Investing in acquiring new customers is necessary for business growth. With consumers being exposed to so much advertising and branded content every day, it’s critical to develop programs that capture your target customers’ attention and drive them to make purchases.
Spend too little on acquisition, and consumers will never become aware of your brand and may do business with your competition. But spend too much, and it will take a long time for new customers to generate the amount of money invested to acquire them. This is where Customer Acquisition Cost (CAC) payback period comes in.
CAC payback period is the amount of time it takes for a newly acquired customer to generate the same amount of revenue it cost to acquire them. In other words, the amount of time it takes for customer lifetime value to equal CAC. In this post, we’ll be diving into how to calculate CAC payback period as well as how to establish a good CAC payback period for your business.
The first step to understanding payback period is to determine Customer Acquisition Cost (CAC).
Customer Acquisition Cost (CAC) is an essential marketing metric that enables businesses to understand how much sales and marketing budget they are spending for every new customer acquired.
To calculate Customer Acquisition Cost, simply divide your total sales and marketing spend for a specific time period by the number of new customers acquired during that time period.
Total Sales & Marketing Cost
_______________________________ = Customer Acquisition Cost
Number of New Customers Acquired
When determining Sales & Marketing Costs, it’s best to include all costs related to team member salaries, tools, and advertising fees to ensure your CAC calculation accurately represents your balance sheet.
By analyzing CAC alongside customer lifetime value (CLTV) – the total revenue that a customer generates for your business over a specific period of time – you can understand how much revenue a customer will generate compared to the amount you invest to acquire them.
When CLTV is equal to CAC, customers are generating the same amount of revenue it cost to acquire them, on average. As customers make more purchases or subscription payments over time, CLTV will increase further, ideally surpassing CAC and making your acquisition model more profitable.
But while profitability is certainly important, the rate at which you generate profit from new customers will fuel or hinder business growth in the long run. A customer that becomes profitable to your business in 6 months is much more valuable than one that becomes profitable in 6 years. This is where CAC payback period comes in.
CAC Payback period is the amount of time it takes for a newly acquired customer to generate the same amount of revenue it cost to acquire them. In other words, the amount of time it takes for CLTV to equal CAC.
To calculate payback period, divide your CAC by your gross profit.
Customer Acquisition Cost
____________________________ = Payback period
Monthly Revenue x Gross Margin
When making this calculation, note that you must factor the cost of goods sold (Gross Margin) into monthly revenue, as you are analyzing for profitability.
Payback period is important because once customers become profitable, the profits they generate can be reinvested into further business growth. Short payback periods lead to compounding growth over time, while long payback periods lead to stagnation. Let’s look at an example to explore this important point.
Take two eCommerce mug retailers, Fresh Mugs and Mugs4Your. Both retailers leverage Facebook Ads as their preferred channel for acquiring new customers, and both have been able to achieve a CAC of $20. Through a combination of better pricing, better retention marketing, and better brand loyalty, Fresh Mugs has been able to reduce their payback period to 3 months – quite impressive. Mugs4You, on the other hand, has a payback period of 12 months. Due to their shorter payback period, Fresh Mugs can reinvest the gains generated from profitable customers more frequently, capturing more of the addressable market which in turn leads to more revenues. Mugs4You, on the other hand, is forced to wait longer for new customers to become profitable, and therefore will not be able to reinvest profits in advertising as frequently, leading to slower growth in comparison to Fresh Mugs.
CAC payback period is often analyzed as an essential metric as it allows teams to assess the efficiency of their customer acquisition, retention, and pricing models. Businesses with a highly-predictable payback period can forecast future revenues more easily and invest in acquisition with greater confidence.
As with CLTV:CAC ratio, payback period can vary depending on industry, business model, and maturity stage. While transactional consumer businesses may achieve a payback period between 1-6 months, B2B companies can aim for a payback period between 6-12 months, and even 12-18 months if they’re focused on selling to enterprise brands.
High average order value transactional businesses may achieve a shorter payback period as new customer acquisition is marked by a product purchase. Automotive manufacturers, for example, may recoup CAC as soon as a new customer buys their first car from the brand.
Subscription-based businesses, on the other hand, may see a longer payback period as they depend on new customers continuing to subscribe over time to cover the cost of acquisition. A streaming media platform, for example, may allow new customers to sign-up for free and depend on collecting subscription payments over the following months to recoup CAC.
Mature businesses that have a highly predictable CLTV and strong retention, such as established enterprise SaaS companies, may be willing to tolerate a higher payback period as they have greater certainty that customers will pay them back within the payback period (and likely more cash in the bank).
John Joe Smith, founder and CEO of WasteNot, is hosted by Tom Triscari, founder of Quo Vadis, for a Q&A conversation on the future of audience suppression.
Many advertisers waste up to 40% of their ad budgets due to inefficient targeting, and they aren't even aware of it. In this article, we'll walk through how brands can use modern audience suppression strategies to improve advertising efficiency and performance.
.png)
WasteNot is the only platform focused on allowing marketers to activate and optimize real time ad exclusions across all biddable media.