I had a good conversation with a client about this the other day. He asked, “How much should I plan on spending on online advertising?”
It may seem like a fairly basic question, but it’s not. It’s an excellent question, one that goes to the fundamental issues of business and marketing.
One answer is that you should spend a million dollars on advertising if you can sell a million and one dollar’s worth of product. This, however, does not take into account the cost of the product and the opportunity costs of doing something else with your money.
The answer I like to give is this:
What is the lifetime value of a customer for you? If you are selling a consumable product, organic mac nuts, for example, you might expect the average customer to buy a few times a year for a few years. Factor in single purchases and client churn (how many you lose a year) and you might find the average new customer is worth $100, on average, in lifetime orders. Some will re-order frequently, and some will order only once.
Then figure out your lifetime profit for an average customer. That is, for the $100 in sales, how much do you make after you subtract all of your costs (this is a very hard number to get right!). You might be left with $50 for a very high margin product like mac nuts or $5 for a commodity like pencils.
The next step is to run some test campaigns on the pay-per-click platforms: Google, Bing/Yahoo and Facebook. Write solid, targeted ads and let them run for a few weeks. Make sure you have tracking installed on your website to be able to identify the source of your sales.
After a few weeks you’ll have some data about customer acquisition costs. How much does each new customer cost?
Let’s imagine that you have the following numbers:
- $500 in sales directly attributed to pay-per-click ads
- $50 per customer, 10 new customers
- 30% profit on sales
- $15 profit per customer on first order, on average
- $75 lifetime value of new customer
- $100 spend on pay-per-click ads
So, in the single transaction, the net profit way of looking at the advertising, you would have spent $100 to make a $150 profit (10 sales @$50 each with $15 profit each). Not bad, but not spectacular either, as you probably have more expenses than you realize.
But if you look at the lifetime value of a new customer, the numbers look much better:
10 new customers x $75 lifetime value of the customer x 30% margin: $225 return on $100 investment.
So, if you had these numbers, it would make sense to increase advertising dramatically, as you are getting a 225% return on your advertising dollars.
The key is to keep monitoring your advertising and make sure that the customer acquisition costs and the lifetime value of a customer do not change for the worse. Our experience at Kona Impact is that the cost of each new customer gained through pay-per-click is fairly constant, and if we fine-tune our ads, the cost can go down.
So, the answer to the question about how much you should spend on online advertising needs to take into consideration advertising cost, customer acquisition costs, profit margin and the lifetime value of a client.
The take away lesson is that a data-based approach will help guide you to the best decisions for your business. It should be noted that no other advertising medium—TV, radio, print—allows you this level of accountability and data.
The Kona Impact staff has been running online advertising campaigns for over 15 years. If your business is on Hawaii Island and you would like some proven methods to help your business grow, give us a call at 329-6077.