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A quote from Mr. Wonderful from ABC’s Shark Tank

So Mr. Business Owner, what is your customer acquisition cost and the life time value of your customer?

As you often see on the show, the owners who know these numbers like the back of their hand are often in the best position to run their business, while scaling them profitably.

The following white paper will help you answer Mr. Wonderful’s question for your business.

 

Note: This white paper is written for the average small business owner with deep detail on how to calculate customer acquisition cost and lifetime value of a customer.

 

In order to consider spending on any advertising platform, it is first important to decide what you can afford to spend on advertising to acquire a new customer, while also determining their lifetime value to your business.

There are several ways to do this, but the following formula has guided me well throughout my career and in my personal pursuits of raising capital. I have raised over $500,000 from strategic investors following the “advertising rules to grow your business” below. And to run your business effectively, you need to know your Customer Acquisition Cost (CAQ) and Lifetime Value (LTV ).

As a client of ShoppeSimple Network, I want you to be prepared to answer these CAQ and LTV questions on any advertising platform. In fact, you will reduce your overall business stress when you know these CAQ and LTV numbers. Knowing your business marketing/advertising do’s and don’t numbers will give you the guidance (no emotion) to understand which marketing programs work, and which don’t. The ultimate goal is to STOP the advertisement programs that do not work or meet your CAQ/LTV metrics, and do more of those that do provide results.

Here are a few metrics you need to know to make the CAQ and LTV calculations.

Collect your data on the following questions:

  • What is your average order size or service order size?
  • How many visits would it take for an average customer to buy from you, within one year? This is on any of your channels (store, website or other). I have always found it best to use just one year for this CAQ analysis, but aggressive marketers who want to scale their business quicker may choose two years for their calculations.
  • How long does the average customer stay with you in time? i.e. one year or X years? You need to know or have a good estimate of this number for LTV calculations.If you sell a product once and only once to your average customer, the product purchase (like furniture or a car) has to be high enough retail value with a reasonable product margin to afford advertising. You will see why shortly.
  • What is your average order dollar margin? If you are a service, this would be service dollar margin. Make sure you understand how you allocate an accurate overhead rate into your cost and therefore your dollar margin. You also must know how to calculate order or service dollar margin on sales (not on costs), as this is how your accountant and P&L statements are calculated.

How to Determine Dollar Margin on Sales

Sales – (your product/service cost + overhead allocation) = dollar margin. Divide dollar margin/unit sales to get your dollar margin on sales.

OK — all of these above are easy to get from just thinking about your business and brainstorming. Your accountant can help you to get there too. By the way, I am here to help with the calculations above and everything you tell me is held in the strictest of confidence. These are value-added services I provide my clients. You just have to ask me!

Here are assumptions so you can follow along on calculating CAQ and LTV

Customer Acquisition Cost (CAQ)

Take the dollar margin per order (see calculation above), times the number of orders per customer per year. This number will be your order dollar margin, times the total number of orders per year, per customer. If you know the number of customers who buy from you in a year, you can then calculate total dollar margin for your business per year.

I am only focused on dollar margin for CAQ because that is what counts for your business, as it is what you put in your net pocket that counts. Doing dollar margin on sales only, could be misleading to your business.

Assumptions:

  • Average order size = $100

  •  # of orders per customer/patient per year = 3

  • So let’s say you sales per order is $100, and you have a 50% order dollar margin with a 10% cost overhead allocation of sales, which is your cost overhead allocation percentage.

    Why should a overhead allocation on sales be added to your cost of goods? Because there is typically other expenses that are related to buying products, and that should be better classified into your cost of goods section. Again, it is best to check with your accountant and determine this number with him for your business.

    Product cost + overhead cost allocation. So you actually make $40 dollars of margin on every $100 sale. $100 in sales X 60% (cost = 50% + 10% cost overhead allocation = 60%) = $100. 60% X 100 sales = $60 (=is $60) or 100—$60 =$40 dollar margin per order.

    Now let’s say your average customer comes in three times per year and spends at the same $100 level each time. Of course, substitute your own numbers. So you now see your average customer provides you not $40 per year, but $120 per year in dollar product margin.

    It is at this point you need to then understand your fixed costs too. Remember the reason your costs are called fixed costs is they don’t change the more sales volume you do. As such, the lower your fixed costs per unit of revenue you have, the more net profit you make. This is why your business can see profit leverage from an increase in sales. Bottom line — you are spreading your fixed costs over more sales.

