Determining The Right Customer Cost per Acquisition For Your Business

Trying to figure out your paid search budget? Clearly defining your acceptable cost per acquisition for new customers is the best place to start.

All things being equal, the more your company is willing to invest to acquire new customers, the faster the customer base will grow.  However, there is also a direct relationship with your desired number of new customers and the amount you need to invest to obtain them. Deciding how much to invest in acquiring each new customer depends on the value of your customers over time, as well as your overall business goals. 

Let’s Start with Annual Value

There is a lot of talk about the “Lifetime Value of a Customer”.  Understanding the lifetime value is important, but most businesses don’t have the luxury of waiting a lifetime to get a return on investment. Thinking more in the short term, let’s understand the annual value of a customer.  Take a home cleaning business as an example. The annual value of a new home cleaning customer can be figured out like so:

Average Transaction Amount: $100
Average Transactions per Year: 26
Gross Revenue per Year: $2,600
Average Profit Margin: 50%
Annual Gross Profit Margin: $1,300

In addition to the value of one customer, you should also consider how much of your new business comes from customer referrals.  If 50% of all new business is the result of customer referrals, for example, you can assume that every new customer generates another customer. 

Once you’ve done the preliminary math, then you can wisely determine how much of that annual gross profit margin you are willing to invest.

So What Does All of this Mean for My Paid Search Campaign?

To obtain an optimal position in paid search results, one key variable is the amount your business is willing to pay “per click.” The more you’re willing to pay per click, the higher your search listing, which in turn can lead to more visitors to your website or landing page.  More website and/or landing page visitors mean more leads and, ultimately, more customers.  But paying too much on a cost per click basis may result in paying too much per customer acquisition. 

In order to balance overall business growth goals with financially justifiable customer acquisition costs, business owners and marketing executives need to understand the percentage of “clicks” that result in leads as well as the percentage of “leads’ that result in sales. The higher these percentages, the lower the cost of customer acquisition.  To follow our example a little further, let’s assume our home cleaning business embarks on a paid search campaign and gets the following results:

First Campaign
Average Cost-Per-Click: $3
Click-to-Lead Percentage: 3% (1 out of every 33 website visitors call, email or fill out a form requesting additional information)
Cost Per Lead: $99 (33 visitors X $3)
Lead-to-Sale Percentage: 5% (1 out of 20 leads becomes a customer)
Cost Per Customer: $1,980 (20 leads X $99)

Our conversion rates look pretty solid, and many marketers might be fooled into thinnking they’ve done their job. But because we took the time to determine our Annual Customer Value earlier, we can see quite clearly that our business is losing a lot of money for each customer acquisition.

Armed with that information, our home cleaning business and their search marketing team analyze, adjust, and optimize their campaign and give it another try:

Second Campaign

Average Cost-Per-Click: $3
Click-to-Lead Percentage: 10% (1 out of every 10 website visitors call, email or fill out a form requesting additional information)
Cost Per Lead: $30 (10 visitors X $3)
Lead-to-Sale Percentage: 20% (1 out of 5 leads becomes a customer)
Cost Per Customer: $150 (5 leads X $30)

Clearly, the second, improved campaign is now well worth our investment.

The moral of the story is you need to know your numbers if you want to grow your business profitably using paid search. Taking the time to assess the annual value of a customer will help you gain an understanding of an acceptable cost per customer acquisition. And knowing your campaign’s conversion percentages along the prospect-to-lead-to-customer continuum will make the art of marketing more of a science.     

Tags: paid search