Investor Tip: Customer Acquisition Cost is Key

A conversation with an investor this week brought out that Customer Acquisition Cost is a key to his investment decision-making process. It occurred to me that many new entrepreneurs may not consider how important such a metric is for their venture, whether or not they are seeking investment. Customer Acquisition Cost is not just a measure to determine the average cost to acquire a customer; it is also used to determine the overall health of the business, the marketing budget, and the effectiveness of marketing and sales programs. For an investor, it will demonstrate the short- and long-term viability of the venture.

Let’s examine Customer Acquisition Cost in a little more detail.

CUSTOMER ACQUISITION COST

Calculating the customer acquisition cost (CAC) is not difficult. Start by totaling all of the marketing and sales costs for a period, and then divide those costs by the number of new customers acquired for the same period. Easy enough, right? Except that many entrepreneur’s—myself included—may miss costs in the calculation and do not get an accurate number against which to measure the customer acquired.

For a more detailed analysis of CAC, I think about spend and acquisition by channel. For example, in the chart below, I list the number of channels and further categorize them in measurable and non-measurable buckets. Measurable channels are those from which a customer’s purchase is trackable to the marketing or sales campaign, either through a link, a promo code, a special call-in number, or a sales order tied directly to a salesperson.

 

Non-measurable channels are channels which do not provide for an easily trackable source for a specific sale but are likely to contribute in some way to sales in general and should be calculated as part of the overall CAC. Brand campaigns might fall into this category, as would most promotional activities such as an entrepreneur’s speaking engagements, and networking events, to name a few. By adding the costs together and then dividing by the number of customers acquired for the period we arrive at an Average Customer Acquisition Cost.

One of the advantages to tracking spend and acquisition by a channel is the ability to determine which channel is most effective in generating customers. If, as in the example above, Inbound CAC is lower than PPC CAC, one might look more closely at the PPC campaigns to determine how and where improvements may need to be made if it appears those costs are out of line with expectations. But, how to do we determine what is reasonable? We need to calculate the lifetime value of a customer.

CUSTOMER LIFETIME VALUE

The Customer Lifetime Value (CLV) helps us determine the value of a customer over time. This helps us determine how much we can spend to acquire a new customer, and how much we could spend to retain that customer. The CLV estimate considers several key things: The average order value, the average number of purchases, and the average customer lifespan. The customer retention rate, average margin per customer, and a “discount rate” which adjusts the future profits from the campaign for the uncertainty of performance vs. investing instead in other business operations.

In the chart below, we estimate that a customer will have three purchases per year with an average order size of $35. We anticipate that the average customer lifespan is three years and we will have a 75% customer retention rate.  Based on the particular product we have an average of 70% profit margin per customer. The discount rate in the example chart below is set to 10%; however, the longer future customer revenue is expected, the higher the discount should be to factor the greater possibility of inaccuracy.

We use three different LTV calculations in the chart above: A simple LTV which calculates the sales over the customer’s lifespan, a more customized LTV based on the average gross margin on sales over the customers lifetime, and the more traditional LTV calculation which incorporates the discount rate. Then we average the three methods to arrive at an Average Customer LTV. Using the data in the above chart, the Average customer has a value of $316 over his or her lifespan.

Now that we know our Customer Acquisition Cost and Customer Lifetime Value, we can determine whether our cost of acquiring a customer is reasonable given our assumptions, or if we’re using actual numbers, whether we may be over-spending or under-spending to gain a customer.

CUSTOMER ACQUISITION SUMMARY

Our CAC calculations indicate the average cost of acquiring a customer is $100.00. Our CLV calculations suggest that the average customer spends $105 per year. For most business types, an entrepreneur would want to limit the cost to acquire a new customer to approximately 30% of what an average customer spends in a year. Considering that the customer spends $105 per year, the target expenditure to acquire a new customer should approximate $35.00 as shown in the chart below.

The numbers used in this scenario suggest overspending on customer acquisition by about 186% more than necessary.

As a result of the overspending, the average customer is unprofitable the first year and reduces the overall profitability during his or her lifespan assuming the customer is retained as shown in the next chart. If the customer is not retained, the loss would be much greater.

In the scenario outlined here, the cost of acquisition is much too high and the possibility to recoup the investment over time is suspect. These factors would likely be a red flag for an investor.

