I would not call myself a marketing expert by any reach but I’ve invested in enough companies and served on enough boards to know that if your business has a marketing component to it, how you define and report your marketing metrics can be full of pit falls.
If you use a marketing budget to sell your product or to generate leads for your direct sales team, it is very important that everyone in your organization and on your board use the same definitions for key performance indicators (KPIs).
The cost of acquiring customers (CAC) is often misrepresented
CAC sounds simple enough to track. If you spend $10,000 on Facebook® ads and get 100 new customers, then your CAC is $100 per customer…right? Maybe.
There are a lot of ways to screw this up. One of my portfolio companies has a great product and discovered last year that over a third of its new subscribers were being referred by existing customers. That’s great, except for the fact that the team was attributing these signups to their advertising prowess.
Their CAC was actually 33% more expensive than they thought, which means that for nearly a year they were losing money on several marketing channels they thought were paying off.
Details matter. For early stage companies, if you cannot track a sale all the way back to the specific marketing initiative that originated it then you are not accurately calculating your CAC or managing your marketing budget. Some marketing advisors use the simple maximum, “if you cannot track it then don’t do it.”
I’ve heard marketing leaders state how effective a particular campaign was when in fact it only generated a lot of unqualified leads, which in turn killed the effectiveness of the inside sales team for weeks. There are some leads you don’t want and a so-called successful marketing initiative can actually hurt your venture if it does not lead to real closed sales.
Have Well Defined Stages for Your Marketing Funnel
Be very specific when you define the stages of your marketing funnel. I’ve heard the word “conversion” used to mean all of the following:
- The people who opened or clicked on our ad
- The people who visited our website after viewing our ad
- The people who signed up for a free trial or demo
- The people who did not cancel their subscription after the free trial
- The people who continued using our product after the discount period
- Etc. etc.
I think I’m going to start asking the marketing leaders I meet with to provide me with a definition of the term before we meet. A huge amount of time is often wasted in board meetings trying to get on the same page.
CAC can also be understated
Marketing, early on, is a lot of experimentation to see what works. Over time you identify some channels that yield a fairly consistent and predictable CAC. A very common mistake I see is when a company blends its “experimental” marketing spend with “proven” marketing spend when reporting.
The experimental spend is always a much higher CAC than proven channels because you are trying a lot of channels that won’t pay off. Only when you break out your experimental spending can you determine your real CAC. CAC should be defined as the cost of acquiring customers if all experimentation channels are turned off. That’s your real CAC.
Investors often consider CAC to be your most important KPI
If you are trying to sell your company or raise another round of funding and marketing is an important part of your sales process then you are going to be talking a lot about how you calculate your CAC.
Acquirers and later stage investors are usually very sophisticated in this area. They know that if your real CAC is $100 per sale and the lifetime value (LTV) of your average customer is three years paying $100 per year then every customer you win will ultimately pay you $300 for a lifetime gross profit of $200.
There is no magic here, just math.
If they believe your marketing model will scale then they calculate what their return will be based on how much they plan to increase your marketing spend.
In summary, defining and calculating your CAC effectively will give you the real KPIs you need to manage your business, raise additional rounds of funding and ultimately to exit your venture at a fair multiple.