The Cost of Customer Acquisition: How Much Can You Spend to Earn New Business?
Marketing has become a very data-driven discipline. Marketers spend a lot of time and energy looking at the metrics that illuminate the costs of finding new customers and keeping current customers. In other words, in addition to being a master at the fine art of persuasion, today’s marketer must also be part data scientist.
I recently spoke with Jeff Allen, a Senior Director at Adobe Analytics, about the role data plays within marketing. He compared what we as marketers do with data to the way Billy Beane approached managing the Oakland Athletics in Michael Lewis’ book, Moneyball: The Art of Winning an Unfair Game.
Like many of my peers, I grew up playing baseball. In baseball, you count everything—hits, runs, times at bat, on-base percentage… and wins. Especially wins. Beane’s data-driven approach was created to look at all those statistics and identify the data points that made the most difference in how many times the A’s won—so his team could better compete with bigger rivals with bigger budgets. Beane knew he needed runners on base to get points on the scoreboard and ultimately win. That was a very important metric for him.
“What’s the ‘one metric to rule them all’ in your organization?” asks Allen. “What’s your end goal metric? Is it revenue or is it bookings? In sports, it’s winning. Beane knew if he could improve his team’s on-base percentage and hitting, he could win more games. If you win, you’ll have all the success that’s possible.”
An Important Marketing Metric That’s Often Overlooked
In marketing, like baseball, there are lots of things to measure. Some data points have more value than others. It may or may not be the “one metric to rule them all” in your business, but I think the cost of acquiring a new customer is one of those data points that is critical to understand in any business.
It’s not often that I pull a dusty old marketing book off my bookshelf to talk about a more current marketing topic, but almost 20 years ago I stumbled upon Jay Abraham’s book, Getting Everything You Can Out of All You’ve Got, and I think what he shared in 2000 is still relevant today. When this book was published, Abraham was considered by Forbes to be one of the top five executive coaches in the country. He’s primarily known for successful direct marketing strategies he developed in the 1970s, but I think his insight into this topic is still incredibly valuable.
According to Abraham, “The most profitable thing you’ll ever do for your business or career is to understand…the marginal net worth of a client.”
In other words, the single most profitable thing you can do for your business is to understand the value of an average customer over the course of their relationship with you. So what is the lifetime value of your average customer? Do you know?
“It’s the total profit of an average client over the lifetime of his or her patronage—including all residual sales—less all advertising, marketing and incremental product or service-fulfillment expenses,” says Abraham.
Once you understand the lifetime value of a customer, you can determine how much you’re willing to pay in new customer acquisition costs. For example, if the lifetime value of your average customer is $1,000, anything you spend under that in new customer acquisition costs will be profit—or the marginal net worth of your average customer.
Abraham also provides advice on how to calculate your clients’ marginal net worth. Here’s what he suggests:
- Compute your average sale and your profit per sale
- Compute how much additional profit a client is worth to you by determining how many times he or she comes back
- Compute precisely what a client costs by dividing the marketing budget by the number of clients it produces
- Compute the cost of a prospect the same way
- Compute how many sales you get for so many prospects (the percentage of prospects who become clients)
- Compute the marginal net worth of a client by subtracting the cost to produce (or convert) the client from the profit you expect to earn from the client over the lifetime of his or her patronage
This calculation will work just as well for those who only do business with a new client once. Nevertheless, regardless of how long the average lifetime of your customers is, this metric helps you determine how much you can justify spending for a new customer and how much you can justify spending to keep your current customers. Every additional sale over the average is additional profit for your business and increases the marginal net worth of that customer.
Metrics-Based Marketing Increases Marketing ROI
“Many companies increase their clients and profits merely by shifting their focus from trying to make a huge profit on the acquisition of a new client to making their real profit on all the repeat purchases that result from those new clients,” says Abraham.
If the average lifetime of one of your customers extends to several sales over several years, this approach might even make sense for you. It’s human nature to improve what you measure. Being aware of the lifetime value of a customer will not only help you determine appropriate acquisition costs, it will also help you take efforts to keep your customers longer. You may even be able to justify an investment in keeping them satisfied and coming back for more—basically increasing their marginal net worth.
Ty Kiisel is a contributing author focusing on small business financing at OnDeck, a technology company solving small business’s biggest challenge: access to capital. With over 25 years of experience in the trenches of small business, Ty shares personal experiences and valuable tips to help small business owners become more financially responsible. OnDeck can also be found on Facebook and Twitter.