Numerous consumer internet businesses employ Lifetime Value formula to assess viability of their business models and marketing campaigns. The concept is rather simple: customer lifetime value (LTV) must exceed customer acquisition costs (CAC or CPA), and as long as the LTV is higher than CAC then marketing teams are delivering positive ROI to a company. However, the overall marketing unit economics, as often it happens in business, can be misleading and require further detailed analysis.
STARTUP FINANCE MADE EASY by oleksiy nesterenko provides a simple framework to analyze the overall CPA, which would allow you to gain valuable insights into your marketing campaigns and, if needed, make appropriate adjustments. The framework can particularly be useful to businesses that are expanding their operations, as not all of the marketing channels can be scaled up rapidly.
The proposed framework involves three levels of the overall CPA “dissections”:
• Level I: breakdown the overall marketing expenses into money spent on attracting new customers versus bringing back repeat customers
• Level II: for each of the customer types (new customers vs repeat customers) breakdown the expenses into paid and free channels
• Level III: within paid and free channels finally breakdown into major channels, such as search engine marketing (SEM), affiliate marketing, offline advertising, organic search engine optimization (SEO), CRM, and direct to site visits
To illustrate the application of the proposed framework, let’s assume that a consumer internet business is able to generate an LTV of $30 per customer with an overall CPA of $18.70. On the surface it appears to be a solid business model, and thus the business should go “all in” by aggressively spending on marketing via paid channels (as free channels are extremely difficult to scale up rapidly). Yet, as we start to breakdown the overall CPA number, we notice that CPA for new customers is actually $20.25. Digging deeper, we note that new customer acquisition cost via paid channels is as high as $35, making the strategy of growth through acquisition of new customers via paid channels uneconomic (LTV of $30 < CPA of $35). As we see, the proposed framework enabled the business in our example to recognize flaws in their marketing strategy and to avert loss-making campaign.
While employing the framework it is also important to note the following points:
• Due to the variance between conversion rates from visitor to customer via different channels, CPA (as opposed to CPV) metric should be used in the analysis
• Free channels also have some variable costs that should be accounted for in the analysis
• Other possible channels (e.g. display ads, social, etc.) that weren’t included in the framework should be treated the same way