One of the core tenants of Software-as-a-Service (SaaS) economics is that the cost of customer acquisition needs to be commensurate with the revenue provided by the customer. As an example, if it costs $50,000 to acquire a customer and the customer only pays $1,000 per month, it’s likely that the business, in it’s current form, won’t work (save for an unusual up-sell situation). When looking at SaaS metrics, the ratio of customer acquisition costs to annual recurring revenue is one of the most important.
Here are a few thoughts on SaaS customer acquisition costs relative to customer revenue:
- A general rule of thumb is that the cost to acquire a customer should be less than the annual recurring revenue from the customer (e.g. if it costs $1,000 to acquire a customer, the customer should pay at least $1,000 per year in recurring revenue)
- Length of contract and average lifetime of a customer are also important considerations, especially with products that have high switching costs (e.g. a content management system has much higher switching costs than an email marketing system)
- Gross margin is another critical piece of the puzzle as SaaS companies with higher gross margins can afford to spend more to acquire a customer, everything else being equal
- Cost of capital is another consideration when looking at customers that are expensive to acquire but will likely stay for many years
As a SaaS entrepreneur, SaaS customer acquisition costs relative to customer revenue is one of the most crucial metrics for building a viable, high growth business. Many venture-backed companies burn significant amounts of cash to reach profitability, and many of the most successful ones don’t reach profitability until well after they’ve gone public. Regardless, the economics of customer acquisition need to make sense.
What else? What are some other thoughts on SaaS customer acquisition costs relative to customer revenue?