THE (REAL) COST OF NEW CUSTOMER ACQUISTION
On today’s episode, we have recurring guest Mike Ferranti Founder and CEO of Endai. Damian and Mike pick up their conversation about new customer acquisition. This episode focuses on the (Real) cost of customer acquisition. Some companies try to disguise the cost but it is real and needs to be uncovered for any business that wants to be successful.
First Mike answers the question “Why is knowing the cost of customer acquisition important?”
Next, they try to figure out the right way to measure the cost of acquisition.
Damian then brings the conversation to the Practioner’s point of view. The practitioner is the marketer who is trying to implement a new customer acquisition strategy.
The conversation turns to the differences in companies that have a large brand presence and those companies that need to rely on non brand clicks.
Then they get into a discussion about Seasonality and how some businesses can thrive while others are dying throughout the year.
Damian then brings up Attribution and how some businesses use Last Touch Cost while others use Cumulative Touch Cost. As well as how do you really attribute any marketing to new customers. Mike gives an example of a shortcut that some businesses take when it comes to attribution.
Mike and Damian then discuss how some companies refer to organic traffic as a free channel and how you can match an organic searcher to a previous expense. This then brings up the idea “is new customer acquisition a part of your Cost of Goods Sold”, which both of them refute.
Finally, Mike brings up an example of how a company was marking the sizes on their website was increasing returns. This brings up the idea of, “is a returner a new customer?” This topic is debated and it comes down to of course they are a new customer, getting all the way through the sales cycle is the definition of acquisition.
All of this and more in Episode 9 of the Inevitable Success Podcast.
Part 2 of a 6 Part Series
Need to catch up? Here is part 1:
What follows is a lightly edited transcript of Episode 9 of the Inevitable Success Podcast with Damian Bergamaschi and special guest Mike Ferranti. (Listen Here)
Damian On today’s episode part two of our six-part series about new customer acquisition we’re going to discuss the real costs of customer acquisition.
I’m here with Mike Ferranti and the very first topic that comes up is Why is knowing the cost of customer acquisition so important. When I think about it’s pretty simple, are we making money?
Mike Yup that’s that’s where most folks start. One of the things I would raise strategically is the ultimate answer to the cost of customer acquisition usually depends upon where an organization is in their development and what their goals look like. So just to give an example I would say an early stage company that doesn’t have a great acquisition model or doesn’t have a brand that is driving acquisitions because they exist, the way they view it would probably be very different than an organization that was acquiring customers and had all of those things.
So there might be some expectation that it would be very low because with brand power behind it and maybe with hundreds of physical locations or other assets you know there might be very different thoughts and expectations. Also, a mature business may have so many customers in their database already that they have different priorities right and so they’d be less willing to invest, and so that could really inform it. So I think it’s important to start with where am I today as an organization because that has a huge role in defining what it should cost to acquire customers in the first place.
Damian So clearly it’s going to evolve over time. How do we go out about calculating the cost of customer acquisition or you know the cost per acquisition CPA? There are quite a few ways to do it. I kind of want to deconstruct those. Like the keep, it simple model would be to march over to finance and you say how much money did we spend on you know the departments that touched the customer and divide it by how many new customers you have in the business. That probably gives you a real true answer.
Mike Well in my experience usually the marching goes the other way. Right. So finance usually marches over to you and says here’s your budget to acquire customers and this is the CPA. Especially in large mature organizations. So you know and that that could present its own challenges for the marketer right. Surely it just makes sense that a business should acquire a customer that will make a profit either now or in the very near future. But that point alone we could probably do five or six podcasts around because again that gets to what kind of product do you sell. What is the historical value of customers? And because all of that is going to shape and drive what that CPA or cost per acquisition should be.
In the case where you do the keep it simple finance-driven model where they say well this is this is the budget. I’ve been in meetings with CFOs and CEOs where the methodology for determining the cost per acquisition is driven by Wall Street metrics. So Wall Street says in your category you should spend 3 percent or 10 percent of sales on marketing. Now Wall Street doesn’t say that it’s on customer acquisition. Some of that will go to a branding line item that may not be held to measure the number of customers it acquires, although that’s probably changing ever more in the digital age. But you know you start with a metric on Wall Street because that’s what organizations tended to spend when they achieved a profitability target that was acceptable in the category.
