Marketing Metrics: How to Determine Your Target Cost Per Acquisition

February 2, 2018 Cathy Reisenwitz

There’s one number every CEO needs to determine, and every marketer needs to know—target cost per acquisition (CPA).

Typically, your marketing budget is the money you have left over to grow your business after you take care of your other operating expenses.

The question is, how much of that leftover revenue goes to profit, and how much to marketing? The percentage that goes to marketing is your target CPA. It is the amount of profit you’re willing to spend on growing your business, and specifically, the dollar amount you’re comfortable spending to add each new customer.

When you know how much you’re willing to spend to bring on new customers, and you know how much it costs to bring on a new customer with each marketing channel, it becomes easy to decide which channels are working for you and which are not.

Below, we will show you why CPA is vital for your business, teach you how to calculate it, and show you how to use it.

What you need to know before you spend a dime on marketing

In order to determine how much money you actually have available for marketing, and from there your CPA, the first thing you need to calculate is the lifetime value of your average customer (CLV). That CLV will then be used to set your marketing budget.

Step 1: Calculate the lifetime value of your average customer

What is CLV?

  • Customer lifetime value: the dollar amount the average customer brings into your business over the lifespan of the relationship.

There are many ways to calculate this number, depending on your goals. But for our purposes, let’s keep things as simple as possible.

If your customers pay once, the average amount they pay is your CLV.

Example: Bob sells e-books online. They’re $100 each, and he only has one book available. So, his average lifetime customer value is $100.

If your business has a subscription model, you’re going to need to know your churn rate in order to calculate your CLV.

  • Churn rate: The percentage of customers who stop subscribing to your service every month.

You’ll also need to know the monthly amount of revenue you can expect from each customer on average in order to calculate your CLV.

Example: If every month, 10% of Bob’s customers stop paying, then his churn rate is 10%. He charges $500 per month for subscription access to his library of e-books. His average monthly revenue per customer is $500.

Here’s a very simple formula for calculating your CLV for a subscription-model company:

  • (Average monthly revenue per customer / churn rate) = CLV
Example: Bob’s average monthly revenue per customer is $500. Bob’s churn rate is 10%. His CLV is (500/.1) = $5,000.

Step 2: Calculate what can you afford to spend on marketing

OK, now that you’ve got your CLV, you need to know how much of it you can devote to marketing. But before you can figure that out, you need to know how much of that goes to operating costs. Your non-marketing fixed costs will set the range for the CPA you can afford.

  • If your fixed costs are high, it means you need a lower CPA to stay profitable. But if your fixed costs are low, you can afford a higher CPA and still make a profit.

Example: To get his e-books out, Bob has to spend money on web hosting, editing, publishing, and distribution, as well as whatever Bob wants to pay himself. That total comes to $2,500. So continuing on the subscription example from the previous section where his CLV is $5,000, 50% of his CLV goes to fixed costs.

That means the maximum CPA he can afford while staying profitable is 49.9% of his CLV, or around $2,499.

Are you pursuing an aggressive or conservative growth strategy?

What matters more to you right now, profits or growth?

Remember, your CPA is a percentage of your CLV. It’s how much CLV you’re willing to give up in order to bring in new customers. Giving up less means higher profit, but lower growth. Why? Because the well of customers who you can bring onboard for very little money runs dry quickly.

High growth or high profit?

To figure out your ideal CPA, you need to know what percentage of your CLV you’re willing to pay to get a new customer.

Example: Bob’s web hosting, etc. costs him 50% of his CLV. He wants to stay somewhat profitable. Bob can spend between one percent and 49% of his CLV acquiring new customers and stay profitable. Or, between $1 and $2,499, since his CLV is $5,000.

So now he has to decide how profitable he wants to be.

  • (CLV – fixed costs – CPA) = Profit

He only has one book right now, so there’s really no benefit to growth. This means he may want to prioritize profits over growth.

Example: Let’s assume Bob prioritizes profits over growth. He is willing to pay 10% of his average customer’s lifetime value to acquire more customers. Since his CLV is $5,000, his target CPA is $500. That leaves him with $2,000 in profit per customer per month.

But what if Bob wants to grow faster? That means spending more to acquire each customer but also acquiring more customers.

Example: Let’s assume Bob prioritizes growth over profits. He is willing to pay 45% of his average customer’s lifetime value to acquire more customers. Since his CLV is $5,000, his target CPA will be $2,250.
  • (CLV of $5,000 – fixed costs of $2,500 – CPA of $2,250) = Profit of $250

That leaves him with $250 in profit per customer per month.

Putting CPA into practice

Your target CPA tells you how much can you afford to spend on acquiring new customers.

So why wouldn’t Bob just increase his marketing budget but keep the CPA at ten percent of CLV? Because there are only so many people who can be reached for that low price.

Bob knows that in order to sell more subscriptions, he’s going to have to raise his CPA, sacrificing some profit in order to get more subscribers.

Example: It costs Bob $2,250 to acquire a new customer using Adwords, but only $500 using Facebook ads. He can only do both if he’s willing to sacrifice profits with the 45% CPA. If he’s growing conservatively with the 10% CPA, he can only use Facebook.

Be realistic

All else being equal, we all want as low a CPA as we can get. The problem is that while some customers will walk right in your door with very little spend to get them there, most customers require a little more cajoling. And cajoling costs money.

Once you know you can only afford to spend a certain amount means that when testing a new marketing channel you can quickly see whether or not it’s meeting your target CPA.

More CPA resources

If you don’t know what CPA your marketing channels are offering, check out marketing analytics software. And for more information on marketing budgeting, check out “How to Build an Email Marketing Budget that Scales (Not Scares!)

The post Marketing Metrics: How to Determine Your Target Cost Per Acquisition appeared first on Capterra Blog.

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