How to (actually) calculate CAC

Brian Belfour on Andrew Chen's blog talking correct calculations for one key SaaS metric: CAC.

SaaS is full of acronyms. And they can be confusing to keep track of if you’re new to the game.

But even once you remember what each one means, calculating them can feel like hitting a moving target.

After all, not everyone’s an analyst right?

Here’s Brian Belfour over on Andrew Chen’s blog:

In everything from growth projections to company valuations, it’s common to use CAC and CPA interchangeably — but it’s wrong, and it can cost you.

Improperly calculated CAC can kill your company

When it comes to investing in growth, most calculations will at some point factor in CAC.

So it’s important to have an idea of that, right?

And even if you’re only using organic channels or are somehow magically acquiring users from thin air, if you’re paying yourself or you’re spending any money in running your company, then you’ve got a cost.

If you’re calculating the CAC incorrectly, it will knock all of your figures and forecasts off the chart.

And you know, at some point, the chart hits 0.

That’s never good.

How do you calculate CAC?

Brian offers two main points that most people can improve their calculation on:

  1. Ensuring that you’re not confusing CAC and CPA
  2. Making sure that you’ve correctly factored in how people buy and how that relates to your spending

Ensure you’re not confusing CAC and CPA

The first point is the easier to grasp:

CAC specifically measures the cost to acquire a customer. Conversely, CPA (Cost Per Acquisition) measures the cost to acquire something that is not a customer — for example, a registration, activated user, trial, or a lead. The two are related because CPA is usually used to measure the cost of things that are leading indicators to CAC.

I’ve read so many articles about calculating these metrics that miss this pretty obvious distinction.

If I spend $1,000 on ads in order to win 10 free signups, then I can work out my CPA as follows:

Total spent ($1,000) / Number of free signups (10) = CPA ($100)

I can take that and say: if I want to get 100,000 users, assuming everything’s linear (spoiler: it isn’t in reality), then it’s going to cost me $10,000,000 – which is actually really not a great amount to spend, in case you hadn’t worked it out already.

Why?

Because those are free trial users!

And we want businesses that survive, not ones that kill VC bank accounts.

Not everyone will convert to paid.

On the other hand we can work out how much it costs at a top-level (spoiler: this isn’t the final number you need), to acquire a user (CAC):

CPA ($100) * Conversion to paid rate (100/10) = CAC ($1000)

Or more simply:

Total spent acquiring customers ($1000) / Number of new customers (1) = CAC ($1000)

So just ask yourself: what are you actually paying for?

Making sure that you’ve correctly factored in how people buy and how that relates to your spending

The second, and ultimately significantly more difficult, error people make with CAC is that they’re not factoring in the actual costs in acquiring customer, how those customers actually buy and how things change over time.

In this error, Brian highlights several smaller mistakes people make:

  • Mistake #1: Not Including Salaries
  • Mistake #2: Not Including Overhead
  • Mistake #3: Not Including Money Spent On Tools

The details of this are so complex but so important (and you can see each one worked out with real spreadsheet examples in Brian’s post).

The point here is that CAC matters

Ultimately, the success of your growth work should be tied to the contribution you make towards a company’s goals.

If you’re a founder running growth, you’ll feel this pain particularly acutely.

It is tough to see your growth work seemingly paying off (with the classic numbers going up) while the burn rate stays the same, but the bank account is going down.

And if that’s your case, then you can probably assume that something is not right in your CAC calculation – it’s not hard to fix, but it is complicated.

Here's another link to the original thing. Check it out.
Updated 
October 30, 2020

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