CAC vs. ROAS: How to Define, Choose, and Optimize to the Right Metric

Understanding CAC: The foundation for growth

There is a lot of confusion about which metrics marketing teams “should” be optimizing to and how to calculate them. 

Customer acquisition cost (CAC) or return on ad spend (ROAS)? At what step in a conversion funnel is the conversion or return registered? What should be included in the cost or ad spend numerator?

This becomes more complicated when different internal teams have different answers to these questions. This article will help marketers drive clarity and alignment, which will build internal trust, avoid misunderstandings, and ultimately enable media optimization.

Breaking down cost, value, and return

To set the stage, let’s first talk about cost, value, and return.

• Cost consists of the expenses required to produce the value. Media spend is typically the largest cost. 
• The value is the benefit the company receives as a result of the cost. Revenue is the most typical value. 
• Return represents the spread between cost and value. Great return comes from high value resulting from little cost.

Key insight #1: You need a matrix, not a number. 

Different teams, different priorities

Different stakeholders will focus on different stages of the funnel and will have varying interest in cost vs. value vs. return. As the stewards of what’s often one of the largest budget line items in a company (i.e., advertising), marketing leadership should be equipped to provide any intersection of metric and funnel stage.

Building a funnel-based CAC matrix

Let’s say the funnel stages are as follows: 

Step 1: Site visitor

Step 2: Free account

Step 3: Paid account

Let’s assume “cost” is simply ad dollars and “value” is the revenue collected over the first three months of their paid account. 

A growth team would calculate:

• Cost per site visitor
• 3-month revenue per site visitor
• Cost per free account
• 3-month revenue per free account
• Cost per paid account
• 3-month revenue per paid account

These should all be regularly calculated and reported to any interested parties.

Key insight #2: Align on cost and value definitions

What costs should be included in CAC?

Most companies only include media costs in their reporting of CAC and/or ROAS. After all, ROAS is the Return On Ad Spend. However, this is not a unanimous perspective.

• Some companies will also include their agency costs, but not associated FTE costs. 
• Some companies will include their creative costs, or perhaps only if the creative was created specifically for advertising (vs. repurposed).
• Some companies who drive a high percentage of their overall growth through paid ads will count all marketing costs. And yes, sometimes such costs are included in ROAS calculations, despite not being ad spend. 

What’s the right answer? I don’t know. That’s true partially because the right answer depends on the company, stage, industry, etc. It’s also partially true because there’s not a “right” answer. 

What’s important is that there is broad agreement on specific definitions with an understanding of the pros and cons. For example, sometimes we see companies that agree on a financially conservative position to include extensive fixed costs along with ad spend, but then the resulting ROAS figures don’t support growth, leading to the perception of failure.

For this reason, I typically advise companies to only include media dollars.

Revenue vs. profit-based CAC metrics

Typically the definition of value is revenue. However, sometimes companies should calculate CAC or ROAS based on contribution margin or another profitability metric. It makes sense to consider this when the profitability metric is significantly different between products or services sold. Otherwise, a revenue value metric could look quite positive while the profit value metric, which is typically more important than revenue, is actually negative. 

The other consideration when defining a value is payback duration. Are we talking about first order revenue? First month? First year? Lifetime? This is also very company- and industry-specific. 

• For CPG companies with little repeat purchase, a value metric is often limited to the value of a single purchase.
• For a SaaS product with an average lifetime value of 5+ years, ROAS figures often incorporate years of expected value, sometimes even “lifetime value.”

Key insight #3: Align on payback windows

Once you align on cost and value, it’s important to align on what combinations of cost and value are acceptable to the business. This is typically referred to as a “payback window.” 

If it costs $50 to get a customer whose value is $150, how much of that are you willing to spend to acquire them? Or said differently, how quickly must the value they provide to the company cover the cost to acquire them?

Industry benchmarks for payback windows

• Ecommerce products: the payback window is often 1-2 purchases
• SaaS: the payback window is typically 3 to 12 months

What influences payback windows?

Payback windows are influenced by a variety of factors, including: 

• LTV trajectory. When LTVs are quickly increasing, payback windows tend to be longer. 
• Company funding. When companies have plenty of cash, payback windows tend to be longer. 
• Cost definition. When the definition of cost is inclusive of many costs, payback windows tend to be longer. 
• Competitive landscape. When it’s a land grab with fierce competition in a winner-take-all market, payback windows tend to be longer. 

Key insight #4: Always report the funnel stage with the metric

Preventing miscommunication in reporting

Reporting cost, value, and return is complicated and lends itself to confusion and miscommunication. As a result, I recommend always denoting the definition and funnel stage with each metric. 

🚫 Instead of: “CAC is $50” 

✅ Say: “Cost per paid account is $50.”

Though it won’t be practical in every setting, I would also recommend including definitions in footnotes. For example: “Cost includes ad dollars only.” Another example: a footnote for “ROAS is 3” could be something like, “This ROAS figure compares average contribution margin and average cost of acquired customers, including ad dollars only.”

And please don’t call a figure a “lifetime” value if it’s not actually a predicted lifetime value. Instead call it what it actually is (e.g. 3 year value). 

Such definitions are particularly important when reporting to CEOs and Boards of Directors. Failing to do so can result in misunderstandings that lead to embarrassment for company leaders as well as bad business decisions.

Want a sounding board? Reach out! Defining and optimizing CAC is both an art and a science. If you’re looking for guidance on setting CAC targets tailored to your business, feel free to reach out! We’d love to chat.

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