For a startup or expansion-stage SaaS company, the ability to accurately measure the return on its sales and marketing investment is critical to informing resource allocation, and therefore crucial for its ongoing growth.
Without that SaaS sales and marketing ROI measuring ability, the company is essentially operating in the dark.
While calculating sales and marketing ROI can be somewhat straightforward for companies that sell perpetual licenses of their software for a one-time, up-front fee, doing so for SaaS companies can be slightly more complex.
Since customers pay a renewable, ongoing subscription for access to a SaaS product, looking at the revenue generated by sales and marketing efforts in the first year alone doesn’t paint a full picture of the return on investment, which typically continues generating revenue over the lifetime of the customer. Because of that, comparing sales and marketing spend to revenue gained on a GAAP P&L isn’t very insightful. Instead, the key to calculating SaaS sales and marketing ROI for renewable subscription models is determining your company’s Customer Acquisition Cost (CAC) ratio.
The CAC ratio is calculated by taking the new annualized bookings in a certain time period, multiplying it by the gross margin during that period, and dividing it by the sales and marketing spend required to generate those bookings. New annualized bookings is simply the annualized contract value of customers added (for example, if your company sells month-to-month subscriptions, multiply the monthly value of the new contracts added by 12. If your company sells three-year subscriptions, divide the total value of new contracts added by three). The CAC ratio for a certain time period (t) is shown below:
The CAC ratio can also determine the return on a company’s sales and marketing investment in the first year, so if your company’s CAC ratio is 0.5, this means that your company recoups half of your investment in sales and marketing in the first year. The inverse of the CAC ratio determines how long it takes a company to recoup its investment in sales and marketing, so for example, if a company’s CAC ratio is 0.5, the company will need two years (1/0.5 = 2) to fully recoup its investment in sales and marketing (assuming a 100% revenue retention).
Once you’ve calculated your CAC ratio, you can then use it to calibrate your company’s investment in sales and marketing. In general, the the three guidelines below (adapted from rules originally developed by Philippe Botteri, Principal at Accel Partners) can help you manage your spend:
- If your CAC ratio is above 1.0, then it’s time to invest more aggressibly in sales and marketing to accelerate customer and revenue growth.
- If your CAC ratio is lower than 0.5, you need to improve your company’s sales marketing effectiveness before investing more, and you may need to scale down operations until productivity improves.
- If the ratio is between 0.5 and 1, the current level of investment is generating a healthy return, and you should consider making an additional incremental investment as long as the ratio stays in this range (provided you have a reasonable annual revenue retention of 75% or more, a R&D + G&A spend that combined is less than S&M spend, and sufficient capital).