How Your Cost Per Acquisition Model Is Hurting Your Revenue
by Russell McAthy, on Jun 22, 2021 9:00:00 AM
For most online businesses, the principle behind a cost-per-acquisition model is fairly straightforward. To find the total costs of customer activity in a period, divide the costs of visits in that period by total sales.
For example, if you're looking at the cost per acquisition of your PPC activity, take the total amount of your PPC ad spend and divide by the number of sales and you get cost per acquisition.
This is all very easy to understand, but problems arise when you start to add some complexity. And as more retailers adopt an omnichannel commerce model, the level of complexity in both the customer journey, and how merchants undertake attribution modeling, increases considerably.
Let’s take a look.
How Brands Calculate Customer Value
Cost per acquisition (CPA) or sometimes CPO (cost per order) or CPS (cost per sale), is generally worked out with this equation:
Cost of visits in the period/count of sales in the period
Let’s use the chart of five different buyers’ journeys on the left as an example.
Each grey box represents a site visit for each one of the five shoppers, with the cost per visit displayed in each box. The numbers in red represent the times a shopper converted on the site, and how much money was spent.
If you were to add the total cost per visit, or add up every number in grey, you would have your total cost per visit across all five buyers at $19.30 (the sum of the numbers in the grey boxes) with 4 total conversions (the numbers in the red boxes).
Therefore, the CPA is 19.3 / 4 = $4.83, meaning that on average, it costs this company $4.83 to acquire a conversion.
But the reality is that every customer’s journey is different, with some moving quickly to purchase and others “simmering” for a long time. Depending upon the time period you’re using to calculate cost per acquisition, you may end up with very different data.
Let’s look at the same data in the example below, but now we’ll focus on the time period represented by the dotted box.
With the same shoppers, and the same customer journeys, by changing the lookback period, you now only see the second half of a much longer journey.
If you calculate CPA again using only the information contained in the dotted box on the left, the cost is $3 (0.4 + 0.2 + 1.1 + 0.2 + 1.1) and there are 3 conversions.
Therefore the CPA is 3/3 = $1 as opposed to the $4.83 from the first example above.
How can the same conversions have different costs per acquisition?
Let’s take a look at another dotted box and the buying journey of just our first customer.
With 2 conversions ($40 and $50) and a total cost of $3.9 (2.2 + 1.1 + 0.4 + 0.2), the CPA is $1.95.
But if you segment the first and the second conversion, the numbers are very different.
In that case, the CPA for the first conversion is now $3.3 (2.2 + 1.1 + 0 + 0), while the CPA for the second conversion is $0.6 (0.4 + 0.2).
So what is the actual cost of acquisition for this customer’s purchase? The blended one? Or do you calculate them separately?
The Problem With Last Touch Attribution
Because of this confusion, many fast-growing brands turn to a customer acquisition cost (CAC) model.
This is either the total cost of all of the interactions before conversion (the grey dotted box), or it's the cost of the last visit that drove the conversion (the red dotted box).
But again, it depends on what time period you're selecting, and brands that typically push CAC as a metric use the last touch to calculate the cost of their sale.
As the journeys depicted in the illustration here show, last-touch attribution is not a holistic view of your marketing efforts, and giving credit to just one aspect of your strategy can end up hurting you in the long run.
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CPA and CAC both have their shortcomings when measuring the lifetime value of both your customers and your marketing efforts.
CPA across multiple buyers’ journeys is too broad of a metric to provide you with meaningful data on how your marketing spend is driving conversions. And if you attempt to measure more granularly, you end up with changing results depending on when you decide a customer’s journey began.
CAC can give you a better understanding of your costs per customer, but relying on a single touchpoint as an indicator of what is driving revenue is not an accurate portrayal of your customer journey.
In short, both CPA and CAC are unreliable.
If you want to really understand your performance you should be looking at:
- Customer Cost To Date (CCTD) = total costs per customer so far
- Customer Revenue To Date (CRTD) = total revenue per customer so far
- Future Customer Value (FCV) = forecasted revenue for lifetime - forecasted costs for lifetime
CCTD and CRTD will give you a far more actionable value model. By focusing journey to journey, you’ll see what the most cost-effective marketing channels are, where your chokepoints are, and where you may be spending too much to acquire customers.
Similar to lifetime value (LTV) - which is the revenue you believe a buyer will deliver to your company in a given period of time - future customer value (FCV) forecasts the revenue for a customer’s lifetime.
But unlike LTV, FCV also forecasts the costs of acquisition for that customer over the same period.
With this data, you end up with the insights needed to determine the actual amount of money you should be spending to acquire a new customer.
What This Will Do For Your Revenue and Margins
The easiest way to understand how shifting your focus to CCTD, CRTD, and FCV can impact your revenue is to use an example.
Let’s say you are running a promotional campaign through affiliate marketers with 20% discount codes to drive traffic to your online business. In this case, you’d be paying a percentage of your sales to the affiliate while also reducing your margins by 20% due to the discount.
If you're spending too much to acquire a customer, and you're setting the expectation with the customer that the price for the product they’ve purchased is lower, because it's discounted, you're going to have to spend significantly more on bringing that customer back to make future repeat purchases to earn the marginal revenue required to justify the cost of acquisition.
Getting a customer to convert is not a one-time expense, especially if that customer is making a purchase with the help of a promotion or discount that you are paying to distribute through an affiliate source. So the future customer value of that customer is very small.
In this case, a better approach would be to cut out the middle man and reduce your prices by 10%, creating a far more effective revenue route for your conversions because you no longer have to pay the affiliate and provide the discount at the same time.
Suddenly, your CRTD and FCV go up, while CCTD goes down, saving you more per customer and increasing your revenue per conversion.
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The Bottom Line
If you are currently relying on a CPA or CAC model to make decisions about where to invest your marketing dollars and which channels to focus on, it’s likely you’re spending money in the wrong places.
To truly understand the behavior and costs of your customers, you need to examine their activity every step of the way. This way, you can see if you’re spending too much to acquire a customer who may already be loyal to your brand—or vice versa, if a certain channel isn’t converting shoppers because you are neglecting it.
To learn more about Russell’s innovative approach to ecommerce marketing, check him out at ringside.ai.