In an earlier post, I have discussed the sales funnel’s role in selecting promotional strategies to reach, acquire, and retain your target customer. Each stage of the sales cycle – Awareness, Consideration, Decision, and Post Purchase – was mapped to crucial marketing decisions. Focusing on a specific customer segment, you would take each stage of the sales cycle and consider your promotional goals, customer pain points to address, messaging & content, call to action, and promotional channels to reach the customer.
Once you have mapped the sales cycle process to acquire a new customer, the next step is to determine the financial resources required to execute your customer acquisition strategy. I will assume that you have already chosen your preliminary revenue model and pricing strategy for this post. Some of the financial estimates are calculated based on this information.
You can now calculate your customer acquisition costs with your revenue model and pricing strategies. Next, you should measure and monitor three core metrics to support your promotional strategy, Customer Lifetime Value (CLV), Cost of Customer Acquisition (COCA) and Customer Retention Costs.
Customer Lifetime Value
The CLV is the net profit customers generate over their lifecycle. Therefore, you should not spend more to get customers than their lifetime value, or you might lose money.
Typically, a startup founder looks at the customer value as the amount of one sales unit. For example, if Jan purchases a product for $100, you may consider Jan worth $100 in revenue. Under this rationale, you might continue to see this customer generating individually discreet sales transactions. A more realistic approach is to determine how many purchases Jan will make over a more extended period and consider the time value of money. The actual value of Jan is the initial purchase plus the value of all the purchases they are likely to make in the future (discounted to the present). This approach is, in essence, your customer’s lifetime value.
Several aspects of your business and overall revenue model help determine a reasonable CLV for a specific target. Your basic revenue model is a vital component of this analysis. For example, many startups go to market with discreet product offerings. In this case, you can see that this is a risky proposition for you as a business. Much depends on how long the initial product’s usefulness lasts. How long is the product’s life cycle, and when will the customer need to repurchase? Unless you plan to develop a series of new products for your target customer to purchase, the potential customer lifetime value is driven by the life of the initial product and repurchase rates.
To calculate the CLV of a one-time purchase, you take the initial retail price of the product and deduct any costs related to the production of the product (costs of goods sold) to generate the gross profit for an individual sales unit. So if the initial retail price is $100 and the production cost is $20, your unit gross profit is $80. The next step is to estimate how long the product will serve the customer before there is a need to repurchase it. Is the customer compelled to repurchase every year, the second year, etc.? The period will depend on the type of product and its use. Product life cycles vary quite substantially, usually associated with pricing level. Typically, one expects a product to last longer the more it costs. For example, you expect your smartphone to last longer than a convenience store disposable version.
Finally, you need to estimate what percentage of customers will most likely repurchase. If the product needs to be repurchased every other year, how many customers who made the initial purchase will return to rebuy it? These calculations allow you to estimate what an average CLV will be for this product offering.
As you read the above example, you see why recurring payment revenue models are popular. In this case, your revenue model is designed for the customer to sign up for regular payments over a specific time. For example, you can offer Jan an updated product every year for $100. But this time, you tie a recurring payment and new product replacement together. So now you know that the customer will automatically receive a new product every year, and you will generate the applicable revenue. Recurring revenue models have been around a long time, starting with various subscription plans for media or software. Today, many industries use this model, from automobile purchases to personal care products.
CLV can be managed and increased over time. Increasing the lifetime value of your customers comes down to three objectives:
- Increasing the length of time a customer continues to buy from you.
- Increasing the amount customers spend on each purchase.
- Decreasing the time between purchases.
Such techniques as loyalty programs, discount offers, and recommendation software help to increase the CLV. Research demonstrates that customer satisfaction is essential for returning customers to your brand. I will discuss this further in the customer retention discussion.
Estimating and monitoring COCA is one of the essential metrics for most startups as it drives revenues and is most likely one of your highest costs. Therefore, it is a vital metric to track. Most appropriate for startups is measuring and monitoring the costs associated with new customer acquisition. The cost of customer acquisition (COCA) is generally calculated as total marketing and sales expenses divided by the number of new customers. However, it would be best to consider several factors to make these calculations more robust.
First, calculate marketing expenses from a bottom-up approach by considering the cost of each promotional channel separately and then aggregated into a final cost total. Then, plan to reach and acquire new customers using specific promotional channels. Finally, you will estimate how many customers you will reach and convert for a specified budget.
A standard method to support COCA estimates in calculating “funnel math.” Basic process: Estimate revenue goals divided by product/service price. This approach gives you the number of customers you need to purchase the product. Once you know the number of customers required to meet your revenue goals, you apply industry-standard conversion rates (this will take some research). The funnel labels depend on the industry, but opportunities – qualified leads – prospects – are standard labels. Every promotional channel has its own historic or benchmarked conversion rates. Typically, you can discover the costs per click (CPC), click-thru rates (CTR), and conversion rates for your industry. It is also worth remembering that these rates vary by device – mobile-tablets – computers.
CPC is how much you pay each time someone clicks on your search ad. You can determine this rate based on the keywords you are using. CTR is the number of people who click on the ad divided by the total number of people who viewed the webpage. These two metrics help you determine the top of the sales funnel’s conversion rates. Of course, the number of customers who eventually become actual paying customers is the most important conversion metric.
