NEW CUSTOMER ACQUISITION: MARKETING COST
VS. BUSINESS INVESTMENT [PART 5]
- The effectiveness of all marketer’s performance is tied to the rate of return they generate on the marketing budget over a defined period of time.
- If you aren’t measuring the revenue tied to your marketing budget, you are very likely “spending on” customer acquisition vs. “investing in” customer acquisition.
- There are 3 main ways to measure the Return on your marketing budget (ROAS, ROI, True ROI), You need to be fluent in all three metrics for your business.
- Understanding the cash flow impact of your marketing spend is really important to be able to define the ROI.
- Once you know what your metrics are you can ID the key “drivers” to optimize your ROI
Part 5 of a 5 Part Series
Need to catch up? Here are the first 4 parts:
What follows is a lightly edited transcript of Episode 13 of the Inevitable Success Podcast with Damian Bergamaschi and special guest Mike Ferranti. (Listen Here)
Damian So earlier you and I were talking about; what is the role of a marketer in an organization. Fundamentally, how do we measure the value that they add to the organization? And you said something interesting about spending investment marketing dollars versus investing marketing dollars and how oftentimes we put the wrong label on different marketing spends
Mike Yeah, I think the number of times that I’ve heard people talk about customer acquisition in particular, and say “I’m spending a lot on customer acquisition. I have this much to spend on customer acquisition,” I think that’s indicative of their posture and point of view, and how even they feel about it. It’s probably a reflection of the experience that they’ve had with customer acquisition, and you could probably imagine what that experience is like if they’re characterizing it as “I’m spending on it” as opposed to “I’m making investments in customer acquisition” because as we know, let’s face it, customer acquisition is hard. It’s very expensive, and since we’ve moved to a bit-based world with the rise of digital, now the marketers are at each other’s throats, even more, bidding up costs of customer acquisition. And as everything becomes bid-based, we can only expect that decline. And I think the pivot that you can make as a marketer is if you learn, measure, and have the development experience so that you could truly make wise investments in customer acquisition
Mike Now, sometimes that’s just reduced to testing, which I suppose, to be fair, that that’s some level of investing. I’m going to invest in this test. I’ll learn something from it, and then I’ll either invest further or not. But testing is a form of investment. So those who think they only spend, that’s an investment if you’re doing really thoughtful testing. But I think the main difference- maybe it’s a difference between “I have a spend that I make on customer acquisition” versus “I’m making an investment in acquiring customers” really gets to the value of those customers now and over time. Investments are more likely to have a payoff period. Expenses sound like something you did one time and put it in the rear-view mirror. And I think you could acquire customers both ways, but if you’re going to try to scale, and you’re going to try to grow more thoughtfully than the guy who bids the most perhaps, or bids the least maybe even more likely, you have to have an investor’s mindset.
Damian Absolutely. So when you’re speaking about investing and getting a return on investment, there’s a few key ways that you could measure that, and none of them are really wrong. They just are, but I figured we could go through the three of them. There may be a few others, but these are the common ones. The first one is commonly called ROAS, and that stands for Return On Ad Spend. And basically what that one is looking at is how many dollars back do you get on your ad spend. So the thing that’s interesting about that one is, I see it used a lot in less measurable media. For example, the display uses ROAS a lot. And one thing that’s interesting is if you see 100% return on ROAS, that means you just got your money back.
Mike On the advertising.
I think what you get at, and obviously we’ve been in countless meetings where somebody has been talking about their killer ROAS, and I think there are situations where ROAS is used as sort of a justification or “I don’t have a good metric on return on investment.”
Damian It’s like a euphemism or something like…
Mike But it’s the best number I can put on my PowerPoint. And so that’s a case where I think ROAS, – there are definitely folks listening to this podcast that will say “It’s a yawner”. It’s not exciting, but on the other hand, I think ROAS is a metric, and I think it’s probably your point or part of it.
Damian ROAS, is a metric that should be evaluated, should be looked at, and if you think about it as a step in the value creation process, it’s meaningful. The first thing you got to do if you’re going to generate a positive return on investment is you have to pay for the media. If you don’t get that far, well you’ve got a problem, right?
Mike Sure. Yeah, and sometimes it’s even less than that. Sometimes it’s more like 15 percent. You say it drives the 80 percent, but it’s even bigger than that. It drives all your profit.
Mike And until your return gets substantial enough that you have ROI, Return On Investment, that’s what you have. You have ROAS. So I think it’s the best thing that folks can do is, instead of, gravitating towards “well I’m a ROAS guy” or “I report on ROAS.” And it’s the same guys that always report on ROAS. And we’ve only seen that for a decade. But it’s just part of the journey in developing scalable net new customer acquisition. So it’s OK for what it is, but the question that should be asked, “okay that’s step 1. What’s our strategy from her?. Where does that go next?”
