How do Facebook, Dropbox, and HubSpot calculate customer acquisition costs?

Among all the factors that affect a company's valuation, the two most commonly used indicators are CAC (Customer acquisition cost) and CPA (Cost per acquisition) . Miscalculating CAC and CPA can lead you astray.

In this post, I’ll lay out what real CAC is in an easy-to-understand way and dive into some common mistakes that can lead teams astray.

CAC ≠ CPA

Before we begin, let's first define it. It’s easy to confuse CAC and CPA, but they are actually completely different metrics. To understand CAC, you must first understand the difference between the two.

CAC specifically refers to the cost of acquiring a customer . In contrast, CPA refers to the cost of acquiring traffic that does not necessarily become a customer - such as a registered user, an active user, a trial user, or a user who is simply directed. However, these two indicators are interrelated. This is because some indicators that require CPA to calculate costs often directly affect CAC.

The following three examples demonstrate the differences and relevance between CAC and CPA.

1. Dropbox

Dropbox is a freemium tool product. Its CAC refers to the cost of acquiring a customer who pays for their PRO or enterprise services . Its CPA refers to the cost per (free) user registration, the cost per active (free) user, and some other important but non-paying indicators, but these indicators are all tracking the transformation of some traffic from mere product visitors to actual users of the product.

Dropbox CAC

Dropbox CPA

2. HubSpot

HubSpot is a B2B SaaS product, so the cost of acquiring a customer using the Basic, Professional, or Enterprise plans is CAC . CPA is used for indicators that affect CAC, such as the cost per lead user, the cost per potential user, the cost per trial user, or other conversion points in the sales funnel.

HubSpot CAC

HubSpot CPA

3. Facebook

B2C companies with advertising-based business models may be a little different. In the case of Facebook, the paying customers are actually advertisers, so CAC refers to the cost of acquiring a new advertiser . If you only look at the user level, then users and customers are actually the same. For Facebook, CPA is used to calculate the cost per registered user, cost per active user, and so on.

Facebook CAC & CPA

Understanding the essence of CAC is actually very simple. The first key point is to define who the customers are in your business model.

This definition should be simple and clear enough, and the definitions of CAC and CPA should be consistent to avoid misunderstandings in work communications.

The CAC formula, and why it’s wrong

If you search “how to calculate CAC” you’ll find this basic formula:

CAC = (Total marketing expenses + Total sales expenses) / Number of new customers acquired

It seems to be fine, but this formula ignores a lot of details and the definition of each variable is also vague. As a result, even the simplest calculations can be off. For example, according to this formula you might calculate the following results:

But what if I told you this:

• It takes an average of 60 days for each customer to go from a prospect to a customer;
• Not all customers are new customers, some are former lost customers;
• For products with a freemium model, these costs are actually spent on turning free users into paying users (customers), rather than acquiring these free users.

These three additional information will make us re-examine the accuracy of the above formula. Before using the formula, we need to evaluate these prerequisites.

How to Calculate CAC Accurately

To calculate CAC more accurately, we need to clarify three issues first. All three of these questions will help us define the variables in our formula precisely.

Question 1: How long does it take from your marketing touchpoints to acquiring new customers?

The first problem is that the formula doesn’t take into account the time it takes between your marketing spend and acquiring a new customer . Here are two examples:

Example 1: Freemium Product

Let’s take Dropbox as an example. Once you register, you become their free user. If you've tried Dropbox for free for a while and have used up all your free storage, you might want to upgrade. For most users this period of time may be several months (or more than a year for some users). This example also applies to other freemium products, such as Evernote, Buffer , etc.

Case 2: Inside Sales SaaS Company

The models of many internal sales SaaS products indicate that it takes less than a month to turn a person into a trial user (depending on the marketing efforts that month), but it takes more than 60 days to turn him into an actual paying user because they need to experience the conversion process of the entire sales funnel in the trial version.

If you don’t account for the time these processes take, you could overestimate or underestimate your CAC, leading to serious decision bias. Below is an example of overestimating CAC. In the table below, CAC = total monthly marketing cost / number of new customers acquired in the same month.

In March, we tried some new delivery channels , which resulted in a significant increase in marketing costs. Through simple calculation, our CAC is 148 yuan . If our target CAC is 125 yuan, then we will conclude that the March campaign strategy failed and we need to abandon these new channels.

But what if it takes us 2 months to convert one person into a paying customer? The following chart is based on 2 months, using the same data:

The results of this algorithm are completely different. Our CAC was 84 yuan in March and 111 yuan in April. Not only should we not stop these new channels that we tried in March, but we should increase our investment and expand the scale of the channels.

