There's a new debate about marketing efficiency recently, and it's an important one in the era of product-led growth. If a startup has great net dollar retention (NDR), should it be willing to increase its customer acquisition spend proportionately?
I remain a believer that months-to-repay is the best metric for measuring customer acquisition efficiency for a single reason. You know the answer immediately and accurately. With the annual contract you have in your hand and the amount of money you spent in sales and marketing to acquire a set number of customers in a period, you know exactly your MTR.
Metrics like LTV/CAC or NDR-corrected CAC require predicting the future. Can a company that's been around for 2 years accurately predict a 7 year customer lifetime? Can a startup with 2 annual cohorts predict NDR will remain at 140% for the foreseeable future?
At the scale of a public company, with years of operating experience and a proven ability to predict performance, these other metrics may pose less risk to a business. But in the early days of a startup, when single customers or individual marketing/sales campaigns can inject meaningful variance, there's much more risk.
The risk is burning more cash than you might like. If your startup has a huge balance sheet, then it's in a better position to take more risk and these metrics may suit you. You take more risk because if you assume a 160% NDR this year, and the cohorts regress to 140%, your MTR metric will suffer. In addition, you will burn more cash than you expected because you need more months to recoup your acquisition cost.
Setting aside the philosophy, let's look at the numbers.
We know from the free trial survey that the top quartile NDR metrics are 120%+ and the top decile are 140%+. This means a customer cohort acquired last year is worth 140% their collective ARR this year, including customer losses and expansions.
If your business has great account expansion, one could argue the company then consider the ACV to be 1.2x or 1.4x or 1.6x ACV. Then use that figure to determine whether the CAC is within an acceptable range. After all, buying more of these rapidly increasing annuities earlier means more ARR later.
Let's walk through a scenario. Assume a SaaS company with $20k ACV, 75% gross margin. The marketing team has set a months-to-repay threshold of 18 months, gross margin burdened. This means that the maximum CAC is $20k ACV x 75% gross margin x 18 months/12 months per year for $22.5k CAC maximum.
|NDR||Max CAC||Effective MTR|
The table above shows the maximum CAC if you were to use the end of year ACV corrected for NDR scaling from the $22.5k we calculated above to $36k at 160% NDR in the Max CAC column. The Effective MTR column is the number of months this new CAC would take to repay if the cohort doesn't grow and remains at 100% NDR.
CAC increases linearly with NDR. The Effective MTR grows from 18 months to 29 months, also a 60% increase, which could imply a 60% increase in sales and marketing expense if you decide to float your CAC based on NDR.
So, the math is easy. The key question to deciding whether to scale your CAC as a function of NDR is: how confident are you in your ability to sustain your planned NDR over the long term? And how much risk are you willing to assume given your balance sheet?