How to workout your maximum Cost Per Acquisition

What is Cost Per Acquisition?

Cost Per Acquisition is the cost to you in direct advertising spend, for acquiring ACTION from a visitor. The term Cost Per Acquisition can be used a few different ways, so to clarify this article is focused on two models:

• Basic eCommerce – the cost for generating an actual eCommerce transaction.
• Lead Generation – the cost of acquiring contact information for a visitor interested in purchasing your product/services. Often used interchangeably with Cost Per Lead (CPL).

The other usages of CPA are in acquiring other ACTIONS eg. newsletter sign-ups, video, which we’ll talk about in another article.

1. Calculating Cost Per Acquisition (Basic eCommerce)

So here are 3 basic formulas you need to understand in any Conversion focussed campaign.

Adspend / $CPC = Traffic
Traffic x Conv. Rate % = Conversions
Adspend / Conversion = $CPA

Example:

• $5000 Adspend / $5.00 CPC = 1000 Visits
• 1000 Visits x 3% Conv. Rate = 30 Conversions
• $5000 Adspend / 30 Conversions = $166 CPA

We can simplify this even further by removing Adspend and Traffic because this simplification really gets to the nuts and bolts of improving your marketing campaigns.

$CPA = $CPC / Conv. Rate %

Example:

• $166 CPA = $5.00 / 3%

This simple model works perfectly for eCommerce, where the $CPA can now be directly compared with Revenue.

2. Calculating Cost Per Acquisition (Leads)

For leads based business, you should take it one step further, to take into account the conversions of those leads into sales. There are different terminologies used, but we prefer to keep it simple and use Cost Per Sale (CPS). If the sales team convert 1 in 3 Leads then the CPS is calculated like this:

$CPS = $CPA / Sales Conv. %

Example:

• $503 CPS = $166 / 33%

And in long form:

$CPS = $CPC / Website Conv. % / Sales Conv. %

Example:

• $503 = $5.00 / 3% / 33%

BreakEven (also called Allowable Acquisition Cost)

So that’s how we calculate the $CPA, but how do you work out how to set your maximum $CPA. In a simple model, the maximum $CPA should be set at a breakeven point. BreakEven can be either:

• Transaction BreakEven – a short-term transactional measure of the profitability
• Customer Lifetime BreakEven – a longer-term growth focussed break-even.

1. Calculating Transaction BreakEven

If you have one-off sales and no repeat business, the simplest formula for BreakEven is the profit on the average order.

AOV x Profit Margin % = Transaction BreakEven

Example:

• $300 x 30% = $90 Transaction BreakEven
• So, the example above doesn’t look good to spend $166 here? But see below….

We’ve left the profit margin very loose here because it’s somewhere between Gross and Operating Profit. So what should you use for your profit? It’s something like this

[Transaction] Profit = Revenue – Cost of Goods – Overhead

but taking into account that the Overhead is partly comprised of Fixed Costs. So if the fixed cost is already covered, then it can often be as simple as:

Gross Profit = Revenue – Cost of Goods

2. Customer Lifetime Value (Revenue)

BUT almost all business have repeat customers, so the value of a customer to the business is more than the first sale. A simple Customer Lifetime Value (CLV) is the total Gross Profit attributed to the customer over the lifetime. For service industries, it’s often the monthly gross profit multiplied by the average number of months for a contract, based on retention rates.

CLV = AOV x Ave. Contract Term x GP%

For eCommerce or lead generation for products/services that are not on monthly contract, the CLV is based on the Average number of repeat transactions.

CLV = AOV x Ave. Repeat Transactions x GP%

It’s easiest to think of this as a Lifetime Multiplier eg. x3.0 (representing either average repeat transaction, or contract renewals).

Example:

• $900 CLV = $300 x 3.0

The above models are very simple. Calculating Customer Lifetime can involve complex financial modelling including discounting. 

How to apply this to your marketing

So how should you use BreakEven’s to set your $CPA?

1. Paid Search and realistic $CPA Bidding

The first thing to do is to take a realistic look at your Paid Search. If you have been using Transaction Breakeven for setting your $CPA in search, and wondering how your competitors are consistently outbidding you, one of the reasons could be that your competitors are taking a longer-term view on acquisitions. They're prepared to bid above Transaction Break Even long-termng term customers.

2. Conversion Optimisation

If you think your paid campaigns are already optimised, and yet your Cost Per Acquisition is still too high, the problem probably lies in your Conversion Rates. Remember the Cost Per Click is just one part of the equation.

$CPA = $CPC / Conv. Rate %

You need to look seriously at how to optimise your Conversion Rates – how to get more of the visitors to take action on your website!