The time it takes to acquire a customer doesn’t matter if you meet any of the following scenarios:

1. The time required to acquire a customer is very short. Many B2C companies have very short decision chains in their user funnels, such as Snapchat and Instagram.
2. The marketing budget is relatively fixed and will not change much over time. However, even so, it is best to calculate the costs accurately.

If you need to calculate how long it will take you to acquire a customer, the easiest way to do it is to calculate your average marketing cycle . In other words, how long does it take on average from your first marketing touchpoint to conversion into a new customer?

For example. Suppose we are a SaaS company, the average time to convert a customer is 60 days, and the sales expenses spent in these two months are evenly distributed.

Then the CAC calculation formula is as follows:

CAC = (marketing expenses two months ago + 1/2*sales expenses last month + 1/2*sales expenses this month) / number of new customers this month

Question 2: What is included in your marketing expenses?

To calculate CAC more accurately, you need to answer what exactly is included in your marketing expenses . Before we understand the answer to this question with examples, let’s look at some common mistakes:

Mistake 1: Not including labor costs

You need to factor in the salary costs of all your marketing and sales staff. Many CACs don’t include this part, however we need to include not only those who devote 100% of their energy to marketing, but also those who spend part of their time on marketing (usually department managers or partner departments). CAC that includes labor costs is usually called Fully Loaded CAC . In some cases, distinguishing between fully loaded CAC and normal CAC can be of great help to a company.

Mistake #2: Failing to include fixed expenses

Similar to mistake 1, you need to also take into account the fixed expenses incurred by these employees (such as equipment costs, rental costs, etc.).

Mistake 3: Not including tool costs

Many teams use more than 10 marketing tools at the same time (whether it is a paid software system or a service fee to maintain marketing equipment) to support their work . These tools will also increase expenses and need to be included in the cost when calculating CAC.

If you include all of these factors, calculating CAC starts to get a little complicated and can vary a lot from company to company. Here are some examples:

Spotify and the Freemium Business Model: How to Calculate Product/Development/Support Departments?

Spotify is a free business with millions of users using their product for free, and users help them continue to acquire new users by sharing. In most companies, product, development, and support departments are not included in CAC (they are usually included in the R&D budget). But if the free product is your primary way to acquire customers, then the costs of supporting the free product should be included in your CAC. There are many different opinions on this issue, but we support including this part of the cost.

If you have R&D engineers, product managers , or other people working on marketing goals, then you should include their salaries and expenses in your CAC. These people may not be on the marketing team, but they still incur expenses to support customer acquisition efforts.

HubSpot and the SaaS Model: How to Calculate a Customer Support Team?

Most SaaS companies like HubSpot have fairly large customer support teams . The definition of a customer support team varies greatly from company to company. Some customer support teams simply serve existing customers, while others need to assist in acquiring new customers, and some customer support teams are dedicated to recalling lapsed customers.

This raises the question, should the cost of a customer support team be included in CAC? Obviously, the teams responsible for acquiring new customers should be included in CAC.

Dollar Shave Club and e-commerce models: How to calculate free shipping strategy?

Dollar Shave Club is an e-commerce company. What they are most famous for is that you can try it for one month for only 1 dollar. The 1-month trial strategy requires a large marketing budget, including the cost of the product itself, logistics costs, support costs during the trial period, and some other costs. Should these expenses be included in CAC? The answer depends on how you define a new customer.

In the case of Dollar Shave Club, we can define that someone who spends $1 on the trial is not yet a customer. A new customer should be someone who has gone beyond the trial stage. Then all these costs to support the 1 dollar trial should be calculated in the CAC.

Are all newly acquired customers really new customers? not necessarily.

When calculating CAC, we need to distinguish between new customers and returning customers . Many companies distinguish between the marketing strategies used to acquire new customers and the marketing strategies used to recall old customers. When calculating CAC, the numerator only includes the marketing costs of acquiring new customers, while the number in the denominator is the sum of new customers and recalled old customers. This will make your CAC look like it's low. The following two solutions can help you solve this calculation deviation:

1. The numerator also includes all marketing costs, including the portion used to recall old customers;
2. Distinguish between the cost of acquiring new customers and the cost of recalling old customers. The denominator also distinguishes between new customers and recalled old customers.

Summarize

As can be seen from the cases introduced today, CAC includes many factors, and its calculation formula is not a simple, universal panacea that is applicable everywhere.

Instead, an accurate customer acquisition cost depends on how long it took you to acquire a customer , the number of true new customers (not recalled customers), and the total human and financial expenditures to support acquiring the new customer .

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