RECAP

Remember, Customer Acquisition Cost and Customer Lifetime Value will vary from venture to venture and industry to industry. Benchmarks are difficult to find, but using models such as these, a baseline can be established from which to work forward. As with all financial analysis, each entrepreneur should develop his or her own CAC and CLV models so that the specifics of the business are incorporated.  To assist, I have attached the spreadsheet model to download and explore below.

Understanding the Customer Acquisition Cost is critical to business operations. Every entrepreneur should know what it costs to acquire a new customer and how those costs flow through the business in particular to the impact on marketing budgets, the effectiveness of marketing and sales expenditures, and overall business profitability. Spending too little for customer acquisition will result in missed opportunities, but spending too much will decrease profitability.  Keeping track of Customer Acquisition Costs is a good first step in ensuring profitability, and it will likely play a role in a prospective investor’s decision-making process.

 

 

A few notes on this model:

  • This model is an example and is for use as is. It is not supported in any way. It is not intended to be a tool to use without customization based on the specifics of an entrepreneurial venture.
  • This model is only an example to give the reader an idea of how such a tool can be developed. It is not based on a real business. I compiled this model for a graduate class, but I have developed similar models for entrepreneurial ventures. Each business venture is different, and so is the CAC and CLV that are prepared for that venture.
  • Most CAC and CLV calculations are done annually using actual numbers. This model can be used in that way. It can also be used for estimating and creating variations in the start-up phase of a venture. In the later situation, “what if” scenarios might be deployed to determine the outcome of different of customer acquisition costs or levels of lifetime value.
  • This model is set up for annualized numbers; however, one could create a similar model with monthly numbers to track improvements over time.
  • All of the “Bold Blue” text areas can be changed to demonstrate how the interactivity might work. No other data can be changed.
  • Formulas can be seen in each of the cells (mouse over it), but only the values in the “Bold Blue” text area can be changed.
  • By downloading you acknowledge this is for personal use only. It is not to be sold or distributed in any way.

 

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Featured Image Source: Getty Images/Martin Dimitrov

David Harkins is a business strategist, speaker, and teacher.

He is the founder and executive consultant at David Harkins Company. In his spare time, he writes hikes, explores, and creates art. Although, not necessarily in that order.

Connect with him on social media below:

Can long copy still make the cash register ring?

Long copy ruled direct response marketing, once. Marketers could create a brilliant story-driven copy to draw a reader in and then close the sale with a strong call to action.  David Ogilvy (in the photo above) and his team at Ogilvy and Mather were the masters. But that was more than thirty years ago.

Twenty years ago, I had a great deal of success with long copy in printed direct mail. Just simple letters to the target market that would bring them along in a story and then get them to take action. I am not sure that’s possible any longer. I believe the proliferation of email spam and the dawn of mobile phones have decreased the effectiveness of long-form direct response appeals.

A recent grad school assignment asked for the creation of a two-step direct response campaign. In such a campaign, the first step generates the lead and the second step closes the sale. In the direct mail days, a long letter—often several pages—was more effective as that first step—it told the story and offered the benefits to the prospect. The close came with a phone call or a response card. It was highly effective, and of the campaigns, I was involved in we often pulled a 5-6% response with a 50% conversion to a sale.

The assignment further asked for the creation of a “squeeze page.” A squeeze page is a page on that “squeeze that last bit of info out of you” so that you might get what you’re looking for from the site.  Typically, it is your name and an email address.

In the early days of the Internet, that long-form direct mail piece was often used in a two-step process. You may remember that time. The pages were often a single page with a lot of copy, a few photos, some bulleted text, and multiple opportunities to buy or subscribe as you read down the page. If you took action, you would go to another page—the “squeeze page”—to provide your name and email address for more information or so the sale could be completed.

For the assignment, I wanted to know if long-form still worked in a two-step process for a particular target market (women 25-to-60) for a health and wellness opportunity. My hunch was that given the volume and frequency of content and information we already get it would no longer be effective. Let’s see what happened.

Step 1 – The solicitation.

I wrote a long-form direct mail piece below (click the image to read the entire letter). Granted, I know my long-form direct marketing skills are rusty, but I think it reads well and tells a decent story. I purposefully chose not insert photos or bullet points because it would have impacted how a perceived target would see the offer. In other words, I wanted readers to commit to reading it would have done in a direct mail piece back in the day.

My intent was that this solicitation would be delivered by email, or possibly by mail, to the target market.

Step 2 – The squeeze page.

I created a small squeeze page (see below) to encourage sign up for the offer, a 1-month free trial to a recipe/meal planning service delivered via email. No credit card number was required to participate, and all I asked for was the first name and an email address. As far as offers go, it was pretty low risk.

