What the CAC?!
February 25, 2020
A number of times over the past month, I’ve been asked about how best to present Customer Acquisition Cost (CAC) when investors ask about it. This is a common question that entrepreneurs field regardless of the nature of their business. Sometimes there either isn’t enough information to calculate the CAC or it isn’t relevant for the type of business.
Why do investors ask the CAC question?
The CAC question came about with the proliferation of Business to Consumer (B2C) plays, some of which offered digital goods (e.g. mobile games, SaaS services etc) and other offered real goods (e.g. shoes, wallets, pet food subscriptions).
The commonly accepted way of looking at these businesses was to work out what the Life Time Value (LTV) of the customers is and then calculate the LTV/CAC to compare the current company against the other B2C companies. I’ve written about using heuristics in investing before. If you’re using them, you need to understand why they’re important and how they’re calculated.
Using LTV/CAC makes sense if it’s easy to calculate CAC i.e. there are limited acquisition channels and they’re predominantly digital. If you’re looking at a B2B business that’s reliant on long sales cycles with a sales force that is working on multiple leads, it becomes more difficult to calculate the CAC.
You can’t fight it, investors that have read about CAC believe that it’s important, if they don’t ask it, they’ll feel inadequate. It might not be relevant but they’ll ask it anyway.
What’s the problem with CAC?
If the business is focused on using CAC from the beginning, then it could allude to problems further down the road. If the company doesn’t have a strong value proposition (high churn) and is reliant on external funnels, then it’s likely that the CAC will continue to increase as competitors enter the market. The company will have little control over the pace of growth because it doesn’t control the primary acquisition channel. The calculation is simple – Total Potential User Acquisition = Funds / CAC. The more money that’s poured into the customer acquisition engine, the faster the company can grow.
Ideally, a start-up should be looking to create its own acquisition loops. Andrew Chen, partner at A16Z has written about this here. If a start-up doesn’t control its acquisition loops then it will be subject to increases in CAC as the market reaches saturation and the platforms that provide the acquisition engine will continue to extract the maximum amount that they can.
But they keep asking the question, what should I tell them?
“Not everything that counts can be counted, and not everything that can be counted counts.”
Determine which metrics matter to your business. Are you focused on the top of the pipeline? How about the conversion from the top of the pipeline? Just as different people have different goals and values, different companies will have different goals and values depending on their stage and the markets that they’re trying to conquer.
Focus on telling the story around your metrics. I’ve written about this before here. Explain the things that you believe are important to your business and why you believe that they’re important. They should be related to the hypothesis that you’re testing and the key things that you believe will determine your success.
After having that discussion, it will be up to the investor to determine whether they believe you’re focused on the right areas. If there’s some disagreement, have them explain how they’d view it. A majority of the time, you’ll find that the investors haven’t taken the time to consider the key considerations for each start-up that they talk to.
You should know what metrics are important for your business and be focused on them. You should be able to paint a picture of what the cost structure of the business will look like based on your acquisition pipeline. You should be able to communicate this clearly to potential investors.