And a lot of times if you’re using ROAS to justify, or as the first measurement in what happened with our ad spend, you may be very successful to say “look, ad spend produced some kind of a return there. It had some economic outcome, and there was some value there.” But I think when you leave it at that and declare victory, well that’s not economically viable for long.
Damian Well, I actually think you could use ROAS forever. You just have to know what that means for your organization. I just think that it colors the conversation. I think it biases it, personally.
Mike If your ROAS is high enough, it could be an ROI.
Damian I think it biases no matter what because if you’re making a 100 percent return on something, you’re already in your head you’re like, you can start shopping for Ferrari’s. But in reality, you’re really just getting your money back.
Mike I think, for me, if you leave it at ROAS, I don’t have a problem when somebody brings it up, and I’m looking at the marketing budget, but it’s got to go somewhere. It’s the beginning- because, one of the expressions I love the most, and I always look for, some of the best marketers I’ve met in the world have used this. You have got to look for signs of life, and ROAS is a great early indicator as to if there are signs of life. I mean arguably, before that, there’s things like clicks and opens and deliveries and response rates. But ROAS is a great sign of life. If you have a positive ROAS, greater than 1, well then you covered the cost of the ads, and the ads are now free. And what came after that, you ought to be really interested in that if you’re serious about scaling your business because the problems that come next have to do with the conversion rate, and the experience they have with you, and the site, the product itself.
Damian We’re definitely going to go deeper into that. I mean, I think the thing is, there’s a spectrum here on soft to hard as far as ROI is concerned, and ROAS is typically one of the softer ones. And it could be helpful for signs of life.
Mike Right. Takeaway #1, I guess, is ROAS is not ROI, and that’s OK.
Damian Well put. The second one type is called ROI, but normally what this method does is, is it doesn’t account for the CPA. It’s just looking at the dollars brought back in. So oftentimes, this is basically ROAS without the 100%. So if you spent a dollar and got a dollar back, your ROI would be 100 percent. Actually, you know what? I think I made a mistake on that one. I’m going to have to edit that out. Basically, let me just spitball with you real quick.
Mike The return would be zero.
Damian Yeah exactly. The return would be zero.
Mike Sounds like we should leave that in.
Mike I don’t know. It sounds real.
Mike It is real.
Damian It happened.
Mike You guys heard all that.
Damian And honestly that’s how most of these conversations go like, the first time. I’ll be clear, I’ve been doing this for a long time, and I still think about it. So the next one is typically called just ROI: return on investment. This one will typically account for your cost per acquisition but not your true profitability because it won’t take into account the cost of goods sold or your profit margin. So this one would say “I spent $100. I got $130 back. So I take out the $100 I spent. I have 30 dollars. So I would say, I made a 30% return on my investment because I got my investment back and then 30 percent more. However, it’s not really profitable. Or that’s not a measure of profitability, it’s just…
Mike For the business.
Damian …after you got your money back, what was left over.
Mike Yeah, it’s your gross return on ad spend….kind of like the next step after ROAS.
Damian Yup, and that one actually, I think, is really helpful because the next one after that is True ROI, but that one can be more difficult when you look at an entire campaign because you may be selling different products with different profit margins. So just pure ROI actually, I think, is a helpful hard benchmark. And I use that one a lot, and I know a lot of other marketers do too. The next one is really interesting now, and that’s what we would call true ROI. Sometimes I call it Bank Statement ROI because that’s actually how…
Mike That’s the part you get to take home- or take to the bank.
Damian Exactly. And it’s basically an extension of ROI, but you just take out your COGS, your Cost Of Goods Sold, and that tells you I spent a $100 to acquire this sale. I had $30 in ROI. And then when I take out my COGS maybe my margin is 50% or something like that. You may be slightly underwater on that one, but now you know. That’s what the true ROI was. It wasn’t profitable on that first sale.
Mike Yeah. So for the daring CFO, that’s listening today to a marketing podcast -because we’re getting to the things that the CFO’s office is watching and budget improving- It’s almost like what we’re talking about is your gross margins on your costs which is ad spend and the cost of the product. So you’re getting to gross margin or contribution margin. And then true ROI or what you take to the bank, after all, is said and done. You’re getting to your earnings or your EBIT. And so obviously, that’s much more important. Of course, everybody would ideally love to get right to EBIT, and that’s where we start to see some challenges because of the very very high cost of customer acquisition.