Step 3 – Testing with the target market.

I posted the letter and the image of the squeeze page to my Facebook page, as well as shared with some friends directly asking for input. Eight of my female friends in the target market responded on Facebook or in private messages.

The Feedback.

Overwhelmingly the response to the long solicitation was negative. Aside from some suggesting bullet points or images to break up the copy, the response was that it was too long. Although my friends read the letter at my request, all but two said they would not read it if it came in an email, and probably would not read it if it arrived by mail. And because they wouldn’t read it, they wouldn’t get to the call to action at the bottom of copy.

The squeeze page faired a little better, assuming I could get them there in the first place. Some didn’t like the color choices or food choices I made. Those things turned them off and likely would have affected their interest in subscribing.

A few said they might subscribe if just presented with the signup graphic via email or on a page.

My takeaways.

Clearly, this was not scientific. There were too many variables and too few responders.  Still, I think it supports the idea that long-form copy has a lot of competition these days and not too many people will read it. There’s just not enough time for most people.

I do recognize that the readership might improve with bullet points, graphics, and probably even stronger copy, as one of my friends—an accomplished copywriter pointed out.  Those things could have helped it. There is the possibility that those who were reading were not the true target market – I did not ask more clarifying questions to drill down. That’s possible, too I suppose, although I think it really has more to do with the time-length equation. And the goal of direct marketing is to fill the funnel with a higher number of leads.

Although the squeeze page might work as is, I think I would pull images of food. I struggled with this before putting testing because I did not want to turn people off if they didn’t like grilled peaches (which look sort of like sweet potatoes in the photo). The challenge is determining what kind of image to use so as not to alienate a prospective customer based on their individual likes or dislikes. That will need additional research and testing.

Final thoughts.

The squeeze page might work better in the form of a pop-up on a web page. Personally, I hate them, but they work well. I use them on an e-commerce website for newsletter sign ups (with a discount incentive) and have about a 3% conversion rate, which is about the average conversion rate for top performing e-commerce websites. Those customers over time have a solid sales conversion rate, too. This might address the signup or step-two in the process. Figuring out the best way to get the attention of the target market in the first place might prove to be the bigger challenge.

It seems those of us who are till working, getting emails, and answering texts don’t have the time, interest, or inclination to read those long messages. As a writer who once made a living writing copy, I have a hard time giving up on the idea that long-form direct response is not as effective. Of course, it should be noted that this blog post is clearly long. If I had a squeeze page in the right column of this page, might it entice a reader to sign up for more information?

Maybe.

It depends on how committed that reader is to what is written in the post and their desire to read all the way to the end.

Who does that anymore?

I do. And if you’re reading this, maybe you do, too.

What do you think? Might long copy and the David Ogilvy approach to direct marketing still be effective in a world of information overload?

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Featured Image Source: Getty Images / Keystone

P.S. Check out these thoughts on the matter from Mr. Ogilvy himself…

David Harkins is a business strategist, speaker, and teacher.

He is the founder and executive consultant at David Harkins Company. In his spare time, he writes hikes, explores, and creates art. Although, not necessarily in that order.

Connect with him on social media below:

How social media trust changed marketing

Trust is one of the great cornerstones of life. The most successful relationships, whether personal or business, are built on trust.  Trust is a key factor in the consumption of news and information, too. Over the years, many readers, listeners, and ultimately viewers placed trust in their preferred media channel for the most current and accurate news and information.  Subsequently, each channel began to exploit the trust gained from consumers by accepting advertisements which allowed businesses to leverage the media’s credibility and intimacy through association. The challenge was then, as is now, to determine how to align the marketing and advertising of the business with the media most apt to have the greatest trust among the target customers. Unfortunately, those trusted channels of media and communication are constantly changing.

Much like early newspaper readers became radio listeners, and radio listeners ultimately became television viewers, social media platforms give individuals a different way in which to consume news and information, and this influences how trust is granted. Trust is still the currency, but it is no longer given freely to traditional media (newspaper, magazines, radio, or television) and marketers do not benefit from this association as they once did. Social media has taken the concept of trust in one-on-one personal relationships and created a somewhat commodified version of trust with online peer relationships that are enabled through the distinct differences of each platform. Trust has shifted from the medium itself to an ever-evolving value placed on an online peer relationship with roots established through relational identity (Pan, Lu, Wang, & Chau, 2017). More specifically, if an online peer seems to like and do things similar to the individual granting such trust, a value is created regardless of whether there is any meaningful engagement outside of the online relationship. Social media, then, has established an entirely different trust model—a model built on peer influence and not channel trust. This new model requires entrepreneurs to think differently about advertising and marketing.