For example, if you plan to reach customers using Google Ads, you set a budget and then track how many customers visit your website and how many of those visitors purchase your product. Next, you can determine your conversion rate for this particular promotional channel the percentage of total visitors to your site that become paying customers. For example, if 10,000 people visit your site from a specific Google Ad campaign and 500 customers buy your product, the conversion rate is 5 percent. Once you know how much you want to spend on the drive, you will estimate and then monitor how many new customers the startup acquires for the number of funds expended per the budget. For example, if your ad campaign costs $19,800 to reach 10,000 potential customers ($1.98 per click) and you acquire 500 customers, your COCA is $39.60.
Let’s look at a promotional campaign to solicit and acquire new members for a health and fitness center. Applying the sales funnel method starts with the revenue you want to generate during a specific period.
In this example, you want to generate $1 Million in revenues from fitness center memberships. If you plan to offer an annual membership for $2500, you will need to acquire 400 new members to meet the $1M revenue goal. Suppose you are using a traditional method of promotion, such as direct sales by fitness center representatives. In this case, you need to engage many potential customers to reach 400 signed new customers. Based on expected conversion rates in a traditional promotional sales funnel (in this example, we are using 20% to keep things simple), you would need at least 2000 potential customers who are seriously interested in joining your gym. These “qualified leads” are potential customers actively looking to join a fitness center, manifested in such behaviors as spending time speaking with membership representatives, taking advantage of free passes to work out, etc.
Therefore, you would have to engage a more significant number of potential customers to facilitate 2000 qualified leads members. Now you can plan how to reach out to a more substantial number of potential customers resulting in the qualified leads required to achieve your 400 annual memberships.
Now let’s look at the Google Ad costs required to achieve the 2000 qualified leads. By using the keyword planner provided by Google. You will see that the average CPC for the keywords “gym memberships” is $0.94, and the CTR is 6.3%. So if you want 2000 interested customers to visit the gym and take a tour, you will need approximately thirty-two thousand five hundred (32.5K) individuals to view the ad. If 2000 people click on the ad, it will cost you roughly $2128. Of course, this only gets you to the middle of the funnel. You still need to determine the costs of the customer visits and associated resources to calculate the final COCA.
So, let’s say that to accommodate each of the 2000 visitors, you need to have a fitness trainer spend 2 hours with them at $200 each or $400k. In this case, the 400 paying memberships will cost you $1000 each. If you add the funds from Google Ads and the marketing efforts for the physical visits, your total COCA would be $402,128 or $1005.32 per new member.
Financially, this may be considered a reasonable amount to acquire a new member. Even if the member-only stays one year, you spend a little over 1K to make $2500 in membership revenues. As noted in the earlier section, if the customer remains a member longer than one year, the COCA as a percentage of income will come down significantly. The next step is to see how much to retain them year after year might cost. I address this in the next section.
From the above example, you have to look at the costs at each sales funnel stage for each promotional channel. You can start by applying specific channel averages for a particular industry and estimating the required expenses to meet revenue goals.
Estimating and monitoring COCA is one of the essential metrics for most startups as it drives revenues and is most likely one of your highest costs. Therefore, it is a vital metric to track. Remember, acquiring a new customer is approximately 6X more costly than retaining an existing one. So let’s look at what it takes to keep customers and increase their lifetime value.
A couple of other performance measures are essential when measuring customer purchasing behavior. For example, if you are building a business with recurring payments, you will monitor customer retention rates or, the opposite, attrition rates (sometimes referred to as customer churn rates). Customer churn manifests itself when your customers stop using your product or services. This customer behavior includes ending subscriptions, discontinuing the use of services, or no longer purchasing products from the enterprise.
One calculates and monitors these metrics based on your revenue model and the timing of customer payments. For example, if customers pay fees monthly, you want to watch the percentage of customers who continue to pay recurring fees. Therefore, you can calculate the monthly customer “churn” as follows: customers at the beginning of the month minus those remaining at the end of the month divided by the number of customers at the beginning of the month. Example: 100 customers at start minus 95 at end/the 100 starting = 5 percent churn rates for that month.
As with most metrics, you can evaluate your performance by researching industry benchmarks, internal financial history, and customer exit interviews. Following up with customers who are leaving is a valuable way to reduce future attrition. There are many reasons why a customer ends a relationship with a company. Top reasons include unmet expectations, poor product performance, or inadequate customer service.
You can apply many methods to understand customer behavior and build strategies to retain them. Consider using a customer relations management (CRM) system to manage and document any customer engagements, including any areas of dissatisfaction. When your venture is up and running, there are many communications with customers. The volume and variety make it difficult to manage and see trends without a sound CRM system. In association with documenting customer communications, you can also integrate customer journey analytics and data from online surveys.
While the churn rate is an essential metric for businesses with recurring revenue models to monitor, it is critical to understand the regardless of business model. Retention marketing must be part of a startup’s strategy (new customers cost 5 to 10 times more than retaining existing ones). Many methods increase customer retention, including loyalty programs, special offers, and positive customer engagement and service initiatives. By increasing customer retention, you lower your overall customer acquisition costs.
You don’t have a viable business without customers. Measuring and monitoring customer acquisition and retention rates in a disciplined manner allow entrepreneurs to proactively make timely strategic decisions, thus avoiding potential negative impacts on growth.
For more on this subject and other entrepreneurship topics, get a copy of Patterns of Entrepreneurship Management, 6th Edition.
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