Customer Acquisition Costs Demystified

By John G. Sanchez
Chairman & CEO - Zunch Communications, Inc.

A lot has been written recently about the "path to profitability" and the means of achieving it. Internet companies are still growing at a frantic pace, trying to acquire customers as quickly as possible, and, it seems, at almost any cost. Some companies are willing to spend hundreds of dollars to acquire a customer, while others spend virtually nothing at all. For instance, Hotmail acquired new users through viral marketing (also called word of web, or word of mouth marketing), and thus, spent very little on marketing. E-commerce sites may pay tens of dollars to acquire a customer, whereas brokerage firms are willing to spend hundreds of dollars on customers. In our ongoing efforts to measure online advertising's effectiveness, we've taken it a step further in figuring out customer acquisition costs. Especially now that that generating profits is top-of-mind.

In my ongoing efforts to measure Internet advertising effectiveness as well as reviewing the typical cost for acquiring a new customer, I thought about taking it a step further. Basically, what I am attempting to look at is customer acquisition costs for a typical banner campaign from the perspective of a CFO. Based on what I see and hear, even companies spending significant dollars on Internet advertising haven't done this analysis. It can be an eye-opening experience.

Here is an example that illustrates why:

Typical Income Statement Model
(shown by one unit of sale)

Gross Revenue $18.00 (sales price; Widget example)
Less Cost of Goods $ 4.50 (25% of sales price; a common percentage for software co's)
Equals Net Revenue $13.50 (sales price less cost of goods)
Less Operating Expenses $ 5.40 (30% of sales price; a common percentage for software co's)
Equal Net Profit $ 8.10 (45% typical for a profitable software co.)

Typical Banner Campaign

Ad Impressions Served 1,000,000 (arbitrary example)
CPM $0.70 (Actual 4th quarter average)
Media Cost of Campaign $700
Banner Development (5) $4,000 (five banners x $800)
Total Campaign Cost $4,700 (media cost plus banner creative)
CTR @ .43% 4,300 (CTR Actual 4th quarter average)
Conversion Rate @ 5.5% 237 (Actual conversion rate)
Customer Acquisition Cost $19.87 (campaign cost/number of conversions)

Return on Campaign Investment

Net Revenue $(1,507.25) Net revenue per unit x sales less campaign totals
Net Profit $(2,784.35) Net profit per unit x sales less campaign totals

Additional Revenue Needed Per Customer to Break-Even: $15.70

*Customer acquisition costs less net profit per unit/.75; if it costs $19.87 to acquire a customer and the net profit on the initial sale is $8.10, then you have to acquire another $11.77 in net revenue to break-even. But you have to sell $15.70 of product to generate $11.77 in net revenue (25% cost of goods = 75% net revenue), which is why you divide by .75; and this assumes no additional operating expenses charged against future sales.

Insights

Based on initial sales, the typical ad banner campaign is a significant money loser. And, if you play around with the above model on a spreadsheet, you'll discover that it takes very significant improvements in several variables to generate a profit from the campaign. The big culprit is the high customer acquisition cost, driven by the low click-through rate and to some degree the conversion rate.

The only options for improving results are:

A higher priced product that produces a lot more net revenue per sale.
A lower cost of goods.
A lower CPM, which could be accomplished with cost-per-click and/or cost-per-action campaigns.
A much higher click-through rate, which could be accomplished by properly optimizing banner creative.
A higher conversion rate, which with a higher value proposition offer and a great Web site/jump page, and superior relationship management, may help.

A highly effective program for recovering the customer acquisition cost through customer retention, repeat sales and maximizing lifetime customer value. Such a program requires, among other things, a strategically sound Internet plan, a high-value product, a great Web site, and superior customer relationship management practices.

A high-level online promotion that encourages the use of your product or service and incents the user to spread the message - thereby achieving the viral effect.

Target users who have business decision-making responsibilities, which would allow you to substantially lower our customer acquisition costs over the long run.

You might be thinking that another option is to avoid banner advertising altogether, since it appears to be the culprit in this illustration. But I urge you to plug into the above model the customer acquisition cost from your other sales and marketing strategies you're now using. You'll be right back to the issues of maximizing customer retention, repeat sales and maximizing lifetime customer value.

Please contact me at if you would like a free analysis of your customer acquisition costs.

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