The key to measuring the success of marketing campaigns is understanding exactly how much you can afford to spend on marketing to acquire a new customer. In my experience, most small and medium-sized businesses (aka SMB) don’t know how to answer this question. Below, you will find some simple examples and formulas that will help you calculate the answer for your company.
Acceptable Cost of Acquiring a One-Time Customer
Let’s suppose that you sell something large and that it is unlikely you will get repeat business from that customer. For instance, suppose you sell and install in-ground pools, but not pool supplies. First, you need to identify the amount of your average sale. For the sake of this example, let’s assume you charge on average $30,000 per pool installation. Next, you calculate the average profit from the sale, after paying all costs associated with delivering that pool including variable selling costs. If your cost of goods sold is 60%, you will have 40% left, and that works out to $12,000. The equation you used to calculate how much you have left over for overhead, profit, and marketing follows:
Average Sale x (1 – Cost of Goods Sold %)
$30,000 x (1-.6) = $12,000
Would you pay all of that $12,000 to sell another pool? Probably not, because you want some money left over for overhead and profit. A good way to approach the final part of this calculation is to think about how much you would pay in exchange for another $30,000 pool sale with $12,000 left after paying for costs. That number depends on how much profit you want and what your other costs are, but personally I would be happy to pay $4,000 all day long to have $12,000 in gross margin, so let’s use that number.
Cost of Acquiring a Repeat Customer
If you are Starbucks, the value of their customers are far more than what they pay for their first Frappuccino. In fact, Starbucks knows that the average lifetime value of a customer is over $14,000! Knowing this number helps Starbucks determine how much it can afford to spend to acquire and retain customers.
Let’s use a simple example to show how to calculate the lifetime value of a customer who can be counted on to give you repeat business. For example, suppose you own are a hair salon and that you know, on average, your clients visit every 6 weeks and they pay $100 every time they visit. You also know the average customer keeps coming for 2.5 years and your profit margin before overhead is 40%. You aren’t booked up all the time, so you can easily service more customers. Your average lifetime value for this customer is:
Number of visits x payment per visit x profit margin:
2.5 years x ((52/6) visits per year) X $100 paid per visit x .4 profit margin = $866.67
This calculation doesn’t take into consideration price increases, potential referrals from this client, inflation, or many other factors, but this is a good first pass. In fact, it’s conservative as the lifetime value will most likely be higher since there’s a strong possibility you will get referrals from a salon client or benefit from up sells. What should be clear is you should be willing to pay more than the cost of the first visit to acquire customers like this one.
Measuring the Success of Marketing Campaigns
Ultimately, the success of marketing campaigns is measured by one simple metric: the cost of the sale. If it’s less than the amount you can afford to acquire a new customer, it’s successful. If it’s more than the lifetime value of a customer, it’s probably a failure. If it’s somewhere in between, you will need to sharpen your pencil and think about it.
Measuring the Cost of Client Acquisition
To measure how much it cost to acquire your customer, add up how much you spent on a particular marketing campaign and divide it by the number of customers you acquired.*
Suppose you own the pool company in the example above and you spent $1500 on Facebook Ads and another $500 to have someone set it up and manage it, for a total of $2000. Let’s assume you tracked one sale from this campaign and that you were comfortable with spending $4000 to acquire a new pool customer. This would be a successful campaign. What if you spent $4500? You’d have to sharpen your pencil, but with a $12,000 margin, that would be successful too. Clearly, if you couldn’t track any sales, you should reconsider if Facebook Ads are for you.
$2500 Cost of Client Acquisition is Less Than $4000 Acceptable Cost of Client Acquisition, which Equals a Successful Marketing Campaign!
Why Measuring the Cost of Client Acquisition Gets Tricky
Suppose you utilize email marketing as well as Facebook Ads, and you also have prospects who are referred by customers who contact you from your website. Although you can set up Google Analytics to show you which advertising campaigns generated contact form submissions or phone calls, it won’t tell you how individual leads found you. Whether you are trying to sell $30,000 pools or find your next salon client, it’s important to know the marketing campaign that generated each of your leads that converted to accurately calculate the cost per sale. This is hard to do manually. That’s why we created the Jess, which is a marketing analytics software platform that automatically identifies how your clients find you and calculates the cost per lead and cost per sale.
Other Marketing Metrics
Although measuring the cost of client acquisition and comparing this to how much you can afford to pay to acquire a customer are the only numbers you need to know if your marketing is truly working, other metrics can be useful as you are building out and testing new marketing campaigns or if you are spending marketing dollars to support branding rather than lead generation. We’ll dive into them with our next blog.
Need help calculating what you can afford to spend on marketing? Reach out and we will help you calculate the average lifetime value of your customers so you can figure out how to measure the success of your marketing campaigns.
*Since a prospect can become a client after seeing you across multiple advertising campaigns, you might have to blend these costs, but multitouch attribution is for another day!
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