So that may have nothing to do with the brand, the unique business, or where they are at some point especially if it’s being sort of transported and that CFO goes to you know a middle market private company and says yep we spent 3 percent of sales.
It sort of reminds me of an old story I heard. It’s kind of an old wives tale I guess. Where a woman used to cut the ends off of the ham before she cooked it. One day somebody asked her why do you cut the ends off the ham. She said I don’t know, but my mother used to always do it. So she asked her mother why do you cut the ends off and I don’t know I really never thought about it but my mother used to do it. So they went back to grandma and said hey why do we always cut the ends of the ham. She said “Oh because my pan wasn’t big enough to hold a ham.
And so these things can get carried forward through you know careers and businesses and transported into other businesses when they aren’t driven by a true strategic lever. I think that’s something that we have to think about and be conscious of when we think about how we come up with cost per acquisition in the budget to acquire a net new customer.
Damian Yeah I mean one of the things I like to do a lot is I own the company, take that frame. Because if we’re really being amazing at our jobs that’s how everybody would think. I don’t want to think about it that this is what finance gives me or this is what Wall Street says. I want to think about it as what does it cost me to acquire a customer and then I have to start asking questions like “Okay well what kind of budget goes towards customer acquisition and what doesn’t.” And maybe a simple question that I can think of is “does it improve the conversion rate of customer acquisition.
So let me give a few examples. Let’s say I’m a SAAS company I make software. If I invest in the development and I make a feature that is amazing and because of that feature, the conversion rate on sales demos goes up to 2X. Well, that dramatically reduces my cost for acquisition and those development dollars I could see how it impacts the cost per acquisition. If I’m in retail or fashion and I invest in you know in equipment that makes that product stitches like really neat or clean and it showed was so much better next to the other apparel in the store. Well, that can impact customer acquisition.
I would want to think about what other departments where dollars are going in a company.
Mike Well and what you’re really saying is you’re thinking strategically what you’re describing is more business strategy, which you know the most important thing I think anybody especially new in the marketing field should know is that marketing is strategy right. If marketing has been reduced to something else well that’s probably not going to work out so well. But done well marketing is strategy and absolutely how can you possibly think about what a product should cost, what a customer should cost to acquire. If you’re not thinking about your end customer and what their needs are and what it is and how we’re going to serve those needs. So again this is this is I think it’s the right place to start is to start with the strategy because if you don’t have the product right everything else will go wrong. And what you’re saying is that the value chain really needs to be integrated from the top down.
Marketing can’t be the last right although it sometimes is.
Damian And we’re going to get to the practitioner’s approach to traditional CPA and going to touch that.
Mike I love the idea. You know I think it’s a great point for us to call out here is that you need to really begin with the strategy you need to. Too many brands get so myopically focused on you know the cost of acquiring a customer when they don’t understand what the is worth when they don’t understand what the hurdle really is that you have to clear to get somebody to try the product or the brand the first time. I would agree 100 percent. If you’re not beginning with strategy and really thinking how all of the parts of the business have to work together and it is an integrated KPI for the business. When you talk about CPA rather than the last number you think about after everything else is done.
Damian Yeah. And when brands think strategically like that, to your point earlier, that’s how the CPA can evolve over time. If you don’t do that you will be pegged to your industry benchmark on what it costs to acquire a customer and really be beholden to what the market prices for that.
Mike Right. Well, there’s a company that is in the news lately, Movie Pass. Most folks think it’s a very new company. It’s actually been around for I think four or five years. And really the movie passed story is all about customer acquisition right. So so that story begins with movie theaters who were having a hard time getting customers in. Right. Why. Because there’s so much entertainment available digitally and behaviors have changed. Children you know they don’t need movies the way they used to entertainment is on demand all the time on every device that’s how the grew up.
So movie theaters were struggling with costs per customer acquisition and customer acquisition at any cost perhaps. So Movie Pass you know tried a couple of different models but where it got exciting and where it became newsworthy and the numbers are staggering they’re requiring millions of customers. Now is when they thought about well how do we get them in the door at all. And they came up with a whole new pricing model. You could go every day if you want to see a movie. And it’s one low price per month. So they turned that into a subscription model. So that’s a good example where you know they turn the entire industry model on its head in the first place because what was there was no longer working.
