Why SaaS Companies Underspend on Demand Generation

May 1, 2020

Low confidence in marketing attribution and ROI often causes SaaS companies to cut investments on demand generation. By tracking your CAC and the value of each stage of your marketing funnel, you can allocate your budget to drive real growth.

No such thing as a free customer


Five to ten years ago, marketers were seen as a necessary cost center rather than a source of growth and revenue . Today things are different. Now more than ever, marketers are just as responsible for revenue as the sales team. With the advent of tactics like remarketing, and uploading custom audiences to target people at specific stages, we can effectively carry out full-cycle marketing. Marketers now have the strategy, knowledge, and responsibility to close the loop with demand generation.


It’s impossible to scale without figuring out paid acquisition -- your reps wouldn’t have enough pipeline to meet their quota and grow your bottom line. We’ve all heard it before, “I’m getting free customers through my network, why would I spend money on demand generation?” While it is true that early companies get most of their initial customers for “free” from their network and board members, this is not a scalable way to grow your business. The key to growing your startup with ABM (account-based marketing) and demand generation is figuring out paid acquisition.


Finding your Customer Acquisition Cost


Before establishing a demand generation budget, you first have to understand your customer acquisition cost (CAC). CAC is calculated using this formula:


                                                                                         CAC = total cost of Sales+Marketing / # of deals closed


How many dollars are you spending to acquire a new customer? Believe it or not, the median spend for $1 in new customer annual contract value (ACV) is $1.13! While that may sound like a bad business, SaaS companies follow a different set of rules.! Some companies spend even more than that amount because their focus is the customer’s LTV (lifetime value). A customer’s LTV is the average revenue they will generate throughout their lifespan as your customer. 

CAC calculation
Source: ForEntrepreneurs.com


Something to consider is that the average payback period in SaaS is 12 months. The first year after acquiring the customer you are still recovering your acquisition cost, but that new customer becomes profitable after the first renewal. For example, if your customer’s ACV is $150k, and their average LTV is 3 years, that means they will bring you $450k over the course of 3 years -- making it worth it to spend a little more to acquire them at the beginning. Who wouldn’t spend $1 to get $3 in exchange?


Why companies underspend in Demand Generation


  1. Low confidence in ROI and marketing attribution
  2. Lack of visibility (metrics, results)
  3. Focused on short-term goals
  4. No scalable systems or processes in place
  5. Committed budget to hire more sales resources (where reps source their own opportunities)
  6. Still trying to “hack” free customers
  7. Nobody owns the demand gen budget and attribution


Understanding the value of your funnel

For each channel that you’re running, i.e. LinkedIn, Display ads, etc, you should know your cost per lead (CPL), cost per opportunity, and return on investment (ROI). Once you know these metrics, you’ll be able to see which channels perform the best, as well as how much you would need to invest to hit your goals. 


To understand the value of your funnel you need to work backwards. Let’s say a new customer brings in about $50k/yr annual recurring revenue (ARR). You know that your team closes about ⅕ of your Opportunities (20%), meaning each Opportunity would be worth $10k. Now let’s say 1 in every 4 meetings turn into Opportunities, that means you should be willing to spend at least $2,500 per meeting to match the ARR value. Finally let’s say 10% of your leads turn into meetings, we’ve now come to the conclusion that you should be comfortable spending $250/lead (that’s your CAC break-even point)..

Calculating your budget


Now that you’ve done this calculation, you can go back to your revenue goal and calculate what your budget would need to be to get there. If your revenue goal is $2 Million, and your average deal size is $50k, you would need to close 40 new customers to meet this revenue goal. As a note, the end-to-end average conversion rate is usually less than 1%, so you need to focus on your conversion rates between stages.

Suppose your win rate is 20%, this means you’d need 200 opportunities to meet this $2 million revenue goal. If you convert 25% of your sales meetings into opportunities, you would need 800 total meetings to get to your goal. If we take the cost per meeting we calculated previously of $2,500, multiplied by 800 meetings, we can see that we would need a budget of up to $2 million to reach your revenue goal of $2 million in ARR. Obviously it’s possible to operate more efficiently and significantly lower the cost per opportunity. However, you should always be concerned when there is a substantial gap between the budget allocated and the ARR goal. If you are trying to close $2M ARR by investing only $100K, the chances of hitting your goal are little to none (even if you are the new Slack).

calculate paid acquisition budget


As we mentioned previously, it takes about 12 months to see ROI in SaaS. While you should be willing to allocate that level of budget to acquire the customer, it is with the intention that you will retain them for more than one year. As we mentioned previously it takes about 12 months to see ROI in SaaS, so you have to perform these calculations to understand your funnel’s big picture. If you’re targeting different segments (such as Enterprise, Mid-Market, etc), make sure you understand your conversion rates by segment, as those may vary.

