More specifically, SaaS companies can be better off selling to customers with poor LTV/CAC economics. On its face, this surely appears a strange claim. I hope to demonstrate here some conditions under which it’s true.
Average costs and marginal costs frequently differ, particularly where fixed costs are a material consideration (as in SaaS companies)
Historical CAC is an average cost, not a marginal cost; it’s therefore a dangerous input to forward-looking operational decisions
Suppose there’s some enterprise software company, Saasco. In July, Saasco acquires 10 customers; each of these identically commits to pay $1,000 per year so long as the company uses Saasco’s product. We can see that Saasco’s July cohort starts with $10,000 of ARR. For simplicity, let’s suppose Saasco has 100% gross margins — there are no maintenance costs.
Without understanding the amount of time during which Saasco retains its customers, it’s ambiguous whether our cohort here is profitable. If each of these customers churns after their first year, then Saasco has only collected an aggregate of $10,000 from the cohort. If each customer stays for exactly two years, Saasco collects $20,000 from the cohort.