In an earlier discussion, I dove into the fundamentals of Customer Acquisition Cost (CAC), a key measure of startup vitality, particularly when contrasted with Lifetime Value (LTV) and CAC recovery time. Yet, I've noticed a common oversight in many startups' financial models regarding these calculations.
Sometimes it's due to complexity; other times, the outcomes aren't as attractive. Commonly, startups project sales and marketing based on straightforward revenue growth forecasts. The more nuanced ones compare future sales and marketing expenses to industry benchmarks, ensuring their spending aligns with revenue growth and stays within reasonable limits.
Here's an insightful case: A startup's financial plan meticulously outlined its sales and marketing expenditures over time, correlating these costs with revenue and benchmarking against industry norms. This thorough analysis gave the CEO a sense of security. However, there's a subtle nuance often missed: simply linking Sales and marketing growth to basic parameters like user growth or customer numbers is insufficient. It's like comparing apples to oranges. It's more than just saying the Sales and Marketing portion of total revenues decreased from 30% to 22%, as seen in Exhibit 1.
To deeply understand CAC in CEO presentations, it's imperative to deconstruct Sales and marketing into components aligned with time. Exhibit 2 illustrates the flawed approach of treating sales and marketing as one homogenous block. In contrast, Exhibit 3 shows the division of these expenses by type, each marked with a unique 'Lego brick' color.
For instance, divide total quarterly S&M costs into sales salaries, commissions, lead conversion, promotions, and brand awareness.
In Exhibit 4 , we further split each component into a business-oriented parameter. This breakdown is vital:
- Sales salaries have multiple stages: recruitment, training, and the path from lead to deal. See the extended purple Lego block in Exhibit 4, indicating that this phase often begins well before deal negotiation. For instance, if training a new sales rep takes 1.5 months and the lead-to-deal process takes 4.5 months, the six months of salary should be included in CAC calculations, even if the technical calculation period is just a quarter.
- Commissions are generally paid after a deal closure, sometimes much later. As they are directly linked to the deal, they must be included in CAC, as shown by the blue block in Exhibit 4.
- Lead conversion, indicated by the green block, concludes once a customer is onboarded. Assigning pre-deal conversion costs to specific deals, though complex, is essential.
- Sales promotions and brand awareness, broader marketing activities shown by the red and yellow blocks, require unique calculation methods.
By dissecting Sales and Marketing expenses into distinct components with different timelines, as illustrated, you can accurately determine the True CAC. This leads to an 'apple-to-apple' comparison, yielding far more insightful data.
Adopting this approach has significantly enhanced the clarity of the market strategy and unit economics for one of my CEO clients. It's not merely about possessing a sophisticated financial model; it's about deeply understanding and effectively communicating your startup's economic landscape in a straightforward, comprehensible manner.
