Any time I consider working with a new client to help with their digital marketing efforts, there is one key thing that I always want to know:
How much a client is worth to them for a lifetime of patronage?
Business is simple (but not easy!). The bottom line is determined by revenue, minus expenses, which equals profit.
Digital marketing follows the same principles. As a digital marketer, it is my job to determine the best way to spend money so that it generates more in profit than it costs.
Before getting into the math, let’s identify the key components of the equation. It’s simpler than you may think.
1) Average Revenue per Sale (or Average Sale Value)
To calculate your average sale value, divide your revenue by the number of transactions you made.
The quickest way for most companies to do this, is to divide the revenue by the number of invoices sent out in any period of time. Unless you changed your pricing or business model drastically, a good benchmark is about 12 months. But this may be different depending on the business.
If you did revenue of $1,000,000 and processed 1,000 invoices (or transactions), your average revenue per sale is $1,000.
Revenue ÷ Number of Transactions = Average Revenue per Sale
2) Profit Margin
This one you’re likely familiar with. It’s the simplest business equation.
Revenue – Expenses = Profit
We will use this one to help determine the lifetime value of a customer, which will help us know how much we can afford to pay to acquire a new customer.
3) Lifetime Value of a Customer
The lifetime value of a customer is determined by knowing how much each customer typically spends with your company over the lifetime of their patronage.
For example, if you are a general contractor, and your clients hire you 10 times over 5 years until they eventually stop needing your services, and your average sale value is $1,000, and you operate at a 50% margin, you know each new customer is worth approximately $5,000.
Lifetime Transactions x Lifetime Revenue – Lifetime Expenses = Lifetime Value of a Customer
4) Allowable Acquisition Cost
If we know that each new customer is worth $5,000, theoretically, you could spend $4,999.99 and it would still be profitable to do so.
That being said… there is always risk.
As with all business transactions, there are risks involved. What if your business suddenly slows down or dries up and customers stop coming back? What if you get sued and it throws all of your metrics out the window? What if the market turns and suddenly nobody needs what you sell?
We need to manage risk and hedge our bets.
Let’s say you’re a successful dentist that has been in business for 20 years.
There are no signs of changes coming to the market, the business could even run, for the most part, without you if it had to. Overall, you feel fairly confident that, barring a disaster, your risk of negative change is low.
Since you have a higher threshold for risk, you can probably spend a little more than someone who is in an industry/market that isn’t quite as stable.
That being said, there are still risks. You want to build in padding and make each new customer profitable as quickly as possible.
You don’t want to risk your money to acquire customers unless there is enough margin for error in your profitability, and you don’t want to spend 20 years recouping your cost to acquire them.
Let’s be conservative and say, even with a lifetime value for each customers of $5,000 (profit), you only want to spend up to $1,000 to acquire them – just in case something happens in 2 years and you don’t get a chance to recoup your investment.
While that’s fairly modest, it’s still a lot to pay for a new customer. You likely want to spend closer to $100, but that may or may not be possible depending on your industry.
Let’s do a breakdown of a semi-realistic budget.
Widgets & Co. – Theoretical Case Study:
Widgets & Co. does $1,000,000 in annual revenue.
Their average sale value is $1,000.
New customers typically buy 10 times over 10 years during their lifetime, which works out to a $10,000 lifetime revenue.
Their profit margin is 30%, meaning that each new customer is worth $3,000 profit over their lifetime.
Let’s be cautious businesspeople, and say that we are willing to spend $500 to acquire a new customer (acquisition cost). This gives us lots of room to mitigate risk, should something happen.
We also need to remember that new customers can lead to more referrals, but that’s beyond the scope of this equation. Let’s keep that potential new revenue out of the equation for now.
We now know that we can spend $500 to acquire a new customer.
The fun stuff:
Their goal is to acquire 240 new customers in the year, or 20 per month. They are hoping for an additional $240,000 in new revenue, and they know their customers typically only buy from them once per year at an average of $1,000 per transaction.
Their online presence is pretty bad, so they need a bit of everything. The breakdown is planned as below:
- Social media management: $1,000 per month
- Pay-per-click advertising: $1,000 management plus $5,000 ad spend per month = $6,000 per month
- Blog content writing: $125/post x 4 posts per month = $500 per month
- Email Marketing: 2 email blast per month using content from the blog and exclusive, subscriber-only promotions = $400 per month
- Search Engine Optimization: $900 per month
- Basic Graphic Design: Graphics, business cards, holiday cards and some brochures = $300/month
Total Monthy Spend: $9,100
Annual Spend: $110,400 ($9,100 x 12 months)
Wow! That seems like a lot!
Keep in mind, however, that it’s roughly 11% of their total revenue. It’s not an unusual percentage for an ambitious company, although it is on the high side compared to general business benchmarks.
Let’s say they exceeded their target by 10 new customers, for a total of 250 new customers that year. Were they profitable in their efforts? Let’s do the math.
New customers = 250
Lifetime value per customer = $3,000
Total Lifetime Value = 250 x $3,000 = $750,000
Acquisition Cost (price paid to market + find new customers) = $110,400
Grand Total: $750,000 – $110,400 = $639,300
Return on Investment (ROI) = $639,300/110,400 = 5.79 times, or 579%
Let’s say it takes them 10 years to get their lifetime value of a client back, that works out to 57.9% return on investment per year (non-compounded).
That means, for every $1 invested in their marketing, they got $5.79 back.
Sometimes, it’s not the immediate ROI that counts, it’s the lifetime value. Once you have a solid understanding of how much a customer is worth to you, you can really start marketing. If you have no idea, you’re likely to lose money. Guesswork rarely gets results.
I work hard for my clients to generate and prove a measurable return on investment. The best part about digital marketing is that everything is measurable.
For example, we can track how many phone calls and leads you get, and from where they originated, using services like CallRail. CallRail gives you a pool of local and toll-free phone numbers. With the use of tracking parameters added to your urls, a different phone number will be displayed when visitors land on your site from social media, or paid advertising, or your email newsletters. That’s only the tip of the iceberg. If they leave your site, then revisit your site later from memory, CallRail can track that back to the original time they visited your website, which is called multichannel call attribution.
We can also look at Google Analytics to understand how many people are converting to paid customers, and how much we paid to attract them.
Google AdWords, Facebook ads and other forms of PPC Advertising can make a straight line between spend and results.
Our best clients do between $1 million and $5 million in revenue per year, but we can work with smaller customers too.
My team and I work with many kinds of businesses. We work with professional service firms in accounting, law, real estate, architecture, finance, and post-secondary education; with brick and mortar stores, including hair salons, retail and food products; and a large part of our digital marketing clientele are in the home and commercial trades industry, which include as general contractors, electricians, plumbers, roofers, and other similar companies.
If you’re interested to see how we can help generate an ROI for your business, call us for a free consultation at 1.888.509.9995 or use our contact form and we’ll get back to you quickly with more information.
We tend not to work with clients unless we can clearly see how we can add to your bottom line. Get in touch to find out how we might be able to help.