You’re an entrepreneur who wants to let people know about your business and find potential customers for your products or services. That’s what marketing is all about.
If you’re a small or medium-sized business with a limited budget, you understandably want to make sure you make the most of your marketing dollars.
Actually, no matter the size of your marketing budget, you should always think about how to maximize the return on the money you spend for ads and other forms of marketing.
Depending on the business, this could be as simple as figuring out how much it costs to acquire a customer or a sale. It could also be complex, such as layering in additional metrics into your marketing strategy, such as the potential “long-term value,” or LTV, of a customer.
You’ll hear other such acronyms and concepts if you decide to work with professional marketers. Yes, it can get confusing. So here are some of the important “key performance indicators”—or KPIs in marketing-speak—used by the pros to optimize your marketing efforts:
1. Cost Per Acquisition (CPA)
“Cost per acquisition,” or CPA, refers to how much is spent “to acquire a conversion event.”
Sounds complicated, but a conversion event simply refers to an action taken by a potential customer. This includes submitting an email address or calling your business to inquire or request a product or service. It could also refer to downloading your app, signing up on your website, or completing a sale.
Depending on the business, the relevant conversion event or events may vary. It is important to understand and measure performance across the entire customer conversion funnel to drive insights into potential opportunities.
For most online channels and with proper conversion tracking, costs and conversions can be tied together to understand exactly how much is spent to convince a customer to consider or even buy whatever you are selling.
Online advertising platforms generally have a variety of targeting available to improve the quality of traffic to the business and hence reduce unwanted traffic. Here are some examples:
Let’s say you’re driving people to download a mobile app. Targeting only mobile and tablet devices helps ensure you minimize any wasted spend on desktop users.
Let’s say you run a local restaurant and you want to reach potential customers in your area. You can increase advertising presence to users who are located within close proximity and exclude others.
Day of week
Some online platforms also let you review conversion data by day of the week to understand whether certain weekdays or weekends perform better than others.
Time of day
If the call to action is a phone call, you can limit your advertising spend to business hours only. And you also could limit the advertising to certain hours of the day depending on the groups you are trying to reach.
2. Customer Lifetime Value (LTV)
Customer lifetime value is the total value a customer is expected to generate for the business. The time period could be very short, say one day, or as long as many years, such as with subscription businesses. Having a strong understanding of customer LTV gives you an idea of what CPA to aim for.
It’s not uncommon to have LTVs that are different depending on the specific marketing channel that generated the customer. If your customers are other businesses, a marketing channel such as LinkedIn may drive higher quality and higher LTV customers compared to a more consumer, mass-market channel such as Facebook. However, it may also cost much more to acquire the customer.
3. Return on Investment (ROI)
You’ve probably heard the phrase “return on investment,” or ROI, which is also widely used in measuring how efficiently marketing dollars are spent.
It’s important to monitor ROI both at a high level and by specific channel. For example, some marketing channels may be very efficient from a cost perspective, meaning they have low CPAs. But they may also exhibit low LTVs.
On the other hand, some channels may deliver very high customer LTVs but may also entail high acquisition costs.
Let’s say you own a cleaning company. You try different channels to market your business: an ad in the local newspaper, an ad on a social network, or old-fashion mailers.
An ad on a local newspaper
The cost for every customer you win over is $75, and the LTV of each customer is $50. That means you post a loss of $25 through this channel.
A social media ad
Cost per customer is $100; LTV is $100. This time you break even.
Mailer in your neighborhood
Cost per customer is $150; LTV is $250. With this channel, you make a profit of $100.
I organized the example in a table that helps illustrate the different scenarios to help you evaluate your marketing efforts.
[table id=2 /]
The newspaper channel has low cost per customer but is unprofitable due to even lower customer LTV.
The social media channel’s cost per customer and LTV are the same, netting zero profit.
The mailer channel is our top performer.
Despite having the highest cost per customer, it generates much higher customer LTV, resulting in strong profit margins.
The example shows the importance of understanding lifetime value and “cost per customer” for each channel in measuring the effectiveness of your marketing campaign.
Focusing on channel-specific ROI lets you fine-tune your marketing efforts. If we look at the example above, the business should consider shifting more budget toward mailers, while finding ways to reduce the cost per customer for social media ads to achieve channel profitability.
Marginal Return Analysis
Like almost everything in life, laws of diminishing returns hold true for marketing channels.
There always comes a point when the last marketing dollar spent no longer helps your business become profitable. One way to make sure you are spending marketing dollars wisely is to estimate the marginal CPA for each channel. In other words, how much did it cost to acquire the last customer or sale?
Unfortunately, there is no magic formula that calculates marginal CPAs. One analysis that can help provide directional guidance is to understand how changes in spend impacts conversion counts.
Let’s say for a specific marketing channel, $1,000 in weekly spend historically generated 10 customers, or $100 CPA. If we then decide for one week to increase spend by 50% to $1,500—and that generates 12 customers—we could assume the marginal CPA is $250. In other words, an additional $500 drove two incremental customers.
[table id=3 /]
In the example above, the newspaper channel is the most efficient with an overall CPA of $90. However, it is the most expensive and unprofitable on the margin with a CPA of $160. This implies that while the channel overall is generating the highest profit margins, it is also unprofitable on the margin where it is spending $160 to acquire a customer that is only worth $150. So this means we are overspending in this channel and should pull back spend.
So where do we reallocate the additional funds? Social media. That’s because despite having the highest overall CPA ($110), the marginal cost per customer is lower ($125).
Proper and rigorous tracking of all the relevant KPIs is essential to ensure you’re making the most of your marketing budget.
You should always look to make data-driven decisions to determine where the next marketing dollar should be spent. That’s your best strategy for making the most of your marketing budget.
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