“Would you rather” for SaaS nerds

brendan-church-182747
In an ideal recurring revenue company, you’d have enormous LTV:CAC because sales and marketing costs would be small relative to ACV and there would be no churn. But if you had to prioritize one, would you rather have a long customer lifetime, or a quick payback of acquisition costs?

LTV:CAC is effectively a measure of how much a customer is worth (lifetime value) relative to how much they cost to get (acquisition cost). With a little rearranging, it can be restated in terms of lifetime and payback period.

This tradeoff can be visualized as a matrix of different lifetime/payback combinations that achieve given LTV:CAC values. Because it’s more familiar, I’ve restated lifetime in terms of its inverse, churn.

 

The dark green values are objectively pretty awesome. Those LTV:CACs can get really high because they have BOTH long lifetime and quick payback working in their favor. On the flip side, companies that land in the dark red zone are in trouble. They have really low LTV:CAC—so low that payback period exceeds lifetime and they’ll never recoup their acquisition costs. The lighter reds simply fall below 3, a common LTV:CAC threshold.

Obviously, it’s better to have both long lifetime and quick pa

yback over neither, but the more interesting question is in the middle. Is it better to achieve a satisfactory LTV:CAC score by virtue of long lifetime or quick payback? The light green values meet classic SaaS rules: LTV:CAC between 3-8, payback less than 2 years. In the yellow zone, LTV:CACs are acceptable (or high), but the scores are achieved because of long lifetimes and in spite of slow payback periods. Are the yellow and light gre

en zones equally good?

When it comes to growth, I don’t think they are. Long lifetime is great in the long term, but a slow payback is an even bigger handicap in the short term. To illustrate, consider a fictional company with 500, $10K ARR customers. It has an LTV:CAC of 5, with a low annual churn rate of 6%, but a slow payback of over 3 years. Assume that, as a rule, you invested 35% of beginning of year run rate into customer acquisition each year (the average SaaS company surveyed by Pac Crest spends 35% of revenue on sales and marketing). Five years later, the compa

ny’s run rate would have grown from $5M to $8M.

Now consider a very similar company. It also has 500, $10K ARR customers, and it also has an LTV:CAC of 5, but, it achieves that ratio with a higher churn of 14% and much faster payback of 1.4 years. If you also i

nvested 35% of beginning of year run rate in CAC at this company, its run rate would grow from $5M to $13M in 5 years.

The second company grows faster because the same CAC spend initially buys more customers, and those customers in turn generate more revenue to reinvest. Yes, the second company churns more customers, but in 5 years, it amasses a base almost twice as big. The second company also has less unc

ertainty—it isn’t banking on things like churn rate and market dynamics to stay the same over a 10+ year customer lifetime.

There are plenty of potential caveats and edge cases (what if it’s a small market and there aren’t that many new customers to sell, what if you can’t maintain that sales efficiency at scale, or what if there’s lots of cheap debt to finance growth). But at least in the abstract, I’d rather have quick payback. What’s your pick?

 

 

 

 

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