How much should I be spending on Sales & Marketing?
you can fwd this to your CEO/CFO to explain your acquisition spend 💙
Despite the hype around “startups spending $$$ on unprofitable growth,” I’ve actually found the opposite to be true 9/10 times. Post-PMF startups are almost always underspending on sales & marketing.
There are a few reasons for this.
Investors often heavily promote “organic, product-led growth” even if that’s not what is best for the business.
Attribution is almost universally underreported.
CAC/ROI/Payback Period metrics rarely look at marketing as building assets, and instead classify it as a disposable expense.
Disclaimer: Before I go any further - I should express I am a HUGE proponent of the positive effects of PLG, you can read one of my previous articles on generating negative CAC (an acquisition system where you make profit instead of generating burn).
In this article, however, we are going to take a first principles look at understanding “how much money you should be spending on sales & marketing.”
We’ll look at not just the industry standard benchmarks for CAC, ROI, & Payback Period, but the logic and reasoning behind them, and understanding when you should adjust them.
A 3 month payback period is “bad” 😞
There are a lot of things wrong with using a payback period as your primary metric for measuring your S&M spend.
It’s a solid health metric & can give deep insight into how much financing you might need to fuel your growth, but the primary thing you should be looking at is ROI. AKA - if we spend $1, do we get $2 back in our bank account?
The industry standard benchmark for your payback period is 12 months.
This means that if you spend $100,000 in January on S&M, you’ll have $100,000 of true real profit back in your bank account by the end of December.
An extremely common mistake is thinking that having a shorter payback period is a good thing, that a "3 month” payback period means you are killing it. Your mental model should instead look something like this.
Payback periods (and ROI) should be bid with an ideal target in mind, and anything under or over that target is “bad”. When the payback period is less than 12 months, one of two things are happening.
You’re leaving a lot of volume/money on the table that you could be capturing.
There isn’t more volume for you to capture.
VCs like to hear that you’re growing with wildly profitable unit economics, but that isn’t actually always what’s good for the business. A really great litmus test for startups is to ask yourself before spending each dollar, “will this increase or decrease my runway?”
If the cost of acquiring your next user is shorter than your current runway (ex: 2 year payback period, 3 years of runway), then paying for that user is going to extend your runway and bring you closer to “default alive.”
User retention drastically impacts payback period benchmarks
“What happens after the payback period” is, ironically, fundamentally the most important part of the payback period benchmark.
Let’s say you have a 6-month payback period but 0% user retention after that 6 months is up. You might capture your money back quickly, but then you don’t actually make any profit.
Alternatively, if you have a 24-month payback period but your user/revenue retention is 99% year-over-year, you’ll likely have a 5-10x return on your investment over a 5-10 year user lifetime.
Your retention metrics (primarily after the payback period) determine how short/longer your payback period can be from the “12-month” baseline.
Using the same 12-month benchmark then applying it equally to consumer products that churn 40% year-over-year and also B2B products that have 95% user retention with a 110% net revenue retention, just doesn’t make sense.
The consumer product will likely need a shorter payback period to optimize its ROI, and the B2B product can invest in a longer payback period because it can reasonably expect a long lifetime of returns.
Bidding on ROI vs Payback Period
The thing you ultimately care about is creating a demand generation machine where if you put in $1, you get more than $1 out - this means bidding for ROI.
Payback period is an important health metric, and especially important when your financing is limited (maybe you’re bootstrapping or only have < 6 months of runway), but ultimately your financial story should center around the ROI of your S&M efforts.
There are two key “grains of salt” to keep in mind when calculating ROI:
Confidence of the user’s lifetime value.
“Reasonable” length of time to calculate ROI.
Another major reason why the 12-month payback period is the gold standard benchmark is that startups operate in risky environments where the future is unknown.
If you’ve only been operating for 6 months, it’s hard to have an insane amount of confidence to start bidding on a 3-5 year lifetime value.
The longer you have been operating, the more confidence you gain to begin bidding on the “real” LTV of your users (and why it’s safer to increase your payback period).
An extremely useful tool when you are unsure about the LTV (or even when you ARE fairly confident), is confidence intervals. This is basically forecasting out expected ROI, and then modeling different outcomes in case you are wrong.
Basic confidence intervals allow you to create a base case that says, “if everything performs like it does today, here’s what the future will look like”, but then also to provide a financial model for what happens if you’re wrong.
The example model above says, “we should make $340,000” over a 5-year lifetime, but even if we’re off by 30%, then we should still make $238,000.
We could be spending $161,500 on this cohort for a ~2 year payback period off the base case and still be very profitable even if our expected behavior changes wildly over the user's lifetime.
Investing in marketing as its own asset class
The final piece that is often missed from most financial models, is factoring in marketing assets into the balance sheet.
What gets lumped into “sales and marketing” expenses can have wildly different lifetime of returns and worth.
For example, consider the following investments:
A sponsored podcast ad placement
$10,000 spent on Google Ads
Creating 100 articles
The time frame that these 4 different investments into marketing create returns is wildly different.
The podcast ad will have an initial spike and then a multi-year long-tail effect. The billboard will be generally high impact while it is “live”, with only brand recall as a longer-term ROI. $10,000 spent on Google Ads will have an almost immediate impact with very little if any brand recall value. With the 100 articles there will be extremely little short-term impact, but with potentially huge long-term returns.
The ROI of investing in marketing will look kind of like this, with shades of grey in between.
Spending dollars on things like Google Ads and billboard placements are primarily driving short-term returns.
Investing in articles, building email lists, and growing a social media following, are marketing assets with real monetary value that create decade-long returns.
Sometimes companies will split this out into a “brand marketing” budget - in my opinion, this is a really poor way of looking at it.
What’s important here is investing in building long-term marketing assets & not penalizing your short-term ROI goals. One of my favorite case studies is where Hubspot bought The Hustle for about $27M.
Slap together 1.5M newsletter subs, a strong blog, and a lot of social media followers … and you’ve built marketing assets worth millions of dollars (that should be properly reflected on your balance sheet & calculated into your S&M spend).
What feels “healthy” here can vary depending on the startup (lifecycle, how much you’ve raised, profitability, etc), but ~20% of your total S&M spent building long-term marketing assets usually feels healthy to me.
Optimizing your S&M spend
It’s always important to spend on S&M in a healthy way that’s going to create strong long-term gains, but failing to properly understand the ROI of your spend and the marketing assets you are building up along with way can lead to slower growth - and competitors gaining traction.
TLDR - Focus spend on ROI metrics over a reasonable & understandable lifetime, not any specific payback period (although 12 months is a solid health metric). The better your retention, the longer your payback period can become. Make sure to add in the marketing assets you build into your balance sheet & calculated into your ROI.
Want to keep reading?