The number of customers your company closes and the revenue they bring doesn’t paint the whole picture of your company’s revenue health.
While new customers do generate revenue for your company, acquiring them isn’t free. Failing to retain customers long enough can actually result in your company losing money.
What is Payback Period?
In its simplest terms, payback period is the amount of time it takes to recoup the cost of acquiring a new customer. Knowing how long your payback period is tells you how long you need to retain a customer in order to be a profitable company.
How to Calculate Payback Period
To calculate your payback period, you first need to know your customer acquisition cost (CAC).
The cost of acquiring a customer includes your marketing costs, such as paid advertising, trade shows, marketing software and human capital, and sales costs, like your sales tech stack and human capital.
After you determine how much you spend on acquisition during a given period, divide it by how many customers you acquired during that period to find your average CAC.
The time period you calculate this for will depend on the length of your sales cycle.
To calculate your payback period, you’ll divide your average customer acquisition cost by your average MRR minus the average cost of servicing a customer, such as time and support and service tech.
That’ll give you your payback period in months.
When you’re calculating your payback period, be as granular as you can. If your budget is split up by acquisition channel or you have teams with their own budget that only work with specific buyer personas, then you should try to track payback period by those segments.
In addition to taking into account the differences in cost on the acquisition side, if you have multiple products that have different prices and service costs, you might also want to determine your payback period by product line since the length can vary.
How to Reduce Payback Period
To reduce your payback period and become profitable faster, you can decrease your CAC or increase the amount each customer is spending.
To increase the amount each customer is spending, you can create playbooks to encourage customers to purchase upgrades or add-ons.
If customers are approaching usage limits for your product, such as number of seats, amount of information stored or number of hours, these playbooks can focus on marketing the benefits of switching to a higher tier. You can also give customers free trials of features they don’t currently have so they can see the value and want to purchase them.
To reduce your acquisition costs, reallocate your budget from poor-performing areas to high-performing areas and change how you approach those poor-performing areas to increase output.
If a freemium model makes sense for your product, it can reduce your acquisition costs and increase customer spend. Freemium models are designed to encourage users to upgrade themselves. While the cost of servicing can be higher for freemium, it might still be less than the costs of marketing and sales and lead to more upgrades.
In order for a business to be profitable, they need to understand what their payback period is and then retain customers longer than that.
If the length of time you’re retaining customers isn’t enough to generate the profits you’d like, you can work to reduce payback period by increasing your expansion revenue or decreasing your CAC.