Remember, we use the Net Revenue for these calculations – not Gross Revenue!
Quote of the Day: “It’s not payback! It’s precaution.” – The Usual Suspects