It’s easy to be overwhelmed with data. Each paid traffic platform has its own reporting, third-party tools like Google Analytics add more options and complexity, and various attribution models add to the confusion.
With all of this data available, it’s easy to focus on the wrong things. I see this all the time. Instead of focusing on business management metrics, people focus on account management metrics like cost per click, click-through rate, cost per thousand impressions (CPM), etc.
In my experience, the critical detail that is lost is that account management metrics are important only within the context of business management metrics. Let me explain.
One word of warning — this will seem difficult at first. Stick with it. Understanding and internalizing this framework is critical for success with paid traffic.
We only need to know three numbers to manage an online business intelligently:
- CPA,
- AOV,
- and LTV.
If you understand these three numbers you understand the economics of your business. Let’s look at each individually and then put them into context with examples.
CPA is cost per acquisition. This is what it costs to acquire a (paying) customer.
AOV is average order value. This is the average spent when someone becomes a customer (i.e., the first sale).
LTV is lifetime value. This is the average amount purchased by a customer over the lifetime of the relationship (or some predetermined time frame that is appropriate to your business).
Let’s look at some examples to provide some context.
Example #1 — paid ad directly to a low-cost offer ($47) with an order bump (+$20) and one upsell (+$97).
CPA would be the amount spent on paid ads to generate a sale. Let’s assume it costs $1 per landing page view of our sales page, and we convert 1.5% of landing page views to sales. $100 in ad spend would lead to 1.5 sales. Our cost to acquire a customer would be $67 ($100 / 1.5 = $67).
We don’t know if $67 is good or bad financially until we calculate AOV. Using the same example as above, let’s assume that 25% of buyers choose the bump offer, and 10% of buyers choose the upsell. AOV for 100 customers would be 100 x $47 ($4,700) + 25 x $20 ($500) + $97 x 10 ($970) = $6,170 / 100 = $61.70.
Now we have two pieces of the puzzle. It costs us $67 to acquire a customer, and we recoup $61.70 with the first sale. That means we’re losing $5.30 every time we acquire a customer. At first glance that seems bad financially — however, we won’t really know until we calculate lifetime value.
Let’s assume that we have three back-end offers that we sell over time by email. Those offers are $297 each and, on average, 15% of our customers purchase one of those offers within a year. LTV would be 100 x .15 x 297 = $4,455 / 100 = $44.50.
Now we can calculate the financial health of our business. We spend $67 to acquire a customer (CPA) who spends $61.70 immediately (AOV), and an additional $44.50 within a year (LTV). If we were to acquire 1,000 customers in a year, we would spend $67,000 to acquire those customers, recoup $61,700 in initial (front end) sales, and then generate $44,500 in sales over the year. Our gross profit would be $61,700 + $44,500 – $67,000 = $39,280. “Losing” $5.30 on the front end doesn’t look so bad when we see all of the numbers.
For context, break even CPA vs. AOV is the Holy Grail of direct response marketing because that allows businesses to acquire customers for free. However, it’s very common for established direct response businesses to “go negative”, meaning paying more to acquire a customer than is initially offset by the first order, because they know the lifetime value of their customers and can make those decisions intelligently.
This example is not meant to suggest that paid traffic only works if it leads immediately to a sale, however. Let’s look at another example, this time with lead generation on the front end instead of a sale.
Let’s assume we have an Sphere of Influence inspired multi-page-presell-site that leads to an opt-in. After that opt-in there’s a seven-day email soap opera series leading to a $295 offer, followed by a year of (mostly weekly) emails that include three other $495 offers. For simplicity’s sake, let’s say that our cost per lead is $5, we convert 5% of leads for the first offer, and an additional 5% buy at least one of the other three offers within a year. Finally, we invested $20,000 in paid traffic for lead generation.
With those few numbers we can calculate the financial health of the business. Let’s take a look.
If our cost per lead is $5, spending $20,000 acquired 4,000 leads.
Five percent of those 4,000 leads (200) purchased the initial $295 offer, generating $59,000 in sales.
Over the rest of the year, another five per cent (200) purchased a $495 offer, generating $99,000 in sales.
To calculate CPA we need to know that it cost $20,000 to acquire 4,000 leads and five percent of those leads (200) became buyers after seven days. $20,000 / 200 = $100 CPA.
Calculating AOV is simple because there’s only one $295 offer (no bumps, no upsells), so AOV is $295. The same is true for LTV (one offer, $495).
Is this business financially healthy? It spent $100 each to acquire 200 customers who purchased $59,000 initially and $99,000 during the following year. Or, in simpler terms, this business spent $20,000 to generate $158,000 yielding a gross profit of $138,000. (I’d like to own this business all day long…)
I know what many of you are thinking — your business doesn’t fit this model perfectly. That’s OK — what matters is the conceptual framework:
- How much do you spend to create awareness of your business?
- How many customers / clients do you get in that same time frame?
- How much does each customer / client spend initially?
- On average, how much does a customer / client spend over the course of a year or more (whatever is appropriate to your business)?
If you have those numbers you can calculate the financial health of your business (from a customer acquisition perspective) reasonably accurately.
Don’t get caught up in decimal place precision unless you have data for a lot of customers over a long period of time. Instead, look at these three numbers as guidelines to establish the right direction.
The goal is to provide so much value that your AOV and LTV are so high that CPA becomes effectively irrelevant. The moment you can pay more to acquire customers than your competitors everything changes.
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