Marketing Math

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.

Financial Focus

Entrepreneurs often progresses through four stages of financial management focus – Check book balance monitoring, cash flow monitoring, net income monitoring, and net worth monitoring. Each change brings its own learning curve, and the change of focus brings increasing rewards.

Often a new entrepreneur will gauge their financial health by looking at their check book balance, and very little else. As time goes on and the flaws with this system come to light. A bounced a check or two and the stress of being chronically short of cash pushes your focus to cash flow and timing. First with a week, then a month and eventually working up to focusing on yearly cash flow. Lack of cash flow management will kill a business faster than lack of profitability. Businesses with high debt can easily be profitable but have crippling cash flow issues that shut down a business.

The next step in a company’s progression is to start focusing on managing net income. Cash flow is more important in the short term, but in the long term, you have to make a profit. Cost control measures and sales systems are put in place to insure profits. Plans and processes that put money towards the bottom line.

The last step is one that few entrepreneurs think of – managing net worth. Opportunities that provide the fastest growth to net worth are prioritized and funded. The impacts of debt on growth are understood and exploited. It is a subtle change, but focusing on net worth is what builds lasting wealth.

As a business matures, the monitoring of financial progress must adapt as well. Where are you at on the learning curve?

Think like an Entrepreneur

I was waiting at the doctor’s office one day when the receptionist asked a waiting room full of people “Does anyone speak Spanish?” The lady sitting beside me happily jumps up to help out. I jokingly tell her to ask for an application, she giggles and says $20 per hour, and said she will get rich! If you do the math on $20 per hour, 40 hours per week, 52 weeks per year (no vacation, you are rolling in the money!), you have a gross income of $41,600. That is where many folks stop and say wow, much better than my minimum wage job!

While that may sound like a very good wage to someone who is used to working for others, it won’t support a business for very long. When you have been trading dollars for time all your life, there are many things that slip by you because you have never had to think about them.

For starters, as a self-employed person, you have to cover both the employer and employee shares of Social Security, unemployment insurance, workers compensation, and insurance just for starters. These can easily take 25% or more of your hourly rate to cover your costs. Throw in a computer, continuing education, cell phone, transportation, and a small office and you are racking up all kinds of costs. Now here is the real kicker. Rarely do you get 40 billable hours per week. As a fledgling entrepreneur, you have to spend time tracking your time, marketing your business, making sales calls, billing your new customers and everything else you have to do when you are your own boss. So here is the real math on that $20 per hour job.

 

Dollars per hour  

$           20.00

Hours per week

x

                 30

Weeks per year (you might get sick)

x

                 50

Gross income

=

$         30,000

25% taxes and Insurance

$           7,500

Net Income

=

$         22,500

     
Dollars per hour at 40 hours per week, 52 weeks per year  

$           10.82

     
Percent Difference  

           54%

When you look at the percent difference, you will see that your original numbers were off by almost 50%. By taking a bit of time to run through some numbers, you can avoid making some big mistakes! You can use this same framework when pricing out your services to customers, looking for all of the hidden costs you are facing. A very handy thought process to keep your new business alive.