Damian We don’t know yet how that’s going to play out because that’s a pretty controversial example but it doesn’t change the fact that these guys really turned up new customer acquisition. We’re going to cover you know ROI and the equality of customers in other parts. I wanted to shift over to like you alluded to some of the practitioner’s models and marketer and you have to kind of come up with CPAs. Let’s say we’re going to use a marketing dollar approach and a media approach.
A marketing dollar approach would be you’re taking the marketing budget that’s kind of like your Wall Street 4 percent of sales example. Then you could take all of your customers you acquired divided by that (Marketing Dollars) and that’s your cost per acquisition. When we dig in deeper and we go to a media model some interesting things happen and the very first place I’d like to start is with brand versus non brand. So I know you have some points about that too that you’re passionate about. How do you view those two things?
Mike Well you know our experience has been that most acquisition especially, I’ll focus on, digitally because you know this is where the marketing dollars are going today. Most acquisition that businesses are doing especially larger ones is coming through their brand. It is a good illustration of the power of a brand. But when they buy for example in search, which is not all the time but often a big producer of customer acquisitions and you look back at where they’re coming from in your analytics brand is a huge driver for organizations that have a brand.
Damian And I think the key here is what we’re talking about his new customer acquisition the lifeblood of your business. We’re not talking about transaction count.
Mike That’s right.
Damian Because your transaction count, especially if you’ve been around for a while, it’s going to be heavily skewed towards the brand that’s the value of a brand they keep coming back. They look for you but when you go to, let’s say, search, for example, and you look at the acquisitions of the transactions when you look at most accounts it is depressing.
Mike Yeah and it’s something that’s just not talked about much. I think the reason for that is simple. There are goals about “we have to acquire this many this year.” If there hasn’t been the strategic view of how does this business work and how does customer acquisition work as an integral part of our value chain. That’s when you get these numbers handed down and marketing is going to go and say “Well we hit our number because we’ve got acquisitions.” But I would say in most of these cases there’s likely accounting problem, accounting methodology problem, and that is you know if all these folks came in on the brand it at least suggests that they had awareness knowledge of and if they converted right away there’s a decent chance that some or many of them are not new customers.
Damian Most of them.
Mike So it wouldn’t surprise you that organizations that struggle with that counting methodology are also organizations they can’t uniquely identify customers and don’t have systems in place to determine if an individual customer as they come in is new or if it’s a repeat.
Damian Yeah there definitely is a net new brand aware segment. And the thing it needs about that is that conversion rates are amazing for those.
Mike Yeah CPAs are very low as a result. It’s an easy place to spend the marketing budget. I think the flip side, of course, is when you go over to non brand where there’s no intent for your brand whatsoever and they’re simply shopping the category. And it’s not just about search because search is a mirror of consumer behavior today. So this is where we see the cost per customers skyrocket typically. One of the big reasons that we’ve experienced is it’s just a lot more work, a lot more effort, a lot more optimization, and even then you still have a markedly higher cost per acquisition.
Damian You can’t even do it if you’re sloppy, it just doesn’t work. I’m going to call out the agencies on this. They will take the aggregate, blended CPA, of brand and non brand and it looks pretty good because the brand one is you know pennies or dollars and the non brand one is like. I’ve looked at it in a lot of accounts and I am never surprised when I see your sloppy work yield five hundred dollars thousand dollar CPS for sales that are like 100 dollars or less.
Mike Right. They’re obfuscated with a bunch of brand arrest searches or something else that’s very effective but not necessarily true. Net new customers. I guess we’re being disruptive here because many a CMO have said you know “it’s all about the blending. ”
Damian You don’t say that when you think like an owner. Because I’ve also talked to owners and founders and…
Mike Well that’s another story.
Damian They do not think that way. They think very differently.
Mike Yeah, now we’re getting into OPM versus…
Damian That’s other people’s money.
Mike Right. I laughed the first time there was a founder at the office and he said “Yeah well we will measure in MM” which stood for my money. That was pretty funny.
But I think beyond it all you know for organizations to truly grow, to grow total revenue, and to grow total profit you know that these organizations need to go through that evolution because not a lot changes if you’re just acquiring customers you already had. I say acquire in air quotes. The way that you’re going to change the color and character of a business and its profitability is acquiring true new customers so that there are more people buying the brand that simply didn’t buy it before.
