Q: If we are going to invest effort in ‘moving the needle’ with respect to just one of our core SaaS metrics, where will we get the most bang for our buck?
A: Please read on. The short answer is: CAC, followed by churn.
All other things being equal, if a genie granted you one wish, and that wish had to be which core SaaS metric you would wish to improve, by 10% in the right direction, then which would make the most sense?
First, a caveat: depending on their absolute values, it is clearly not equal effort to reduce your churn by 10%, versus decreasing your CAC by 10%. First, because reducing 10% churn to 9% seems far more reasonable than reducing churn from 3% to 2.7%, and second, because the various knobs that you must turn to achieve these two outcomes are fundamentally different. In the CAC domain, you’ll consider things like content marketing and inbound traffic, conversation optimization and buyer journey. In the churn domain, it’s all about engagement, retention, and upsell – all post-sales functions, mostly in the domain of customer success.
With that said, let’s dive in with an example. Let’s imagine MidChurn is a company with 10% churn and a $100 average CAC (across all channels). You are considering a new content marketing initiative, which you project will decrease your blended average CAC to $90. On the other hand, for about the same effort and expense, you are considering a new Customer Success initiative which you believe will help reduce churn by 1% (this could equally be an extra sprint of new features customers are dying for, that you’re confident will lower churn). Both of these initiatives result in a 10% improvement in the underlying metric, and we’ve setup the example such that both are of equal effort and expense. So, which should you invest in, and how should you measure the results?
Calculating The LTV:CAC Ratio
First, about measurement: regardless of which is more effective, the appropriate metric to measure is the LTV:CAC ratio. Particularly if you calculate LTV as the fully-burdened, fully-discounted figure that reflects the true economic value of a customer, then the LTV:CAC ratio represents the present value of investing one more incremental dollar in customer acquisition; assuming you have the capital to invest, and so long as this ratio is meaningfully greater than one, then you should be investing as heavily as you possibly can! (If you’re interested in learning more about how to calculate fully-burdened LTV, please click here). Now, let’s do some math: plugging the above figures into our LTV calculator and assuming an annual contract contribution of $300 and a 20% discount rate, we get an LTV:CAC ratio of 12.6:1. Reducing the churn to 9% yields an LTV:CAC ratio of 13.0:1 and reducing the CAC to $90 yields an LTV:CAC ratio of 14.0:1.
This is an interesting result. Again, assuming that the efforts are equal in cost, reducing CAC appears to be at least 7% more effective than reducing churn by 10%, in this example. Let’s exaggerate churn to 50% to see if that makes any difference. Same $300 contribution, $100 CAC and 20% cost of capital, and our LTV:CAC ratio is now 4.6:1. Reducing churn 10% to 45% yields a LTV:CAC of 5.0:1, and reducing CAC from $100 to $90 yields an LTV:CAC of 5.1:1. Even when cranking up churn to SMB customer segment levels, the value of reducing CAC still trumps the equivalent % reduction in churn! In fact, increasing churn to a whopping 80% yields a 3.1 LTV:CAC ratio; a 10% decrease in churn yields 3.4:1, and a 10% decrease in CAC yields the same 3.4:1.
The SaaS Rule Of 10%
With this, we give you the ‘SaaS rule of 10%: a 10% decrease in CAC is always more valuable than a 10% decrease in churn’; this applies for all but the very, very highest churning SaaS business.
So, next time you’re contemplating a fancy new customer retention initiative consider this: if you have a super effective content marketing plan or a landing page optimization strategy that will drive a ton of inbound traffic and increase conversions, it’s likely the better investment of otherwise limited resources.
How Does The Rule Of 10% Affect Your Metrics?
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