A range of metrics can impact your marketing strategy and how you run your business (and we have done a few blog posts on this topic), but few metrics are underestimated and underutilized as much as cost per acquisition.
Cost per acquisition (CPA) is how much your business spends, on average, to acquire a customer. When you define this metric, you can use it to optimize multiple facets of your business. If you run your business without knowing your CPA, you might be missing significant revenue and growth opportunities.
Before we get there, let’s talk about how to calculate CPA.
Assigning Dollar Values to the Customer Journey
The simplest way to calculate what it costs to acquire a customer is to add up what you spent on marketing and divide that by how many new customers you acquired in that same month. Having this number is better than nothing, but it’s too broad for you to really fine tune the engine. In other words, you can figure out how many miles you got per gallon, but you don’t know which route was the fastest or what parts of the engine were performing the best.
To do that, we need to map the customer journey and track what it costs the business to move the prospect from stage to stage. Here’s an example:
- Google Pay Per Click Ad: Cost per click of $1.00 (100 clicks total)
- Lead Capture Form: On website, basically free (10 leads captured)
- Lead Nurturing Emails: $10.00 per month fee (1 customer converts)
That’s a really basic marketing funnel. Your business probably has more variables than that involved in any customer acquisition—like retargeting ads, a sales person, a follow-up mailer, and so forth—but this gets the point across. Essentially, this data tells us that for every 100 clicks we get one customer. So…
100 x $1.00 + $10 = Cost per acquisition of $110.00.
(Note: Technically that $10 for email management would get lowered with each new customer you get, but let’s keep it simple for now)
The big takeaway with this formula is that your misses count in this calculation. You will have to filter through non-revenue-generating opportunities to get to a paying customer, and those non-opportunities cost money.
Okay, great, you have this number, but what does it mean? What is good? What is bad? How can you use it to improve your marketing? As we’ve said before, in isolation, CPA is not very powerful. The context that surrounds it is important. For some businesses, a $110.00 CPA would be ludicrous while other businesses would gladly sacrifice an intern ancient Greek style to have that kind of CPA metric.
I know that this might make you wince, but it depends.
Following CPA to Actionable Insights
The fundamental goal of CPA is to have it be less than the profit you make on a sale. If you spend $110.00 and get $200.00 in profit back, well, if that magical ATM was in your office right now you would never leave it alone, right? I think I stole that comparison from Seth Godin, by the way, so check out his Start-Up School series podcast thing on EarWolf.
As “basic” as the comparison between CPA and profit potential may be, many businesses often have a CPA that is higher than the profit on a sale in at least one channel. Without realizing it, one marketing channel might be losing them money while another channel carries the business. Perhaps their pay-per-click campaign is poorly optimized but the word of mouth they generate from social media content is killing it.
Beyond that basic point, CPA becomes a lot of fun to play with. Here are some paths to consider:
1. Given the total lifetime value of a customer, what are you willing to pay for acquisition? Typically, you don’t want to spend more for acquisition than you get back in profit, but the exception to that is if you know what the average customer will spend with you over say 3 to 5 years. This gives you the competitive advantage of being able to bet on the long-term win while your competitors fit for the scraps of the short term.
Returning to our $110.00 CPA example, let’s say that the profit on a single sale is $100.00. In the short term, you have a loss of $10.00 on a customer. But then you look at your customer data and see that once you get a customer, they are likely to purchase from you a second time 3 months from now. In the short-term, you are comparing your $110.00 CPA to $100.00 in profit, but in the longer-term the comparison is actually $110.00 to $200.00. Maybe over 2 years the comparison is $110.00 to $500.00.
That’s a big difference, and knowing those figures could allow you to strategically outspend your competition to capture customers and work harder to retain them.
2. Given your CPA, does what you charge for your product or service make sense? The reality of your industry may be that you are undercharging for your product or service. This doesn’t sound like a marketing problem at first, but this is a discussion that is hard to silo into any one part of your business. If you do not have the profit margins to support marketing activity, your business will always struggle to grow. If you can’t possibly raise your prices (you probably can) and still get customers, well, that’s a pretty big problem for the long-term viability of your current business plan.
An important point to add here—and it’s not new as far as business wisdom goes—is that shrinking your customer base but charging them more actually means greater profit per customer. It costs money to deliver products or services to a customer, and charging a smaller audience more is actually much more efficient than having a higher volume of customers that generate you less profit per head. If you want to do the math on that, send us an email and we’ll make a future blog post about it. Until then, trust me on this one.
3. What can you do to lower your CPA? With your total lifetime value and profit margins set, you can start to increase your profit per conversion by getting better at acquiring customers. That sounds obvious—I mean, of course, you want to spend less per customer—but the math you did to calculate CPA gives you a roadmap for what you could change. If you haven’t done CPA math before, you might discover that one stage of your acquisition process is unusually expensive or perhaps one stage leaks more prospects than any other.
Traditionally, advertising is the most expensive stage because casting a wide net in a competitive market is pay-to-play, but you might find that your landing page is not converting or perhaps your prospects are getting bogged down when they hit the sales team. Working systematically to optimize each part of the journey means an exponential increase in profit on the backend. If you drop your cost per conversion by even a $1.00, that can mean a significant jump in profit played out over a year of conversions.
Challenge the Business with Marketing
At its best, your marketing strategy should help you learn more about your business and your target customers. A metric like CPA—or any marketing metric really—is not just about finding the most profitable way to get new customers. When it’s used effectively, it will actually challenge you to be critical of every facet of your business, not just the marketing. The win you are looking for might not be in an obvious place, and the diagnostic process we outlined here can help you to locate it.
To recap, once you calculate your CPA, do the following:
- Assess the total life time value of a customer to see if you can make a bigger bet on the long-term profit potential of a conversion (and perhaps you put more effort into retention to make this even more profitable)
- Evaluate what you charge for a product and what it costs to produce and deliver it (you might need to raise your prices or be more creative about how you source and execute a product)
- Work stage by stage to make your acquisition process more efficient (any seemingly small improvement will have a powerful long-term tail)
I hope that helps. We talk with businesses every month who do not know their CPA and have never evaluated how it affects their profits. If that’s you, change that today to make smarter marketing and business decisions tomorrow.
Photo by Richard Jones. Used with permission under Creative Commons License.