And so, what it also gets to is another financial, or even accounting concept, which is the matching principle. So for the marketers out there, this is what your CFO’s thinking. They’re trying to match their revenue to their expenses. And a lot of organizations, especially public companies, are going to be subject to and report under generally accepted accounting principles, or GAAP. And so when they spend a dollar on an ad, they want to be able to match that back to a dollar in revenue or some dollars in revenue. And I think this is where the rub comes from finance and marketing. So the C-suite is driving for growth. Growth comes from, of course, maximizing the value of the customers you have and growing great customer relationships, but it also comes from getting net new customers and maybe even the best ones while we’re at it.
But that’s where there’s this bifurcation that is really worth talking about because when you go to match that dollar, the question is when do you match it? And in a public company, you might want to match it in the period that you’re reporting on. In a private company you might have more latitude, but the awakening I would say that’s been going on in CRM and in businesses due to digitalization and increased measurement is, when we spend a dollar on a customer that we earn a dollar back on, and our gross margin or our ROI is break even, that same customer turns into an extremely valuable asset over time because a good customer will continue to spend especially if we do a good job or a great job in marketing and create a relationship with them.
Damian So you actually also touched on a really important point that actually you cannot remove from the conversation when it comes to ROI which is time horizon. I mean, technically you need three things to have an ROI. You need to have what you started with, what you ended with in terms of dollars over a period of time. So a lot of people kind of forget that last part.
Damian But what is your ROI in a day, on the first sale, you can measure the ROI over a month, a quarter, a year, five years. You have to make a decision on that.
Mike Sure. It’s like we said when we talked about ROAS, you should look at that, at all of those data points. So if an organization understands that, well this program at this juncture is able to pay for the advertising, it’s one of the reasons ROAS exists because well that’s pretty important. If you’re going to be a brand you want to be out there, you need to have awareness. You need to carry your own message, and if that message pays for itself, that’s an important step. But if that’s where it stops, well that’s just not going to work long term. So, lifetime value can mean a lot of things. This is the new metric, I would say. It is not entirely new, but a lot of organizations haven’t been able to measure lifetime value.
Damian Right, so the metric that always existed that you can now affordably measure.
Mike Well put. And so for the organizations that are new to it, they’re starting to look at lifetime value and figure out well, what period of time does it make sense for us to essentially finance that customer at some cost to capital? That’s what they’re really doing, at least the more sophisticated organizations. But if you can’t measure it, and it’s been very hard for many many many organizations to measure, then all of this isn’t even a conversation and you talk about ROAS.
Damian It’s interesting too. I know there’s a psychology study where they say that when things are going good, people will measure stuff constantly. But when things are going bad, we tend to not look at stuff, ignore it or…
Mike Look away.
Damian …choose to look at– put your head in the sand. And I think that probably happens a lot, hence the spending versus investing mindset.
Mike Sure, sure. Look, we’ve had many conversations where we bring the analytics and help organizations to effectively and cost-effectively measure and then take action to grow their customer value, their lifetime value. We could provide analytics and measurement to really define, “What is that horizon that we should call lifetime value or customer value?” It’s not just the life of the individual on Earth. It’s the realistic expectation of their lifetime with our brand and our product right before they move into a life stage potentially where they no longer are consumers of that product. For example, when you don’t have young children you don’t buy children’s wear anymore. So that’s a consideration, but the other consideration that we touched on was, “What is the lifetime that we can realistically finance some cost of customer acquisition on some expected value that will get out of it over time.
Damian Actually to that point, there’re three time horizons that I’m very partial to that I think are very very hopeful. The first one is the first day because that gives you a sense of, for all the people that just buy once, and there’s a lot of them, where do you stand on that? Because if you can be profitable on the first sale, you really have something special because you can get back a break-even or a profit on every customer that you acquire. And then some of them buy more and more times than this big return on investment when you have a campaign like that.
The second one that I like a lot is 30 days, and this one is more pertinent to, I think, entrepreneurs or owners. And the reason why I like this one a lot is because that’s typically your net terms. So you can pay media, borrow it for 30 days, get the money ahead of time, and then if you already make the money back, you can literally have somebody else finance that customer acquisition. And if you’re an entrepreneur, that’s a really big deal because you can scale up with that kind of a model.
And the last one that I like a lot is a year because just from what I’ve seen, I know you’ve seen this too, that it’s typically most of the lifetime value or a big part of the lifetime value of a customer happens in the first year. And we just tend to plan for budgets annually. So it kind of helps to…
Mike Yeah, that brings up two complications. One is there’s a year, but you might be on a fiscal or a calendar year.
And if you’re in November, the year that you’re looking at often becomes 2 months. So that’s a challenge.
