Understanding the CAC: Expansion ARR ratio for your SaaS
Episode 47
Hello friends, welcome to Episode 47 of Good Buy. Today’s theme is:
A short 250-word essay on the CAC: Expansion ARR ratio and one example of how to use it.
Let’s dive in..
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Friends,
A useful metric to measure the impact of your SaaS user acquisition & churn (and to a large degree PMF) is your CAC : Expansion ratio.
It is calculated by: (Sales & marketing expense / new & expansion ARR) over 12 months time
This formula gives you what proportion of your sales & marketing (CAC) budget actually drove expansion ARR.
Expansion ARR is important because it gives you data on which cohort of users upgraded to a higher tier - which is a great signal of PMF.
Based on this data, you could find patterns in user behavior that you can leverage to convert more users to upgrade into the higher tier - boosting revenue, reducing churn, and increasing LTV.
You could then invest in sales & marketing experiments based on this data.
For example, lets say you run an analytics SaaS and you have a usage-based pricing. Tier 1 has Feature F1 limited to 1000 tokens and Tier 2 has 2000 tokens.
Upon surveying your users, you find that folks who upgraded to Tier 2 from Tier 1 used feature F1 45% of the time and fall under Persona P1. You also find that this is the most commonly used feature post-upgrading.
Now you run an email marketing campaign targeting P1 personas subscribed to Tier 1 and send them a case study of how Feature F1 helped users achieve value (based on customer surveys & data).
Post which, you incentivize your Tier 1 users to upsell to Tier 2. Make sure to remove unnecessary friction in the user journey (eg: sign on, fast customer support, free trial etc)
Now you measure the cost of this marketing experiment and how much new & additional ARR this experiment produced using the formula above.
It’s 2-3x more cost-effective to grow $1 of ARR from existing customers than gaining $1 from new customers.
And you can iterate & optimize based on your findings.
A good benchmark is: $0.69 of CAC investment to generate $1 of expansion ARR.
A pretty simple yet powerful concept - definitely one to think about
That’s all for today. Hope you found this post useful. More tomorrow!
Cheers,
Shaunak
Download this essay to read on the go if that’s your jam
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