Understanding Revenue Cost Ratios

In the first two parts of the financial foundations series I wrote about Customer Lifetime Value (LTV), its importance to your company, and the critical role customer success plays in driving this metric. What we haven’t discussed yet is the costs associated with these post-sales revenue streams, namely the cost of retention and expansion.

Revenue Ratios: When it comes to pre-sales metrics like the customer acquisition cost (CAC) a CEO can immediately give you their number… something like “it costs us $16,500 to acquire a new customer”.  This number is calculated by taking your sales and marketing costs and dividing them by the number of new customers acquired.  Although typically calculated, when you think about it, this metric doesn’t provide a lot of insight.  After all, it’s one thing to invest $16,500 in acquiring a new customer when your average contract value (ACV) is $25,000, but the implications are totally different when your ACV is $5,000. This is where revenue ratios come into play.  If you ask a VC about acquisition costs, they are likely to talk in terms of cost ratios, or how much you spend for each dollar of new revenue.  As for what a good CAC ratio is, most VCs will tell you that your target should be 1, meaning you should spend a dollar in sales and marketing for each dollar of revenue from new customers. It’s important to note that when people talk about revenue cost ratios, they usually talk about them as dollars.  From a mathematical perspective, this may not be accurate, but from a practical perspective, it is easier for people to grasp the concept.  As an example, when you say that your CRC ratio as $0.12 it means that you’re spending 12 cents on retention for each dollar of Annual Recurring Revenue[1] (ARR).

Post-Sales Revenue Ratios: Although CAC metrics are tracked, and target numbers are commonly defined, the same isn’t true for post-sales revenue retention (CRC), revenue expansion (CEC) and upselling costs (CUC).  Investors won’t typically state what a good target ratio is for post-sales revenues, and CEOs often have a tough time telling you what their numbers are.  In most instances, this is because these metrics aren’t tracked or even calculated.  This is a real problem and it’s something that needs to change.  As for determining the appropriate ratios for your company, one approach is to look at benchmarks like the ones presented in the graph below that provide insight into what others spend.

Bottom Line: The amount invested in the retention and expansion of customer revenues has an enormous impact on your post-sales strategy and tactics.  In most instances, the focus for customer success organizations will shift over time. Because of this, the amount invested in post-sales, the skill set required, and the implications to organizational responsibilities will change as well.

A Final Note:  Recently “blended rates” have become all the rage.  Basically, the way you come up with a blended rate is by taking your CAC and CEC and combining them to come up with a single metric, your “blended” CAC.  The problem with this is that it makes it challenging to understand your true revenue acquisition costs, which in turn makes it harder to understand where your resources should be focused, ultimately making it more difficult for everyone to contribute to your company’s success.  As a result, to add the most value to your company, both your CRC and CEC ratios need to be defined and measured.  This is something that customer success executives need to own because of their responsibility in increasing LTV.  Why? Because what is at stake here is ultimately the future of any recurring revenue company.

[1] The actual budgeted amount for customer retention is a function of dollars of recurring revenue under contract.