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You Can’t Fix a CAC Payback Period: An Operator vs Investor Perspective on SaaS Metrics
Dave Kellogg from SaaS Metrics Palooza
During SaaS Metrics Palooza 22’, Dave Kellogg, a seasoned enterprise software and SaaS operator, creator of the KellBlog, SaaS company board member and EIR at Balderton Capital, delivered a highly entertaining and information rich presentation on CAC Payback Period. The key theme was contrasting the different uses and perspectives that operators versus investors have on SaaS Metrics.
With a wealth of diverse experiences, Dave has a unique 360-degree view on using, analyzing and interpreting SaaS metrics. He typically approaches the use of SaaS metrics from an operator's standpoint, but can readily shift to board or advisor mode, depending on the context.
In this week's newsletter, we'll delve into the key takeaways from his presentation, which include understanding the difference between compound and atomic metrics, the importance of benchmarking against relevant company cohorts, and how to implement his recommendations on using CAC Payback Period in your company.
What is CAC Payback Period (CPP) and What Does it Measure?
Dave provides valuable insights on CAC Payback Period (CPP), including its definition as the number of months required to recover the cost of acquiring a new customer using the gross margin adjusted ARR from new customers in a specific time period such as a fiscal year or fiscal quarter. He shares OpenView's formula for calculating CAC payback, involving sales and marketing expenses in a period divided by net new MRR acquired in the same period times the gross margin. However, Dave prefers a simpler formula, which is the CAC Ratio divided by subscription gross margin, for easier calculation.
CPP is not an efficiency metric, but rather a risk metric that indicates the time required for a company to recoup its customer acquisition costs. A primary reason to calculate and use CPP is to analyze other potential customer acquisition strategies with a shorter payback period.
The CAC Payback Period does not consider customer lifetime value or churn rate. The Customer Lifetime Value to CAC ratio is a better measure to understand the longer term ROI on customer acquisition investments. While a shorter CPP may indicate an efficient Go-to-Market motion for acquiring new customers, it should be used in conjunction with other measures to gain a comprehensive understanding of a company's revenue growth performance and overall financial health.
What does good look like? (CPP Benchmarks):
Dave discusses how to define what "good" looks like when it comes to CAC payback period, and mentions that there are material differences in CAC Payback Period benchmarks for companies primarily selling to SMB versus Enterprise customers. He compares different data sets and discusses how the definition of "good" varies depending on the comparison universe, business segment, company size, and growth rate. In Dave's world of VC-backed enterprise companies, a CAC payback period of six months is considered amazing, 12 months is very good and even 18-24 months can be good based upon the average contract value. Dave also warns against a “slippery slope of corrections”, which are dimensions with the intent on making the CPP more accurate, but often makes it less comparable.
Why You Can’t fix a CAC Payback Period:
CAC Payback Period is a compound metric.
There are limitations of using CAC Payback Period (CPP) as an operational metric for businesses. According to Dave, CAC Payback Period is a compound metric that can be influenced by various factors, such as inefficient sales, marketing, or subscription delivery costs (gross margin). He explains that a long CAC Payback Period does not necessarily indicate a problem that can be easily fixed. Instead, he suggests using other metrics, such as CAC Ratio and subscription gross margins, which provide more specific insights into where to focus efforts to improve business operations. Dave highlights that the more a metric measures one thing, the easier it is to fix, but when it measures multiple things, it becomes more challenging to pinpoint the issue and address it effectively.
Understanding the Difference Between Compound and Atomic Metrics:
Using first hand experience, Dave discusses the different perspectives of investors and operators when it comes to SaaS metrics. Investors prefer compound metrics because they are making investment decisions and need to quickly sort through deals to determine which ones are worth pursuing. Compound metrics, such as the Rule of 40, CAC Payback Period and Net Revenue Retention are also preferred by investors for comparability purposes.
On the other hand, operators prefer atomic metrics because they help in improving operations and identifying which levers to focus on to improve operational performance. Operators also tend to benchmark against all SaaS companies, while investors focus on the top-tier companies that they are interested in investing in. However, operators need to remember that they also need to care about what investors care about if they want to secure funding for their company.
It is important to monitor both compound and atomic metrics, but operators should focus on the atomic metrics,especially leading indicators such as win rate, gross revenue retention, pipeline conversion rates and sales cycle length to drive business performance while watching the compound metrics because investors care about them.
The Silicon Valley Supply Chain View:
Dave reflects on his previous views as an operator in the industry, versus investment firms which have the tendencies to pattern match. However, as he transitioned to angel investing and working as an EIR in an investment firm, he began to see the value in also understanding an investor's point of view. Entrepreneurs should understand that investors are part of a larger industry supply chain, which includes universities, entrepreneurs, VCs, Private Equity and investment bankers, who work in partnership to create and sell companies to the public markets.
Dave urges entrepreneurs to understand that investors, like real estate agents, have a lot of knowledge about what their customers want and to aim for those preferences when considering an exit strategy. He suggests that applying this perspective can help entrepreneurs better navigate the supply chain and increase their chances of success.
How to Apply Dave’s Insight:
Dave provides several pieces of advice for companies to effectively track and use metrics for both internal and external purposes.
Understand the difference between the operator and investor POV
Track both operator and investor metrics
Develop a deep understanding of the metrics you track
Benchmark against the appropriate company cohort(s)
Wear the investor hat
Beware that investors sometimes use metrics as excuses
Understand your company is part of a bigger industry supply chain
You can learn more from Dave Kellogg by listening to the presentation at SaaS Metrics Palooza here. You can also listen to my conversation with Dave on the Metrics that Measure Up podcast by clicking here.
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