For all the art, creativity and storytelling required in marketing, it’s a discipline that ultimately finds truth in math and economics. Are sales increasing? Is marketing generating enough leads? What’s an acceptable amount of advertising spend to acquire a new customer? Ultimately, the right answers to these questions depend a lot more on accurate data analysis than imagination.
Most marketing organizations struggle with attribution and ROI, particularly when buyers interact with their brand across multiple devices (mobile, desktop, TV), channels (email, social, events, etc.) and locations (retail, home, out-of-home). So how do you assess the health of your marketing economics? Here I’m going to share one approach we use at Percolate to evaluate the success of our inbound and content marketing programs. If you sell products or generate leads on the internet, this framework should be helpful. If a big portion of your sales cycle takes place in-store — or is driven directly from sales with little or no input from marketing — this may be less actionable for you as an ROI model, but hopefully still informative. Ultimately, the underlying framework for understanding customer acquisition economics is the same for every business, the main differences lie in the nuances of how their particular customer profile buys the brand.
In my experience, the best way to approach modeling the success of your customer acquisition efforts is to start with the ultimate business objective, then work backwards to “reverse engineer success.” If your goal is to acquire new customers, start by calculating the lifetime value (LTV) of your customer. If you’re not familiar with LTV, it’s the projected revenue the average customer will spend with your business during their lifetime. There are a few different ways to calculate LTV, but generally to do it there are six things you need to know:
- Average customer purchase amount ($) → (p)
How often your average customer buys from you (your sales cycle length) → (f)
Average gross margin per sale (% or $) → (m)
Customer retention rate (%) → (r)
Your interest rate or discount rate (%) → (i)
Your average customer lifespan or relationship (years) → (t)
For example, let’s say you operate an e-commerce company that’s been in business for 3 years. Working with your analytics and finance teams, you determine your average order value (p) is $50, your average customer buys from you twice a year (f), your gross margin is 20% (m) and your customer retention rate is 75% (r), meaning three out of four customers that buy from you once keep buying from you in the future. For simple math we’ll use a 10% discount rate (i). Based on your best information, your average customer buys from you for 2 years (t). Here’s the formula to calculate your LTV
Putting that together, here’s what it looks like:
If you perform the calculation, you’ll get the LTV result = $42.86
If that seems complicated — or you’d like to perform this type of calculation but you don’t know some of the values — don’t worry too much. Start with what you do know, and try to use thoughtful assumptions (or, better yet, relevant industry benchmark averages) to fill in the blanks. It’s also not a bad idea to perform multiple LTV calculations using different methods, then take a blended average and work off that. Ultimately, even if your LTV math isn’t perfect, it’s a critical starting point for understanding your marketing economics and the ROI your campaigns are generating.
Once you know the average lifetime value of a customer, you can start working backwards. Map out your customer lifecycle steps. This is an oversimplification, but for an e-commerce business, it could be:
- Visit website →
- Sign up for email list →
- Purchase (conversion event)
If you’re a software company or sell a B2B product, your sales funnel might look more like ours at Percolate:
- Visit website →
- Lead →
- Marketing qualified lead (MQL) →
- Sales qualified lead (SQL) →
- Opportunity →
- Purchase (conversion event)
Using the first (e-commerce) example, let’s break down the marketing economics for this business, starting with purchase. If we know our hypothetical customer LTV is $42.86, then the next thing that’s important to understand is the conversion rate from the previous step in the funnel. Let’s say our analysis shows 20% of people who end up on our email list respond to an email offer and buying our product. Therefore, the value of an email subscriber to our business is $8.57 ($42.86 * 20%). Then we can perform that analysis again at earlier steps to understand the value of advancing a potential customer to each stage in the sales cycle.
|Funnel step||Conversion rate||Economic value of completed customer action|
|(2) Subscribe to email list||20%||$8.57|
|(1) Visit website||20%||$1.71|
By doing this, you’ve mapped out your customer acquisition cost by stage. In other words, you have a sense of the unit economics of an average customer as they move through your sales cycle. Once you have this estimate, you can start to estimate the right amount of budget to spend across your advertising and content operations to keep your marketing economics in the green. To get 1,000 visitors to their website, our illustrative e-commerce company shouldn’t spend more than $1,710 ($1.71 * 1,000) on top-of-the-funnel advertising or content marketing to generate it — the economics don’t justify the additional cost.
Your target CAC (customer acquisition cost) to LTV ratio is also going to depend on your business. If you’re a relatively stable, established company, you probably want to target a CAC that’s equal to 20-33% of your LTV. However, at a well-funded, high growth startup that’s focused on scale and winning their market, the optimal CAC:LTV ratio could be closer to 1:1.