Given the perception that marketing is such a glamorous, sexy, shiny thing – as well as being evil and misleading of course – it is surprising how much of it has to do with numbers. CT, ROI, CRT, CPC, CPM and so on and so forth, there are dozens of acronyms to potentially track and pay attention to. An overwhelming prospect when you are just starting out or wadding your toes in marketing strategy for the first time. But knowing where to start the investigation is a fantastic start. Let’s look at the two most important metrics that are absolutely essential to measure the overall profitability and sustainability of your business and see the big picture.
CPA, cost per acquisition
Ignore this one at your own peril. Cost per acquisition is the price of buying yourself a customer, all the way from the first ad she sees, to her interaction with a salesperson in real life. The absolute simplest way of calculating this number is taking every expense you have in a month considering your marketing and dividing it by the number of customers you’ve actually sold something.
all your marketing costs last month
_______________________________________________ = CPA
the number of buying customers last month
This is, of course, the uber-simplified way of looking at CPA. It doesn’t take time into account and there is usually a significant period passing between someone first hearing about your product and actually buying. It also doesn’t calculate with repeat customers who are much cheaper to acquire, if happy. (we’ll get to that in a minute) And finally, the performance of different channels and seasonality can cause big changes.
However, I’d much rather you have a big picture understanding of the state of your business than giving up on the maths because it’s just too much information all at once. The key to getting better at something is taking small steps and practice and the first step to start thinking about strategy is to have a birds-eye view of the current state of affairs. If you calculate absolutely nothing else, understanding your CPA in itself can provide a guidance.
Why is this important?
Budgeting for marketing is a pain if you have no cornerstone to start with. CPA is that cornerstone. If you know how much it costs to bring in a customer, you are going to have a better idea about how much you need to invest in marketing spend in order to achieve the number of customers you need to make a good revenue.
This number is an extremely important indicator of the health of your business too. Is it lower than what they spend with you? Great, there is potential there. Do you spend so much that there is no actual profit left? Then you are provided with an opportunity to fix the system, find which channels are not performing, change the product or the business model.
There are three common fallacies when thinking about one’s CPA:
- Assuming that just because you don’t use traditional advertising methods, it is going to be zero.
- Ignoring hidden costs or forgetting to take built-in expenses, like your marketing manager’s salary, into account.
- Looking at only one channel (usually Google Adwords or the Facebook ad manager, because these platforms give you the exact numbers, provided they are hooked up properly with your website)
Once I had a consulting session with a tech startup founder, who claimed their CPA is zero. I started prodding and it slowly became clear that it would only be true if the cost per acquisition could only be money spent on straightforward advertising. Which is not true at all.
First of all, her community manager sat right there in the room with us: her salary has to be part of the consideration.She told me about their university ambassador program, explaining that the ambassadors – social media influencers attending the target schools – will get rewards, whether financial or in kind. Their strategy to achieve a very wide reach also consisted of incentivising fashion bloggers to use and promote the platform they were building. These bloggers would receive a fee if new people signed up via their links. (Which is, by the way, a fairly standard advertising method called affiliate marketing.) Do you see where I’m going with this?
It is possible that you are not spending a penny on Google Adwords or full pages in shiny magazines, but it doesn’t make your costs zero.
You have to be realistic and see that time spent on realising a project is a cost. So is any contemporary approach where you spend money in order to get in front of more people. Sure, you can choose to not call an ambassador program marketing or ignore that you are paying bloggers to spread the word. Will it help your business on the long run? Will it convince smart investors? Will you know how well your efforts are paying off? No an all counts.
It is very tempting to skip a serious analysis of how much you are spending in total, when handy advertising platforms feed you all the data you might need, but don’t fall for it. It is only one item on your list of things to consider, and they don’t exist in a vacuum either: someone who clicks on your ad and buys straight away might have met your brand several other times already.
CLV, Customer Lifetime Value
This one helps you make sense of the CPA and prepares you for long term planning. The customer lifetime value considers how often a person comes back and how much he spends in accumulative. Ideally, the product or service you offer is great and the person buying from you will come back the next time he needs them, slowly building towards brand loyalty. It is also always cheaper to convince an existing customer to come back and buy, about 10 times less than wooing a new prospect. This is why CPA is not enough to pay attention to: one customer will worths you much more than his first spend.
So how do we figure this out?
Ideally, you have records of sales and customers that will provide you with this number. In this case, it is a relatively simple task: the three pieces of information we need is a) how much a customer spends on your site on average (total spend divided by the number of customers, over a period of a year) b) how often people come back to buy again on average, over the same time period (total number of purchases divided by the number of individuals buying) and c) average retention time, how many years a customer is likely to stick around.
average spend X average number of repeat purchases X average retention time = CLV
This number gets even more informative if you can throw in the profit margin as well. Let’s look at an example, where the average spend of customers is £55, they buy 3,5 times a year and bound to be repeat customers for 5 years. The profit margin is 25%.
£55 X 3.5 X 5 X 0.25 = £240
This means the pure gain of bringing one customer to the fold is £240. Here is a handy little CLV calculator to feed your numbers into.
Why is this important?
If you know how much a customer will pay you, you know how much can you afford to spend on getting said customer and still make a profit. Ideally, you want to gain back the money spent on advertising within the first year. If you know that the average customer brings you £1,500 over 3 years, you should be spending a maximum of £500 to acquire one new buyer.
Normally 3:1 is a good CLV:CPA ratio, so you should not spend more than the third of how much money you will make over that customer.
If the ratio is closer, for example, 1:1 or 2:1, it’s probably killing your revenue and you are spending too much.
If it’s 5:1-4:1, unless you are a tech startup where this number would be ideal, you can probably invest more in your marketing and stop leaving business on the table.
If you don’t already have data, there are two things you need to do in order to be able to make projections or budget decisions:
- Build a system to keep track of customers, via a good customer relationship management system or your webshop’s analytics. If you have a brick and mortar business element too there are software to connect the data of purchases made online and offline but loyalty programs and memberships can be a huge help, especially when it comes to cash purchases.
- If you have no data and no system yet, look for benchmarks. There are typically industry reports to be found in every category which can be revealed with a simple Google search and you can always dig a little deeper in Quora threads, the resources of e-commerce systems. Of course, every business is different and you’ll have your own unique scenario, but knowing what to expect helps a lot when you are planning what to do and how much to budget.
Looking at numbers and doing match may not be your idea of an amazing time but these two are essential for your understanding of your business. Understanding your business and the current state of affairs in return is the basis to move forward: if you don’t know where you are departing from, there is no way to plan your route towards the results you envision.
Any questions? Hit me up in the comments section or send an email to firstname.lastname@example.org.
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