Case 051SaaS metrics and diagnosticsWarm up

Rekhavik Design wins customers through free sign-ups; a sales-led rival wins them through a field team. Compare the CAC and payback of the two models.

The situation

Rekhavik Design sells a browser-based design tool with a free tier. It gets 2 lakh sign-ups a month and spends Rs 40 of marketing per sign-up, mostly on search ads and free templates. 3% of sign-ups convert to a paid plan at Rs 800 a month.

A sales-led rival sells a similar tool to large companies through a field team. It spends Rs 1.8 lakh in salaries, travel and demos to win one account, which then pays Rs 25,000 a month. Both run at an 80% gross margin.

Your task

What are the customer acquisition cost and the payback period for each model, and what does that comparison leave out?

Quick check

Which model earns back its acquisition spend faster?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

Rekhavik's CAC is about Rs 1,333 and pays back in about 2.1 months; the rival's CAC is Rs 1.8 lakh and pays back in 9 months. Rekhavik spends Rs 80 lakh a month to win 6,000 payers, each earning Rs 640.0 of gross profit a month against Rs 20,000 for the rival's account. Payback measures speed; whether each customer is worth winning depends on churn, which the question does not give.

Step 1How do you get CAC when the spend is counted per sign-up?

Think of a sweet shop handing out free samples. Each sample costs Rs 5 and one taster in twenty buys a box, so each buyer costs Rs 100, not Rs 5. CAC is spend divided by paying customers, so a cheap sign-up becomes an expensive customer once you divide by the conversion rate. Rekhavik spends 2 lakh times Rs 40, Rs 80 lakh a month. 3% of 2 lakh is 6,000 payers, so CAC is Rs 80 lakh over 6,000, about Rs 1,333. The shortcut is the same: Rs 40 divided by 0.03.

Same four lines, two funnels: what a customer costs against what it earnsRekhavik Design, product ledMarketing spend a monthRs 80 lakhSign-ups, then 3% convert2,00,000 to 6,000CAC = spend / payersRs 1,333Gross profit a month (80%)Rs 640Payback in months (bar runs 0 to 12)0612CAC back in 2.1 months of gross profitSales-led rivalField cost to winRs 1.8 lakhAccounts won1CAC = cost / accountsRs 1,80,000Gross profit a month (80%)Rs 20,000Payback in months (bar runs 0 to 12)0612CAC back in 9.0 months of gross profit
Rekhavik spends Rs 80 lakh a month to turn 2 lakh sign-ups into 6,000 payers, a CAC of Rs 1,333 that Rs 640.0 of monthly gross profit repays in 2.1 months, while the sales-led rival spends Rs 1.8 lakh per account and needs 9.0 months at Rs 20,000 a month.
Step 2Why divide by gross profit rather than revenue?

The Rs 800 a customer pays is not all available: a fifth goes on hosting, support and payment costs. Payback is CAC divided by the gross profit a customer earns each month, because only gross profit can repay the acquisition spend. Rekhavik earns Rs 640.0 a month, so Rs 1,333 comes back in 2.1 months. The rival earns Rs 20,000, so Rs 1.8 lakh takes 9 months. On revenue the answers would be 1.7 and 7.2 months, flattering both by a fifth.

The relationship
Payback (months)=CACprice×gross margin=1,333800×0.8≈2.1\text{Payback (months)} = \frac{\text{CAC}}{\text{price} \times \text{gross margin}} = \frac{1{,}333}{800 \times 0.8} \approx 2.1
CACmarketing or sales spend divided by customers won
pricemonthly subscription, Rs 800 for Rekhavik
gross marginshare of revenue left after the cost of serving the customer, 80%
What it says in wordsPayback is how many months of gross profit it takes to earn back what the customer cost to win.
Share of CAC recovered from gross profit, month by month50%100%150%CAC fully recovered036912Months since the customer was wonRekhavik: 2.1 monthsSales-led rival: 9.0 months
Rekhavik recovers about 48% of its acquisition cost every month and passes full recovery at 2.1 months, while the sales-led rival recovers 11.1% a month and needs 9 months, so Rekhavik can recycle the same marketing rupee about four times as often.
Step 3What does payback leave out?

Payback says how fast the money returns, not how much a customer is worth over its life. Small self-serve customers leave more often. Suppose Rekhavik loses 4% of payers a month and the rival 1%; these are assumptions to test, not facts in the case. Lifetime gross profit is roughly monthly gross profit divided by monthly churn, so the slower model can still be as good per rupee. Rekhavik's customer is worth about Rs 16,000 against Rs 1,333 of CAC, 12.0 times. The rival's is worth Rs 20,00,000 against Rs 1.8 lakh, 11.1 times.

Per customerRekhavik, product ledSales-led rival
CAC, Rs1,3331,80,000
Gross profit a month, Rs64020,000
Payback, months2.19.0
Assumed monthly churn4%1%
Lifetime gross profit, Rs16,00020,00,000
Lifetime gross profit / CAC12.0x11.1x
On assumed churn of 4% and 1% a month, both models return about eleven to twelve times their acquisition cost over a customer's life; Rekhavik's edge is that its money comes back in 2.1 months rather than 9.
Step 4What would you tell a partner about each model?

Rekhavik's funnel is efficient and forgiving. If conversion fell from 3% to 2%, CAC would rise to Rs 2,000 and payback to 3.1 months, still fast. The real diligence questions are cohort churn and whether paying teams add seats, because a Rs 800 plan has little room to grow. The rival's model is slower but each account can expand. Many product-led companies end up adding sales on top: if Rekhavik spent Rs 30,000 to convert a large free team into a Rs 6,000 a month contract, payback would be 6.25 months, a sensible use of a salesperson because the product already sold itself to the users.

Where candidates lose it

The common slip is taking Rs 40, the cost per sign-up, as the CAC and announcing a payback of a few days. The conversion rate is the step people skip, and it multiplies the answer by more than thirty.

The second is declaring the product-led model better on payback alone. A 2.1 month payback with heavy churn can be worth less than a 9 month payback on a customer who stays for years; say what churn you would need to see.

What the interviewer asks next

  • Conversion falls from 3% to 2% and monthly churn rises to 6%. Is the funnel still worth running?
  • Why can a blended CAC across the free funnel and the sales team hide a problem?
  • What would you ask to see in a cohort chart for Rekhavik?

Company names and figures are illustrative.