How to allocate your budget


Once you’ve established your total budget, you must decide how to allocate between your different channels. All channels are important -- to figure out how to divide your budget you will need to align with your sales team and understand each channel’s ROI. Get key players in the same room to decide on KPIs and agree on expectations. After establishing goals with Sales, you can make tradeoffs on how much to invest in each channel/area of the business, and the core tactics that align with each channel. 

Dividing the budget between marketing and sales depends on your go-to-market (GTM) strategy. Are you building a foundation, finding market fit, and building awareness? Or focusing on repeatable business, scaling programs, and moving upstream? The way you invest will be different depending on what stage your organization is at, and which GTM strategy you are following. Before you divide your budget, work with your team to understand your company’s stage, the overall short and long-term objectives, and how to balance these things as you’re planning. Finally, allocate the per channel budget accordingly between your target account tiers, (Tier 1, Tier 2, and Tier 3). Tier 1 are your top premium accounts-- if 50% of your revenue comes from Tier 1 accounts, they should receive 50% of your budget.


GTM strategy

Fast Growth Vs. CAC Efficiency


Your budget should accurately reflect your company’s current goal and appetite for risk. Your balance sheet, sales process maturity and stage of growth will strongly affect the level of investment that you are willing to allocate to demand generation. 

If you are a Series B or Series C startup, or you have just closed a significant round of funding, you are in full growth mode. You are probably being pressured by the board to increase the number of logos as fast as possible. CAC becomes a secondary thought: it’s OK to spend a little higher amount to bring in new customers, since you are trying to acquire market share and to get referrals. You can always optimize CAC at a later stage, when you have more data on what channels are generating ROI, and you are closing deals from organic leads as well (due to the increased visibility of your brand).

On the other hand, if you are bootstrapped or seed-funded, you must play more carefully. Even if you are certain that you can get positive ROI from a demand generation investment, your company’s cash flow situation doesn’t allow for too many long-term investments, especially if your sales cycle is 6 months or more. The recommendation is to take a more conservative approach, starting with smaller bets and gradually increasing the investment as you start seeing the deals closing.

fast growth cac efficiency


Both strategies have their pros and cons. The only mistake to avoid is to try to sit in the middle: trying to achieve fast growth while maintaining CAC efficiency from day 1 (this never works out). 


Measuring success


To accurately measure success in demand generation, you will need to track all relevant metrics in your CRM. Most B2B companies use forms as a lead capture mechanism on their websites. When a form is built, you can embed hidden fields called UTMs (Urchin Tracking Modules), which help you capture additional information when someone fills out and submits the form. On a form, you’re likely already tracking things like name, company, and email address, but you also want to know where the person came from. You can use these hidden fields, or UTMs, to learn this information, (like content, medium, or source). This way you can run reports through the CRM to track leads and opportunities per campaign via their UTMs. You’ll want to show the value of your campaigns in the context of your business goals. How many opportunities? How much pipeline was generated? How many of them close?


Optimizing your campaigns


While some channels may produce more leads at lower costs, results change as you move down the funnel. If you take a look below at the MQLs that turned into actual paying customers, those who came from LinkedIn not only converted at a better rate, but the ultimate impact to revenue was $32,000 vs. $4,000 from the Facebook leads. This example is just illustrative, the channel that will yield the best results for you depends on your strategy, business, and industry.  In the scenario below, if you had optimized for Facebook, you would have missed out on the significant revenue that came from LinkedIn. To summarize - not all leads and marketing channels are created equal.


Conclusion


There are no “free leads” or “free customers”. The key to growing your business with ABM and demand generation is figuring out paid acquisition. Get a clear view of your funnel metrics and decide how much you are willing to invest for each acquired customer, (aggressive growth or low CAC?). Diligently track campaign metrics and distribute budget accordingly. Now, you have the data to ask for more budget with proof of ROI!


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