Damian: [00:19:38] Yes.
Mike And that requires another level of analytics, and it requires a certain discipline to do that segmentation and really come up with numbers that are meaningful and dependable and that finance could buy into. So that’s one challenge. The second challenge is, depends on your business. If your seasonality like many retailers is at the end of the year, most of your customers come in at the end of the year. Your year ends days after your biggest customer acquisition. Well,s that’s going to be challenging. And that could force you into this mode of “I am spending on customer acquisition. I am not investing.” Meanwhile, the investment opportunity that’s beyond that horizon is potentially magnificent.
Mike There’s one more, I think, that we can add to that, and that is it has to do with the inter-order purchase time for your product. I like to sort of get these things into kindergarten speak. How long is it realistically before you’re likely to buy that product again? So if it’s toothpaste, it’s however many days before the tube runs out. And that’s not a lot if you’re brushing twice a day. On the other hand, if it’s a motor vehicle, you’re not exactly getting a new car every two weeks. And there are many many things in between. So all of these are major considerations where we would challenge organizations to think about how should we really be measuring and reporting on both the present value of the business’s activities as well as the future value of those activities if that organization has the tools, the discipline, and the metrics to make that a viable investment thesis in the first place.
Damian You know it’s funny. The more we get into this conversation, I almost kind of have a “get real” with what is a marketer, and I think ultimately maybe they’re more like investment managers. They have to make investment decisions than anything else.
The really good ones. Yeah. So, one of the other things that naturally come up when you measure your ROI in whatever way is good for you is, that’s what it is: “What should it be?”
Mike Yeah. I think that that does get another skill that goes beyond. We tend to talk about the measurement, the analytics, the ability to even know what that value is both now and over time. But the other part is that the marketer has to have the communication skills to credibly establish that value and illustrate and simulate for the rest of the organization that has maybe an entire career of short-term thinking when it comes to marketing and instant gratification expectations when it comes to marketing especially if some of that management came from a different category or an altogether different brand at a different stage in its development.
These are things that can become essentially lenses with which they are viewing all of the metrics, and it requires a level of communication from the marketer. And the senior most marketers need to really be able to have these conversations to create more meaningful and more strategic value for the organization over time. That’s how you build the best organization. Typically it’s when you make longer-term decisions, not just everything is a short-term decision.
Damian Yeah. If you have the ability to think long term, it’s absolutely a competitive edge. I’ve seen that over and over and over and over again. So I know you got to wrap up soon, Mike. I just wanted to hit on a few of the key things that could help improve ROI that we’ve seen on new customer acquisition.
Mike Let’s do it.
Damian So, the first one is, you have to identify what is the true driver on your return on investment. So one example is, maybe your cost of acquisition is too high. So if that’s the case, and the way I would look at that is relative to your other channels you’re doing or your industry. You could pay less for your bids for example or negotiate better rates on your media. Remove waste; that’s a huge one. And then also, you could stick to more efficient channels too at large. Those are all things that you could do -not an exhaustive list but things to do to lower your cost per acquisition.
Mike Yep. And that gets to there are two sides. One you could lower your cost and two, you could push up your revenue whether that be price or the suppression of discounts.
Mike Which is a huge opportunity for most organizations today. And it also gets to…
Damian That’s the first one is, can you raise your price?
Damian That’s an easy one if it’s possible.
Mike Yep. That also gets to product. So we have clients that have actually introduced new products because the new product would give them the latitude to command price over the product that that customer’s previously buying. So there’s basically an upsell that got built in through the adaptation of products and the introduction of new similar products.
Damian Or even just look at your product line today. Some of the stuff you probably have much higher margins on than others, and that might be a more effective product to focus on for new customer acquisition to get your true ROI up. Lastly, you can also improve conversion rate. You can do AB testing and work on your message and offer and creative because that will drive down your CPA. So you’ve got to figure out what is the lowest hanging fruit or the thing you have the most impact on out of any of these to improve your ROI.
Mike So maybe a good way to wrap this conversation is, once you have clarity on the drivers and the metrics that you can use to optimize ROI whether it’s product, whether it’s price, whether it’s cost on the media and the marketing, you can then start to look at it through multiple lenses, I think is our biggest takeaway. And that is, I think you said earlier, day one, over a month, a quarter, a year, two years. For some brands, three years might be relevant, but this all can give us a new sort of perspective that, if we have those metrics, now we can begin to become more of a long-term investor rather than a short-term spender when it comes to customer acquisition.
Damian We don’t want to spend all of our ROAS in one place.
Mike Well put.
Damian Alright, thanks everybody.
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