If you’re not growing the breadth of your customer base, the true breadth, that creates a lot of limitations because there’s only a finite amount of sales that you can get from an individual in any period of time. That really breaks down into cohorts and there are groups that will buy many times and their cohorts that will only buy once.
But even so if you’re not expanding the breadth of net new customers that the brand sells to you’re not expanding the brand.
Damian And if you just go to the value of the business if you’re not growing at a certain rate then your business is just not as valuable. And that’s that’s part of marketing’s job, to increase the value of the business.
Mike Now you know one of the things that you mentioned either earlier today or in another podcast was CAC or cost of customer acquisition. And there’s a there’s an example that’s probably very different. I think it was Groupon was famous at one point, as they were exploding in growth because when they went public they took the controversial measure of excluding their CAC or capitalizing is I guess what they did. But they didn’t count that as an expense, I don’t know what they put it into but when they added it back and it was a very different business. And I think the point of that is it’s a good illustration the other way.
Damian Cap x or something.
Mike Yeah I believe they capitalize that. I think that’s a fair point. It’s just not…
Damian If you do get a job at it right.
Mike So you know these are all different ways to look at the cost of customer acquisition and how different organizations have either ignored it.
Damian Or cooked the books on it.
Mike Yeah cooked the books on it. You know we tend to subscribe to the philosophy of let the numbers be what they are and let’s figure out the next most logical and valuable step right to improve that number. But clearly, if you have organizations and many of them that are obfuscating their cost per acquisition either deliberately or inadvertently.
Damian Specifically new (customer acquisition).
Mike Yeah, net new customers and you have the other extreme where you have the cost being very high but not counted at all. It just goes to show you that there is some great passion and there is some great pressure to acquire customers and do so cost-effectively. You know again we would not advise or we don’t see the value frankly and you know getting there by playing with the numbers. There’s an old expression numbers are cowards if you torture them they’ll confess to anything. You know to look for a business to really thrive. Going to have to do more than that. Right.
Damian Were you reading like Aesop’s fables or something before the podcast?
Mike I read many many things. Since you’re asking about it I think I first read that in grade school.
Damian That might even have been your grandma actually.
So the takeaway is it’s not just about sales. It’s about new customers look deeply into brand versus non brand and you know to challenge the numbers.
So let’s move on into some of the inputs into CPA cost per acquisition and some things to consider. One is you know basically this boils down to the cost of the media and the conversion rate of that media. And one of the things that I see not thought of often is that while CPA change over time over years and within the year, for example, sometimes the cost of the media is very different in the business cycle or even throughout the year. Sometimes the conversion rate is very different throughout the year, for example, Q4. Most brands tremendously higher conversion rate in Q4. Let’s talk about cost first, the seasonality of cost.
Mike Sure. So seasonality works for both the media outlets where you go and get your traffic in the first place and for the brands. Right. So I guess the ideal situation would be a product or category that is perfectly negatively correlated with the sort of major trends and how media money is spent. And to your point, Q4 is when everybody is spending, they’re spending the heaviest. They typically overspend on cost per customer because it’s now or never and that comes from the traditional Black Friday. This is where the retailer makes their profit or them don’t for the year.
I think in a measured media digital environment that’s probably starting to change and in most cases where I’ve seen it significantly. If you’re buying media when everyone else is in an era where most media is moving to bid based systems whether formal or informal. Informal is what I would consider the Super Bowl. There’s a finite number of slots. There’s one Super Bowl a year if you’re going to be in it you know they’re selling those ads to guys quote unquote bidder. All the way through programmatic display, and AdWords, search engines where it’s bid based on a computerized system. So when there’s a lot of bidders the cost goes up and typically your cost per acquisition goes up.
So if you’re buying media when others aren’t the best example I’ve seen, a few brands that have had the experience and you know for lack of a better word courage to heavy up their spending when everyone else stopped. And that’s in a recession.
Damian You can also put in planning.
Mike Right. There is another well-worn expression where you know everybody knows the first thing you cut when times are bad is marketing You know, which is similar to saying you know well you have to sell when equities go down and the stock market. Well actually you are supposed to do the opposite of that. Brands that get aggressive with the customer acquisition when everyone else pares back on their spend, they’re going to capitalize on that depression or recession in advertising.
Damian Well basically the cost of new customer acquisition is going on sale.
