Cost per acquisition (CPA) is one of the toughest marketing metrics for me to put my head around. CPA should be easy to understand, right? It’s simply the math used to calculate how much of your hard earned dollars are needed to acquire a new customer/sale/conversion. Divide the amount of marketing spent over a specified period of time by the number of orders and, voila! Your cost to acquire a new customer is calculated. Not too tough, right?
It’s figuring out how much you should pay for this sale/lead/customer/conversion where things start to get a little dicey. This part requires some intellectual heavy lifting, something I at times am averse to (Paul on the other hand is a CPA ninja!).
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It’s determining the optimal CPA that’s the hard part!
The CPA number by itself doesn’t add much value to evaluating your marketing efforts. This number simply provides a report card for how well you did. It’s the optimal CPA number, the “you should pay no more than” target that provides the utility. It gives you a benchmark from which to judge that first CPA.
So how do you determine your firm’s optimal CPA? Well, you can’t figure out how much you should pay for one if you don’t know how much one is worth, right? This customer lifetime value, (CLV) equips the business owner with context and meaning from which they can equate the optimal CPA.
To determine how much we should pay for a customer we must first determine the lifetime value of the relationship with that typical customer. How much will they spend with us over a period of time? How much profit can we expect during that time. These are the sort data points we’ll need to create a table like this:
This CLV of $72 is the maximum cost per acquisition of a new client we can spend in marketing dollars, in this case for Adwords. Anything more and we lose money for every dollar that exceeds the $72 CPA.
Remember, you are in business to make a profit and you are making this profit over time. Therefore, your CPA should never exceed 30% of your CLV. In the example above your CPA should not exceed $21.60 ($72 X 30%).
Let’s construct another table to fully illustrate our example from above:
In this scenario the Adwords spend of $5000/month is is producing new customers at a cost well below the CLV of $72, but most importantly below the CPA target. You can determine breakeven by dividing your spend by the CPA target. The breakeven in this example is 232 orders per month ($5,000/ $21.6).. Conversely, you could increase the spend to create more orders as long as you can maintain the CPA target. This is where having strong Pay Per Click management comes into play.
30% CLV > CPA
Cost per Acquisition and Customer Lifetime Value: “buddy metrics”
We used this example to get you thinking about CPA and CLV at a very basic level. Rather than thinking about how you can acquire a lot of customers and how cheaply you can do so, CLV helps you think about how to optimize your acquisition spending for maximum value rather than minimum cost. In a future post we will discuss how to maximize the value of CLV as a KPI.