Higher Growth And Lower CAC — Optimise Your Conversion Funnel! (Part 1)
How to accelerate growth? How to improve the growth rate? How to acquire more customers? How to get more traction? If you are a founder looking for answers to these questions, do not directly jump to analyzing options to increase the number of website visitors and prospects that can be converted into customers. Do not immediately consider spending more on marketing and sales or finding other ways to fill the top of the conversion funnel. You should rather ask yourself: How to analyze our conversion funnel? How to improve our conversion funnel? How to increase our conversion rate? Simple math can nicely explain why you should optimize your conversion funnel first.
Optimising the conversion funnel will not only lead to more customers, but also to lower customer acquisition costs, shorter payback periods, better CLV/CAC-ratios and ultimately higher growth. After you have optimised your conversion funnel, you may fuel your growth engine and fill the top of your conversion funnel.
This article uses a software-as-a-service business to illustrate the impact an optimized conversion funnel can have. But the insights can be applied and adapted to all businesses: B2B, B2C, platform, marketplace and SaaS businesses.
The first part of this article focuses on the simple math that demonstrates the significant positive impact an improved conversion funnel can have on your business: the number of new paying customers, customer acquisition costs (CAC), payback period, unit economics and ultimately growth. The second part deals with topics you may look at in order to get from this simple math to tangible business improvements.
IT’S ONLY SIMPLE MATH, BUT I LIKE IT, LIKE IT, YES, I DO
More Paying Customers
Let’s assume a software-as-a-service (SaaS) company spends $100,000 per month on marketing and sales and generates 10,000 monthly website visitors. Let’s further assume that 2% of these website visitors can be converted into 200 leads. Applying a conversion rate of 30% from lead to marketing qualified lead (MQL), from MQL to sales qualified lead (SQL) and from SQL to customer, the 200 leads can be converted into 5 new paying customers.
The conversion funnel in this original example — starting at the lead stage — looks as follows:
Here the math:
10,000 website visitors * 2% = 200 Leads
200 Leads * 30% = 60 Marketing Qualified Leads (MQL)
60 MQL * 30% = 18 Sales Qualified Leads (SQL)
18 SQL * 30% = 5 Customers
If the same company improved the conversion rate at each stage of the conversion funnel by 10% only (from 2% to 2.2% and from 30% to 33%) it could increase the number of new customers from 5 to 8.
The conversion funnel — starting at the lead stage — looks as follows:
Here the math (rounded figures):
10,000 website visitors * 2.2% = 220 Leads
220 Leads * 33% = 73 MQL
73 MQL * 33% = 24 SQL
24 SQL * 33% = 8 Customers
If the company found ways to improve the conversion rate at each stage of the conversion funnel by 20% (from 2% to 2.4% and from 30% to 36%) it could more than double the number of new customers from 5 to 11.
The conversion funnel — starting at the lead stage — looks as follows:
Here the math again (rounded figures):
10,000 website visitors * 2.40% = 240 Leads
240 Leads * 36% = 86 MQL
86 MQL * 36% = 31 SQL
31 SQL * 36% = 11 Customers
Yes, this is only math, but this math shows nicely how a company can increase the number of customers significantly by optimizing the conversion funnel only slightly.
Lower Customer Acquisition Costs (CAC)
At the same time, the optimized conversion funnel leads to significantly lower customer acquisition costs (CAC). $100,000 spent on marketing and sales will lead to CAC of $20,000 in the original example ($100,000 / 5 new paying customers), $12,500 in the example with a conversion rate improved by 10% ($100,000 / 8 new paying customers) and $9,091 in the example with a conversion rate improved by 20% ($100,000 / 11 new paying customers).
Since a better conversion rate leads to more paying customers, it also leads to more growth. Assuming an average monthly recurring revenue of $1,000 per paying customer, the new monthly recurring revenues amount to $5,000 in the original example (5 new customers * $1,000 new MRR), $8,000 in the example with a conversion rate improved by 10% (8 new customers * $1,000 new MRR) and $11,000 in the example with a conversion rate improved by 20% (11 new customers * $1,000 new MRR). Correspondingly, the new annual recurring revenues (MRR * 12) amount to $60,000, $96,000 and $132,000 respectively.
Shorter Payback Period
If a company improves its conversion funnel and spends less on acquiring a customer, the payback period gets shorter. In the original example, it takes 20 months to pay back the customer acquisition costs (CAC of $20,000 / $1,000 new MRR).* In the example in which the conversion rate is improved by 10%, the payback period is reduced to 12.5 months (CAC of $12,500 / $1,000 new MRR). In the example in which the company found ways to improve the conversion rate by 20%, the payback period is reduced to 9.1 only (CAC of $9,091 / $1,000 new MRR).
For the business, a reduced payback period means that the money invested to acquire a customer can be reinvested earlier again in order to acquire further customers. Shorter payback periods enable stronger growth!
Better Unit Economics
Assuming an average customer lifetime of 48 months and the same monthly recurring revenue of $1,000 per paying customer, the customer lifetime value is $48,000 ($1,000 new MRR * 48 months).*
In the original example, the CLV/CAC-ratio is 2.4 ($48,000 CLV / $20,000 CAC). In the example in which the conversion rate is improved by 10%, the CLV/CAC-ratio improves to 3.84 ($48,000 CLV / $12,500 CAC). In the example in which the company found ways to improve the conversion rate by 20%, the CLV/CAC-ratio is improved to 5.28 ($48,000 CLV / $9,091 CAC).
When analyzing SaaS businesses, investors look for CLV/CAC-ratios >3 (as a rule of thumb). Hence, without looking at additional options to fill the top of the funnel, founders can improve the unit economics and the attractiveness of their businesses by only optimizing the conversion funnel!
…Stay tuned for Part II: From Simple Math to Tangible Business Improvements
Now indeed, so far this has only been applied simple math. And whether or not a company can in fact improve the conversion rate and at which stage of the funnel is something that needs to be analyzed on a case-by-case basis. However, stay tuned for Part II in which I explain how to get from simple math to tangible business improvements.
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*For simplicity reasons, the calculations in this article disregard the gross margin (or contribution margin) that needs to be applied to the new MRR figure in order to get to the real monthly contribution per customer. At SaaS businesses, CLV should be calculated as follows: Average monthly revenue per account (ARPA) * Gross Margin (GM) / monthly churn rate. Payback period is calculated as follows: CAC / the monthly contribution per client (ARPA*GM).