Mike That’s right. Customers are on sale.
Damian We want to buy when things are cheap.
Mike Right. Absolutely.
Damian As good stewards of marketing dollars that’s what we would do.
Mike Absolutely. So that’s a good example. Also, there’s seasonality to your point in various businesses. Some businesses thrive in the summer others go into their low season. So there is an example of seasonality that can impact the business and you could take different strategies. One is it’s time for all of us are furl the sails in our slow season and it’s an uphill battle and you can’t get people to buy snow shovels in August.
Damian Yeah. The two key things are that these things are a point in time, they change. Some of them you can predict. Some of them you can expect. But the most important thing is the ratio of cost to conversion rate because things can get a lot more expensive. You know before Christmas for example. But if the conversion rate goes up more than the cost does actually cost per acquisition will go down. So you have you be very conscious and understand the metrics for your business, be measuring them properly so that you can capitalize when there is an opportunity because you will find trends in seasonality of when it’s most effective to acquire customers.
Mike Sure. And you know again you could have different strategies to approach that. If you sell snow shovels and it’s August that’s where strategy comes back in and says, “Hey so we can’t sell shovels or snowblowers but maybe we need a line of water skis, sunblock, or something that is.
Damian Or bigger ham pans.
Mike Better correlated right.
(Both Laughing)That’s right.
Damian So the next part we had here this is this is a little bit of a deeper topic. So we often talk about attribution in terms of what gets credit for a sale. I want to talk about cost attribution. There are two main approaches to this and they’re just different. So the first one is last touch cost. That’s when you say alright this is the amount of money I spend on this channel. This is how many customers I acquired the last touch from this channel. And an example of that would be paid search. You’re paying a dollar a click and every 100 clicks you acquire a customer. My CPA is a hundred dollars. Right. But let’s take a different way of looking at this and I’m sure you’ll find examples in your own business where we take a cumulative touch approach and that’s where you add up all of the costs of each touch to get a customer.
Let me give you an example, retargeting. Retargeting display that’s when somebody goes to say your website and they see a banner ad and then that person clicks on it. Historically that has a way better cost per acquisition as a channel than other forms of display and even many other channels. But if you think about it because it’s a retargeting touch there had to be other touches before that and likely there was costs and expense associated with those touches.
So is it really fair to say when you look at retargeting as a channel only, that that’s the cost per acquisition, for example, maybe the person first clicked on a non brand click that was ten dollars. Then a few days later they came back on a brand search that was a dollar and then they came back on a retargeting click that was another dollar. So that’s you know 16 dollars versus saying it’s a dollar to acquire that customer and you have to be very conscious of that type of cost per acquisition. Not always the easiest to measure but when you’re a practitioner trying to make decisions about you know is this really adding value. That’s a good way to kind of look at it.
Mike You know a shortcut a lot of organizations take is at the end of the day they’ll true up what they think their actual cost per acquisition on a cohort by cohort basis, for example, those who came in on a last touch of search or retargeting and then add up all the expenses for those individuals that they can measure. Then true that up against the total ad spend versus the total number of net new customers acquired. And then you sort of can work your way into it. I think over time that continues to get tighter.
Damian Actually we covered some of this and another podcast with Gary (Beck) where we talked about getting the marketing mix or the media mix just right. When you do this stuff really well this is where that kind of all plays together because the right media mix could give you the best CPA and you have to kind of look at it from that cumulative touch cost approach versus the last touch cost.
Mike Yeah that’s a good way to get an artificially low cost per acquisition.
Damian Yeah, but the KISS (Keep, It, Simple, Stupid) method that we addressed before that catches everything. So you should kind of look at this a few different ways.
Mike Yeah and I think that’s that’s really important. I mean I would always take it back to sort of where the organization is at strategically, what their goals are. Because that will inform how you should look at it such that you could achieve your goals.
Damian So we are going to wrap this up soon. But I had two or three more questions. So sometimes we get asked well what is you know how do I sign the cost of something that’s a free channel in quotes. Nothing’s free. But for example organic search I wrote a post that’s generating a million hits a year and I wrote it three years ago. Is that a zero dollar cost per acquisition?
Mike Yeah. In reality, most organizations aren’t tooled to measure in that way. Probably a good business opportunity to create that measurement.
Damian Yeah, we’re going to cover this in series the part number five. There’s a difference between spending on customer acquisition and investing in customer acquisition. I think that kind of touches part of it. But you know traditionally I guess you would say is what did you spend on the resource that produced that content and what kind of dollars do you invest to maintain that content. Via the website or optimizations to that content over time and maybe even promotion of the content. Another good question is do I count the cost of goods sold in cost per acquisition?
Mike Well I would say by definition cost of acquisition can’t include the cost of goods sold. So that’s a good way of measuring contribution margin or profitability but it’s not actually the cost that it was to acquire.
Damian Yeah I totally agree. I mean the simple way to think about it is this thought experiment, you have a factory that produces a widget at ten dollar cost and then you just switch to a more efficient factory that produces it for five dollars. The cost to acquire a customer is going to be the same because they don’t really know what factory costs are anyway. So it’s not going to change. So it definitely is a different metric and I don’t think you should include it in your cost per acquisition.
Mike Yes it’s very rare that you see it but I’ve seen that once or twice.
Damian So last good one. This is this is one that I see a lot of people miss net customers and what we mean by that is you have to net out fraudulent first-time purchases and returned first time purchases. And I know that that last one is a little controversial. So we could talk about that one.
Mike Yeah. I would distinguish between returns and fraud. Fraud absolutely you have to because it’s not real. However, if an individual responds to your marketing into your message makes you know pulls out a credit card puts product in cart completes a transaction takes the product home or gets it shipped to them. That’s all quite real right. Those are all hurdles in customer acquisition that you’ve really cleared. You know the world changes when someone puts a credit card in and it works because they want the product.
So even if there is a return on a net new customer we would agree that you no longer have a customer acquisition in the sense that we have somebody who bought the product and kept it. But I would say I would be reluctant unless the return rate was abnormally high, which is indicative potentially of the source is a problem and maybe we’re starting to border on the fraud issue which is very real it used to be a tremendous problem in affiliate marketing. But an individual that bought and returned simply because it was the wrong size, the color didn’t look the same as it did on their computer or their phone.
Damian That’s a big one.
Mike You know those are legit issues but the solution to those problems lies elsewhere. For example, we had a customer that had an inordinate number of returns because the way they presented sizes in the US and the UK was confusing and folks kept picking the wrong size. So there was nothing really that would change in the acquisition because the acquisition was actually working. They just needed to improve the presentation and communication so that folks can get the right size and when we solve that problem returns went down and we had a legitimate customer acquisition story there.
But I think you see for example an affiliate that is generating an inordinate amount of returns. One thing you might see and again this starts to get to fraud, at least if it’s not transparent to the person buying the advertising, it might be incentivized traffic. You’re getting some incentive for clicking and possibly even incentive for buying. That could work too but it’s not working if you’re getting an inordinate number of returns. You know a 30 or 40 or 50 percent return rate. You know you have a problem. And so those do need to be excluded. But that’s a really good point is a lot of brands may not know dissect if it was a return did I still succeeded acquisition. It’s not to say that our total goal for the business of adding customers that buy and spend more has been met but a customer who goes through all of those hurdles is one that we succeeded in acquiring and so thought should be given to that.
Damian Absolutely. You know to kind of wrap up when in doubt put your owner hat on and just ask you know what would you do.
Damian Thanks so much Mike. This was a fun and exciting discussion. I love this topic and this is what separates…
Mike It’s a great topic.
Damian This is what separates the average from exceptional. So looking forward to doing the next part three of the series.
Damian If you enjoy today’s episode we ask you please leave a and write a review. Or better yet share with another marketer. Be sure to subscribe to the podcast for new episodes. Also, check out the show description for complete show notes and links to all resources covered in today’s episode. If you’d like to speak to someone about any topics covered in today’s episode please visit buyerenomics.com and start a chat with the BG team today.
Host: Damian Bergamaschi
Special Guest: Mike Ferranti
Mike is the Founder and CEO of Endai, brings 20 years of marketing, analytics and technology depth. He has developed solutions and software to major brand clients and niche marketers alike. Mike is a recognized thought leader in the database, search engine, email, and direct response marketing. He provides commentary and analysis to the media including Bloomberg TV, Brandweek, and DM News. Mike earned an MBA from The University at Albany and an Entrepreneurial Masters from the Massachusetts Institute of Technology