Entrepreneurs may realize the benefits of social media tools to both spread word about their business and to engage with customers in a meaningful way. However, it is not enough to understand the broader value of social media use; it is more important to know how to use each platform to engender trust (Cesaroni & Consoli, 2015). Each social media platform, for example, has a specific way of facilitating engaging its users and each user has his or her pattern and practice of using the different platforms (Kerpen, 2015). No one platform can reach all customers or prospects effectively. Each has its purpose. While Facebook, Twitter, LinkedIn, YouTube, Instagram, Pinterest get the lion’s share of attention, social media and engagement are much broader than these few networks. In fact, the number opportunities for social engagement is vast and growing every day.

Analyst and cultural anthropologist Brian Solis has been tracking social networks and their use in an ongoing study since 2008. The latest version of The Conversation Prism (below – click to see a bigger version) is Solis and Jesse Thomas’ visualization of these networks. Solis shows large buckets of engagement identified as Listening, Learning, and Adapting, and then further subdivides into smaller buckets related their functional business support: Brand, Community, Service, Development, Marketing, Sales, Communications and HR (Solis & Thomas, 2017). Solis’ work argues that social media is not necessarily platform driven, but instead, engagement is driven based on the unique needs, values, and expectations (NVEs) of individual customers.

Arguably it is the NVEs that drives the platform choice; therefore, a niche platform that aligns better to an entrepreneur’s business offering may prove more productive for the entrepreneur than the more conventional networks like Facebook, Twitter, and LinkedIn. This is especially true when considering the growing number of platforms. It can be difficult for an entrepreneur to determine where to place his or her time and energy for social media use. In fact, determining the best fit between the user patterns and the most appropriate platform for the business’ current and potential customers can make or break an online marketing campaign. This is not to say the more traditional networks should not be used at all. Instead, they might be utilized in a more limited manner depending upon the target customer NVEs.

Regardless of the hype, social media is not a replacement for face-to-face customer engagement. A social networking platform, like letters and the telephone, is a tool in the entrepreneurial toolbox. It is imperative to select the tool or tools that will help best achieve the business goals and then stick with the plan. Do not, for example, launch a Twitter account, Facebook Page, or even a blog and then let it go dormant. In today’s active social environment, a stagnant online presence can be more detrimental to the business than no presence at all (Geho & Dangelo, 2012). Keep in mind that the wrong tool or using the right tool in a wrong way can also be detrimental to the business, and no one social media tool is likely to reach all current customers or prospective customers. In the end, marketing online is largely like marketing offline: Go where the customers are, engage in a relevant dialog, and gain their trust. Valued relationships are what build businesses.

 

References

Cesaroni, F., & Consoli, D. (2015, December). Are Small Businesses Really Able to Take Advantage of Social Media? (P. Peres, & A. Mesquita, Eds.) The Electronic Journal of Knowledge Management, 13(4), 257-268.

Geho, P., & Dangelo, J. (2012). The Evolution of Social Media as a Marketing Tool for Entrepreneurs. Entrepreneurial Executive, 17, 61-68.

Kerpen, D. (2015). Likeable Social Media (2nd ed.). New York: McGraw Hill.

Matney, L. (2017, June 22). YouTube has 1.5 billion logged-in monthly users watching a ton of mobile video. Retrieved July 5, 2017, from techcrunch.com: https://techcrunch.com/2017/06/22/youtube-has-1-5-billion-logged-in-monthly-users-watching-a-ton-of-mobile-video/amp/

Pan, Z., Lu, Y., Wang, B., & Chau, P. Y. (2017). Who Do You Think You Are? Common and Differential Effects of Social Self-Identity on Social Media Usage. Journal of Management Information Systems, 34(1), 71-101. doi:10.1080/07421222.2017.1296747

Solis, B., & Thomas, J. (2017). The Prism Chronicles. Retrieved July 5, 2017, from conversationprism.com: https://conversationprism.com/the-prism-chronicles/

 

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Featured Image Source: Getty Images, Pixelfit

David Harkins is a business strategist, speaker, and teacher.

He is the founder and executive consultant at David Harkins Company. In his spare time, he writes hikes, explores, and creates art. Although, not necessarily in that order.

Connect with him on social media below: