Building a successful SaaS startup and putting it on a growth trajectory involves a great amount of effort and a thorough understanding of the market dynamics. To begin with one would need to build a product and achieve product market fit. Once you have a product market fit, you know there is a target segment that you can sell into. The question then becomes – How do I reach out to my target audience and start converting them as paying users?
An easy answer some would say with the amount of options a SaaS company has to interact with its customers in today’s digital world. But is it so? To understand SaaS customer acquisition and business viability one would first need to understand a few basic metrics that become extremely crucial to understand the health of a SaaS business:
- LTV – Lifetime Value of a Customer
- CAC – Cost to Acquire a Customer
- Sales Velocity – Number of days required to acquire a customer from the first point of interaction
- Payback – Time taken to recover the CAC
- Churn(monthly) – % of customers you lose in a month
A well balanced business model will always have a LTV value greater than the CAC. If it’s not so for your SaaS business, then it might be a good option to reconsider the business model you are building.
One in a million SaaS startup would be able to depend upon the inherent virality of the product to scale up. But even in case of these startups there is an initial threshold value for the customer count that they need to hit for the virality to kick in. Rest of them, well they have to use of mix of SEO, SEM, Social Media, Direct Sales, Channel Sales, PR etc to hit their audience. Let me tell you, the CAC for majority of the SaaS companies have shot up so much that it becomes really difficult during the initial days of its incubation to rely on the Paid channels to acquire customers.
So, when does Paid Channels Work for a SaaS Startup?
Paid Acqusition works only when LTV > CAC
To elaborate, let’s assume a startup which relies on Google Adwords for eg to generate leads and works with the following numbers:
|Scenario-1||Scenario – 2|
|Cost Per Click||$1||$4|
|Conversion to Trials||10%||10%|
|Conversion to Paid Customer||5%||5%|
|Number of Trials||800||800|
|Number of Paid Customers||40||40|
|Cost of Converted Trial||$10||$40|
|No. of Sales & Marketing Resource||7||10|
|Cost per Employee per Month||10000||10000|
|Total Cost Incurred Per Month( Without salary)||8000||32000|
|Total Cost Incurred Per Month( With salary)||78000||132000|
As you can see the CAC is a function of CPC, Conversion % at each stage, Sales & Marketing Overheads, Churn and the Sales velocity. You would want to have a high velocity and a churn percentage close to zero to reduce the CAC. Similarly, with more human touchpoints, your CAC value goes higher. Touchpoints could be any of email followups, sales calls or demos the inside sales team does. The CAC value goes even higher with direct Sales team involved, however in such cases your Average Contract value will also be much higher. In short it’s important for any company to keep their CAC < LTV to sustain.
While you do your math and try and figure out the CAC number during the early stages of your business, another important metric to track is the payback period. Let’s assume in the above example your avg. revenue per customer is $400/ year.
Scenario 1: Payback Period = 200/400 = 0.5 years
Scenario 2: Payback Period = 800/400 = 2 Years
Implies, in Scenario 1, you would take 6 months to recover the amount of money you had invested in acquiring the customer, while in Scenario 2, you will take almost 2 years to recover the money you spend on getting your customers. For a Startup at an early stage having limited access to capital the second Scenario is a sureshot bankruptcy contender, so while you analyse your business keep in mind the payback period and the amount of capital you would need to sustain your business. A simple workaround in Scenario 2 would be to collect the payment upfront – For more, refer Pricing Strategy makes or breaks a SaaS startup.
Always be asking yourself the following questions before you decide to spend on acquiring customers through Paid Channels:
- Has my product already achieved Product/ market fit?
- What’s my CAC for a paid channel?
- How much Capital do I have?
- What’s my runway with the Capital I have?
- What Pricing Strategy can enable me to sustain the business if I am relying upon my cash reserve to acquire customer.
- Do I plan to raise more money or am I planning to run the business through the revenue generated? If you are planning to raise funds, burning money to show momentum might be a good idea. You may want to read this article The Incremental Customer
Find answers to these questions to have a clear understanding on why and when to use paid channels for customer acquisition. Remember you will have a sustainable business only when:
- CAC < LTV (general rule of thumb is that LTV should be 3 times your CAC)
- Payback period < 1 year