Everybody loves math! I know, people always tell me so! Hmm, now that I think about it, perhaps they were being sarcastic. What do you think?
Seriously, it is important to make decisions based upon solid numbers. Today, I want to talk a bit about marketing math. Anyone who has listened to a sales pitch for advertising should consider a few calculations before spending any money. How much does it cost you to acquire one customer? How much does one customer spend over their lifetime with you? How much do you spend to purchase the product you are selling – which is called Cost of Goods Sold (COGS)?
Here are the math formulas for you to follow along with:
Cost to acquire 1 new customer = Marketing campaign $ divided by number of NEW customers.
Lifetime spending = Average sale times average times per year a customer buys times average years a customer buys.
COGS = how much you paid for your product. If you are making or assembling a product, add up the component costs plus the labor to assemble or produce. If you know what your sales margins are, you can use that percentage to come up with an average COGS.
Now for the number crunching. I have seen people say it costs me $100 to acquire a new customer, they buy about $500 worth of product over their lifetime with us. Good deal, right? Maybe… Depends on how much your COGS is. If you spend $100 for COGS, you have 300 to go to overhead and marketing. More than $400 COGS, and you have a real problem. You have not covered the COGS and additional marketing costs might be pushing you into a rising sales and falling profits scenario, a very dangerous place to be. There are other cost factors to consider, but this simplification is a good starting point.
This is why so many businesses go under during a sales growth period. Perplexing to the folks who don’t understand the numbers and it is hard to catch in time. But if you have rising sales and yet cash flow is getting tighter, that’s your sign to delve into the numbers. Ignore the euphoria when sales are growing fast and focus on the bottom line. That’s what is important.
If you find yourself in a low margin business – businesses like grocery stores, farm markets, and gas stations, what can you do? Lower the cost to acquire a new customer, develop loyalty programs to get your customers to buy more frequently and keep them longer, and add symbiotic products to raise the average a customer spends with you.
For many, this kind of math is as boring as watching paint dry, but if you want to play the entrepreneur game for a long time, you had better get used to it. Because if you wait until tax time to figure out you had a year of costs rising faster than sales, you won’t be around for long. Don’t like doing the math? That’s fine, we do.