To scale your business effectively, you need to pay close attention to customer acquisition costs. And that’s where the return on ad spend comes in handy.
The return on ad spend, or ROAS is a metric that shows you how much you’re earning for each dollar spent on ads.
In many ways, this metric is similar to the ROI (Return on Investment). The difference is that ROAS takes only into account ad costs, whereas ROI includes all types of assets.
ROAS measures campaign effectiveness.
If an ad placement brings in great clicks that convert at a high rate, then more product is being sold for each dollar spent on the campaign. This is a high ROAS. However, if you spending more than you are making, then the ROAS is low.
A number of factors play into ROAS, the channel, the cost per click, the click-through rate affected by targeting and messaging, the conversion rate, the cost of the product and the business model.
Measuring ROAS and continually finding ways to lower the customer acquisition cost will increase profitability, especially over time (lifetime value or LTV). Finding clever ways to do this is the key to a successful business.
How to Calculate Return on Ad Spend
Arguably the most important metric to focus on, ROAS is simply the average lifetime value of a client divided by the ad cost associated with acquiring new customers.
How do you calculate customer acquisition costs? It’s easy.
The customer acquisition formula involves dividing the cost of marketing campaigns by the number of new customers within a specific timeframe. It can be for one channel, placement, or across all campaigns in aggregate. This number matters because understanding a business’ customer acquisition metrics is vital to growing company efficiency and profitability.
Here is a simple example of the math.
If a business spends $1000 on an ad campaign and gets 500 customers in 30 days, the customer acquisition cost is $2 per customer.
If the value of each customer is $2 to the acquirer, then the ROAS is zero. However, if the company continues to market its products and services, then the lifetime value of this customer could be considerably higher. Not all businesses aim to be profitable out of the gate. It depends on their business model. Doing all that can be done to extend the value of a customer, creates greater opportunity for growth. Having these strategies in place, and knowing these metrics allows ad buyers to be more competitive in media buying marketplaces. By bidding higher, a company can win more of the inventory and although they may not be as profitable to start, they know that in the long run, they have an asset base that will grow and provide income.
Customer acquisition costs and a client’s lifetime value are fluid metrics. Over a period of time, there may be ups and downs. That is why the average lifetime value over a significant sample and timeframe should be used to determine the ROAS calculation.
How do you determine the average lifetime value of a client?
Simply, subtract the lifetime ad costs from the lifetime customer revenue.
For instance, if a customer spends $1,000 during the lifetime relationship and the costs associated with products sold are $300, then the
lifetime value for that client is $700.
When the calculation is done for each customer and added up, and then divided by the number of customers, an average lifetime value emerges.
The Three Tips to Lower Your Customer Acquisition Costs
Tip #1 – Be Conscious of Your Time to Break Even
Know your product’s profit margin and lifetime value. This way the ad spend and a comfortable break-even point can be calculated. For some companies, the break-even point is immediate. For others, it can be months or even years into the future.
For example, if you’re selling an infrequently purchased product, such as glasses, there needs to be immediate profit with the sales transaction or a positive ROAS if the business wants to sustain itself and grow… Additional revenue however can be generated via add-on products and services to increase the customer’s LTV and engagement.
On the other hand, businesses that sell recurring services or subscriptions may be ok with losing money upfront, knowing that the LTV far exceeds the initial customer acquisition costs.It’s important to remember that a business only incurs this fee one time. Therefore, all additional revenue can contribute towards profitability.
Watch your campaigns carefully and manage your key performance metrics. Don’t go too far beyond your break-even point before you optimize.
However, if you do, don’t panic. See tip #2.
Tip #2 – Focus on Increasing the Lifetime Value of the Customer
Once you acquire a customer, they are yours for life, provided you provide good value for service, communicate effectively and remarket to them with your own or partner products.
The sale doesn’t stop when the initial transaction is made; it’s just the beginning. If this strategy is carefully considered, implemented, and consistently improved, a company’s value is exponentially increased.
A great example is a suggestion tool as the customer journeys through the sales process. Or an upsell or cross-sell program on exit.
Once the product is purchased, ensuring that the customer is satisfied and comfortable with its usage is often critical to building trust between the brand and the consumer. The more trust earned, the more likely they will return for new or complementary products or services.
Additionally, ongoing customer support and communication across multiple channels helps to retain customers. They have so many choices these days, that getting feedback on their preferred communication channel can help with messaging breaking through everyday clutter. Testing a variety of monetization methods and communication strategies is the only way to know for sure, which ideas are most profitable.
Tip #3 – Use Laser-Like Targeting to Reduce Your Cost of Acquisition
Reach the right people at the right time with the right message, and bingo, conversion rates go through the roof and costs decrease dramatically. But how do you make all these variables happen successfully at once?
Testing, measuring, and analyzing data.
Monitoring ad spends with performance and volume metrics in mind over a statistical sample ultimately gives the details of a company’s ideal customer. Then, finding placements that are most like this audience becomes easier – especially with current retargeting and custom audience-building capabilities.
Data appending and/or lead scoring allows businesses to classify each customer and personalize their journey. Implementing more complex flows is mutually beneficial although harder to implement.
Using the data to make smarter media buying decisions, reduces wasted ad spend. Making campaigns as efficient as possible ultimately decreases your cost per acquisition rate and increases profitability. Smart!
Can You Decrease Your Customer Acquisition Costs & Increase Profitability?
Of course, you can. And now, you know the most effective tactics to do that.
Know your key performance metrics and continually work to measure and improve them. Find new strategies to increase customer lifetime value.
Keeping customers for a long as possible means greater profitability and viability.
Wondering if performance marketing is right for your business? Contact us today for a FREE evaluation of your marketing strategy.