    Now do you know how many customers you see per week? This is another critical metric. The more customers you see spending at the level of above, the more your bank account will cha-ching.

    So now ask yourself or your accountant: Is your business able to cover all of your fixed and variable expenses to make your business profitable? Because the goal of driving more advertising is to learn how to get more volume into your business and obviously, do it at a price you can afford to spend per customer/order. The goal is find the right tipping point to maximize net profit. This is the leverage gained from advertising the right way.

    Now, let’s say at the end of the day your accountant says you have 5% net profit on all of your sales for the year. Great, you are above break-even for the year and not at a loss position. Now is the time to learn how to fuel your business, and you are also in the driver’s seat to determine the per customer advertising investment you want to make to scale your business. Even if you are at a yearly loss, this document will help you turn your situation around from loss to profit.

    Assumption:

    Let’s say your business does $100,000 in sales per year. A 5% net profit means you have 5% of $100,000, or $5,000 in net profit. We will come back to this number shortly.

    Let’s say you want to put 2% of your top line sales into an advertising campaign. So on $100, you would be able to spend between $2 per order. But that’s not quite right. Since you are getting three orders per customer per year, you can actually eventually spend $6 to get a customer, and now you see how your bottom line can and will change.

    Test, Test and Test Again

    Successful advertisers and business owners know that they must always go into advertising with a test-first mentality. Then they test again and retest, continually optimizing their programs. They do more of what works and stop the programs that don’t work. There is no emotion here. It is always cold hard facts that must guide your path.

    Understanding that we want to first do a test of any ad campaign — to start, 2% is my recommended number to begin any advertising campaign. It is also important to be patient and spend money on a program for a consecutive three-month trial, so that you have time to optimize the advertising. You also must commit to diligently tracking your advertising programs. Once you do you will be able to move the program spending from all angles and optimize the spend. You will see positive effects to your net bottom line. Why? Because more profitable sales volume spreads your fixed costs and increases your net bottom line.

    Assumption continued:
    $2,000 ad spend per 12 months = $166 ad spend per month.

    Let’s say you get 1,000 orders a year from your core business. 1,000/12 months = 83 orders per month. Again, work your own business math here. 1,000 orders/by 3 orders per customer and you have determined you have approximately 333 customer who buy from you in a year. 333/12, or you see 27 buying customers a month, or around one customer a day. I have purposely kept the numbers small to include all business customers, to provide the learning landscape of why you should consider testing advertising for your business and how it can provide new customer leverage.

    1,000 x $100 per order = $100,000 in sales
    You make $40 net order margin, so you make 1,000 X 40 = $40,000 in order margin to cover all your other expenses.

    Let’s say you decide to test advertising to grow your business in 2016/2017, and therefore you spend 2% of revenue (100,000 X 2% = 2,000/12 = $166) per month advertising, that brings you conservatively three new customer every month (this is speculation until you track what is reality, which Mr. Wonderful says you must do).

    It may not start that way, but the goal is to optimize the advertisement campaign over three months and through A/B split testing you will learn what is working and what is not. Simply stop doing what isn’t working and do more of what is working.

    What is A/B Split Testing?

    A/B split testing is a scientific technique smart advertisers use to optimize advertising programs. It involves testing copy and photos to see what performs poor, better and best. Again, your goal is to continually move along a continuum to improve the overall performance of your advertising campaign. A/B split testing is a science, not an art. It takes solid analytics and patience. Again, if you are good at numbers, you could easily do this. If you are not good with math, don’t worry, this is a service I do for my clients on their advertising campaigns.

    Note: I have found you need to invest at least three months of advertising campaigns to move your needle, and as such you need to be patient. If you can’t commit to spending for three months, you need to know this up front and probably not move ahead. But consider the following — someone wiser than me once said – “without spending money you can’t make money.” The power in the lessons in this white paper is to help you spend money the “Right Way” and get your advertising to perform at its peak.

    A case study from my past using the Facebook Advertising Platform

    I have conducted hundreds of advertising programs in my career, but I will highlight one here from a  Business 2 Consumer (B2C )advertising program. It will also work for business to business (B2B). I have seen from Facebook ads, advertising order costs of $36 (or five orders per month) for the first month from Facebook, and once the campaign was A/B split and run for three consecutive months, the cost per order dropped to $6.25 per order. The media budget started at $170 per month, and once we saw the per order reach and acceptable return, we increased spending to $500 per month. The result at $500 a month scaled and generated 80 orders per month at $6.25 per order. Can you make money in your business getting a new customer for $6.25? Likely so.

     Now remember, it really isn’t $6.25, is it? Remember this one customer will buy two more times from you. That means you can amortize the $6.25 advertising cost per order over three orders, so the cost per new customer is $2.18. Can you make money in your business finding a new customer at $2.18 per order? How much dollar margin will you make from the three orders from this customer? Can you now see how the math is working to your profit leverage? A huge drop in cost per order from the campaign optimization was the critical factor in its success. Eventually this program was bringing in new business on auto-pilot, which was fabulous for this B2C client.

    Back to the Assumption:
    So your 2% advertising spend got you 36 new customers in year one, who came into your business or bought through any of your channels, including your website. This customer then bought on average three more times in the same year and spent $100 each time. 36 x 100 x 3 (each customer bought three times in a year) = (108 x $100) times in a year = $10,800 in new sales in year one. You have $40 dollar margin on those orders, so you have 108 orders x $40 = in dollar margin profit = $4,320.

    Your fixed expenses, like rent, heat, electric, ect., stay the same on more sales volume. All overhead in most cases doesn’t change (stays fixed), but only your sales volume grows. The result is your sales start to cover more of your fixed expenses, and there you begin to make even more net profit.

    To repeat, a social campaign like we are discussing on Facebook needs to run for a minimum of three months, but also note it is being optimized each day to find the best results.

    So bottom line, change for your business begins to look like the following:

    $4,320 in margin profit from these 108 new customers per year, and you spent $2,000 on advertising. Both in a year or a gain in profit per customer of $4320 – 2,000 = $2,320/36 customers = $19.33 profit/year per customer. (Note all of this needs to be verified through your metric tracking. Again, if you need help, I am here to help you with your advertising math. The result would be different for each client and their business. This is the nature and risk of proceeding with the test.) So now you can see CAQ and the power of this to scale a business.

    There is another important point to consider when investing in an advertising program, and it rests in the knowledge gleaned from my clients telling me just how their business is run on referrals mostly. So when you get more customers, you also get more referral business. By the way, what is the advertising cost of a referral? It’s near zero — so this is why I asked you at the beginning of this white paper to track customers and determine the source of where they came from. This number will also drop profit to your bottom line and increase your customer LTV.

    But there is even more, and remember Mr. Wonderful asked: What is the LTV of your customer?

    How long does a customer stay with you? Two years, 5 years, 10 years? I have some of my clients saying 25+ years.

    Now you can see where year one investments really scale.

    Let’s say a customer stays with you for 5 years.

    At 5 years, each customer buys from you three times a year X 5 = 15 orders at a net margin of $40 per order = $600 in sales. Remember, before advertising began you had a 5% bottom line on your sales or $5,000.

    You just made a net profit increase of $600/$(5,000X5=25,000). $$600/25,000 = 2.4% growth in profitable bottom line.

    I have purposely not considered the customers you would get from referrals, but you should allocate a number into your calculations from customer referrals.

    More Profit Leverage

    You may be thinking that is a lot of work to increase my profit 2.4%, but what you are not considering (and I didn’t consider it in this case study), is you just spread more sales over your fixed costs. You would also see a dramatic change in CAQ investment numbers, fueling your advertising leverage even more. You will be getting many more customers than is presented in this case study after advertising optimization and customer referrals. Remember, you are also getting email captures and sending them out offers perhaps monthly, which further increases sales. I didn’t include any of these powerful leverages to drive your business. But you should when deciding to move into an advertising program to build your business.

    Facebook Advertising Program:

    Items included:

    • Strategy creation
    • Optimization of strategy and program
    • A/B split testing
    • Copy and photo selection and optimization
    • Program runs two week alternative in a month
    • Landing page built to tell ad story
    • Lead capture page built to house both emails and mobile numbers
    • Lead database build for future email blast opportunities
    • Program needs to be purchased for a minimum of three months to see social proof
    • Analytics and metrics will be provided monthly
    • As client is in good standing, all data is owned by the client

    If you have an interest in moving into a Facebook Advertising Program or need help with your CAQ or LTV calculations for your business, please contact me at Jeff@shoppesimplenetwork.com,  952-807-8364 or schedule time for a chat. For more info visit http://www.bookeo.com/shoppesimple