How to calculate your target CPA

What’s your target cost per acquisition?

That’s a question that a surprising number of people who sell online don’t know the answer to.  At its most blunt, a cost per acquisition is just the cost of your online advertising budget, divided by your number of sales.  (Whether or not that number turns a profit for you is another question.)

Even scarier, many merchants view their CPA as just a big piece of their overall marketing costs, as just another line item that builds cost, resentment, and is ripe for the chopping block.

If you think you might fall into one of these categories, this post is for you.

What is an acquisition anyways?

An acquisition is any form of customer contact that has value your business.

For an ecommerce business, this is as simple as making a sale.  For a service business like a plumber or solicitor, an acquisition is likely to be a phone call or a prospective client filling out an online form.  For other businesses, an acquisition can be as abstract as the download of a whitepaper, report or sales presentation.

An acquisition is whatever your business is measuring from an online marketing campaign.  It is the goal that your marketing team or agency is working towards and that you turn into sales.

How to view CPA and marketing costs

We encourage our clients to view their CPA as more than just a line item.  An AdWords budget, usually the biggest online advertising cost a merchant faces, should be seen as an integral part of the sales channel – just as important as the wholesale cost of the product, a phone line, or a website.  It is integral – without the online marketing spend, there’s no sale.

With that marketing philosophy in mind, we work with our clients to establish a realistic target cost per acquisition (CPA).  A realistic cost per aqusition is the maximum amount that you’re willing to pay for each goal – be it a phone call, online lead, or sale.

For online marketing to be effective, this needs to be a quantifiable number and not a statement like “as low as possible” or “whatever doesn’t hurt my margins”.

Your realistic target CPA is a number, that:

• Is high enough to give your marketing team or agency room to scale up and grow your campaign as far as the available search traffic allows, and;
• Leaves you with a tidy, predictable, scalable profit.

Here is how to calculate a realistic target CPA

You’ll need to know the following numbers to get started.

Your average order value

• This is the amount you make every time you make a sale.
  • For service businesses, this is usually relatively static.  For ecommerce businesses, this may vary greatly and may need to be calculated per product category.
• It is also important to take the lifetime value of a customer into account.
  • If your customers regularly return to you to make a second purchase, this will increase your average order value.

Your gross profit margin on that value

• This is your gross profit per sale, after fixed expenses per unit.
  • For ecommerce, this is easy to calculate, especially if you sell just one kind of product. For service businesses, this can a bit more difficult to calculate with factors like rent, staff costs and even fuel.  However, it should be possible to arrive at a basic number.

If you’re a service provider, your lead-to-sale conversion rate

• This is your success rate in turning your leads, be it phone calls, online leads or even just emails, into actual sales.

Marketing as a fixed unit cost

In our experience as an agency, we’ve found that most businesses are happy to spend about 25% of their gross profit margin on actually acquiring the sale, and towards acquiring new business.

This number may be different for your business, and can be higher if that’s what necessary to scale.  However, 25% is a good benchmark that leavs a healthy profit on each sale.

Once you know all these values, you can calculate a realistic cost per acquisition.

Your target cost per acquisition should be:

• For service businesses: (Gross Profit per Sale X 25%) X your lead-to-sale conversion rate
• For ecommerce: (Gross Profit per Sale x 25%)

Example by the Numbers:

In this example, we have a plumber who advertises via AdWords and takes calls from clients over the phone.  He has a success rate of just over 50% at converting these leads to sales.

• Average value of each sale: £220
• Gross profit per order: £150
• Phonecall to sale Conversion rate: 52%

(£150 x 25%) is £37.50

(£37.50 x 52%) is £19.50

Leaving a realistic CPA of £19.50 for this client. This is the maximum they are willing to pay to generate a phone call lead.

What to do with your realistic CPA

Your marketing team or agency should know your target CPA.  It should practically be tattooed on their foreheads.  It’s the goal that they’re working towards!

Knowing this number allows you to calculate if a marketing channel like AdWords is likely to work for your business.  In some cases, it may be impossible to deliver leads at that CPA, and your agency will need to seek other methods, like Bing or Yahoo, to deliver at a cost that works for your business.

Keeping your CPA in mind also allows you and your agency to focus on the metrics that matter.  Getting bogged down in numbers like Cost per Click, Quality Score, Impression Share and Click Through Rate is no way to manage an effective campaign.  CPC, CTR and all the million other metrics provided in online marketing are just tools to do one thing: deliver leads and sales within the target CPA.

As long as you or your agency is focused on CPA, you’re in the right frame of mind to scale up your business.

If you’re interested in running a CPA model campaign for your business, give us a call 0n 0207 993 8886 now – there’s no risk, and you’ll only be billed when you make a sale.