We’re going to break down a little formula into four steps to help reveal what you should actually spend per year and per month on marketing. Your business. Your numbers.
Knowing what you want to spend and what you should spend are connected, but they’re not the same. What one’s marketing budget should be is a question tucked away in many business leaders’ minds that doesn’t get addressed often. The reason? Because many business leaders are marketing using the ‘leftover’ funds. Like most people, we want to get the most for the least amount of dollars. It’s human nature. And the reason we’re just throwing money at things a little bit at a time is because we know we need to do something, but spending it on marketing and advertising seems like we’re paying other people—like Facebook.
Ultimately, the power is in your hands to invest or to not invest in your business. We’re going to break down a little formula to help reveal what you should actually spend per year and per month on marketing. We believe this little formula will help you understand real numbers along with vision to where you want to be. At the end of this, you should have a pretty good idea of whether or not you’re underpaying for your marketing costs. If you’re seeing great results, you may see the room to pour more gasoline on the proverbial fire for continued growth.
Now, let's calculate what you should be spending on marketing.
1. Find the Lifetime Value
The LTV of a customer, or lifetime value, essentially tells you the long-term worth of obtaining one new customer.
If you offer a service or product that is strictly a one-time purchase, then the LTV is simply the margin between what it takes to sell your product or service and how much the consumer purchases it for.
*And for all intended purposes in this case, LTV is really only of value if your customers can continue to be a customer.
LTV can be extremely important if you have a subscription service or a product that aims to have repeat business.
First, you need to establish how long the average customer stays with your company (continues to buy your products or services). For example, Starbucks established that the average length a customer continues to be a customer for them is 20 years.
Next, you need to establish the average frequency of purchases over the duration of their relationship with your company. Do they purchase your product once a year for five years? Do they purchase your product once a month for 15 years?
A simple equation of multiplying the gross revenue from a customer purchase by the amount of times they purchase over the course of their relationship with your company will tell you generally what the gross lifetime value of an average customer is. Keep in mind this is not including the cost to acquire that customer, yet.
A great marketing plan executed by a great team will actually drive your CAC down—and your profits will increase.
2. Find your Customer Acquisition Cost
How are you currently obtaining customers? What methods are you using and how much does it cost to acquire them?
Answering these questions and knowing your customer acquisition cost (CAC) will give you insight into your current efforts. A great marketing plan executed by a great team will actually drive your CAC down—and your profits will increase.
If it costs you $25,000 to acquire 1,000 new customers (marketing and sales costs), then your CAC would be $25.
Now, let’s find the value of the customers versus the cost to obtain them.
• Subtract the CAC (step 2) from the LTV (step 1). The LTV should be greater than your CAC (i.e. your number shouldn’t be negative). See a nifty chart below that demonstrates this. This new LTV, minus the CAC, gives you a realistic look at the value each customer ultimately brings your business for the longterm on average.
Vision is crucial to your business success—and also for knowing how much you should be spending to attain those goals.
3. Define Clear Goals
This next step isn’t necessarily talked about a lot, but we think vision is crucial to your business success—and also for knowing how much you should be spending to attain those goals.
What’s your goal (realistic) for your gross revenue for this fiscal year? This should be based on your numbers from last year and the plan your team came up with for this year. Now, take that number and head to the next step.
4. Create a Baseline
To create a baseline (or to know how much you need to spend to reach your goals), we’ll need to put a few of the numbers together from above.
Divide your goal (gross revenue goal from step 3) by the cost for your product or service to a new customer (don’t count repeat customers here, only count new customers). This will tell you effectively how many new customers you need over the course of the next year to fulfill your goal.
Example: If your goal was to make $1M in gross revenue over the next year and your product cost the consumer $125, you would need 8,000 new customers. Now, if your CAC was $25 per customer, then it would cost you $200K to obtain those 8,000 new customers. Your gross profit (before cost of goods sold) would be 80% (or $800K). Then, if each of those customers had a lifetime value of $1,250, then one can quickly see that the original cost to obtain the customer for $25 was a really good value as those 8,000 new customers would have generated about $10M in sales. One can also see why placing money into CAC (i.e. marketing) is a valuable investment for a business. In this example, your baseline for your marketing budget could be calculated at $200K.
If you’re thinking about growing, it may take more than what you currently have.
Ultimately, your marketing budget is determined by your goal and your cost to acquire that customer. One might have expected to read that your budget would be determined by how much you have in the bank to spend. If you’re thinking about growing, it may take more than what you currently have. This may include dollars from outside investors, loans, or even eating a little more of your margins now in order to scale and grow for the long-term. The key here is to think about ROI (return on investment).
Marketing is investing. Making a good investment in your business is where that mentality of value versus cost comes in. You can pay for someone to provide services for what you want to pay, but like many things involving quality, you get what you pay for.
Do you want to know how you’re doing in regards to your current marketing spend based on your current revenue (not goals based)? In other words, are you spending too much, not enough, or just right?
For starters, the SBA recommends that established businesses should spend about 10% of their yearly gross revenue on marketing. And if you’re a newer business or startup, it’s recommended that you would need to spend about 20% or more of your yearly gross revenue. Now, these numbers may help you just maintain. How do these numbers compare with your yearly revenue goals?
Cost vs. Value
Some people want good deals and some people want good value. There is a difference, and this may play a role in how you currently look at paying for marketing. People looking for a ‘deal’ are often price hunting and don’t have quality at the top of their priority list. People looking for good value, though, are wanting something that is truly good in quality, service, etc. with a reasonable price. When someone says, ‘I feel like I paid what it should have cost,' this is a statement indicating their perception that they have received good value. They received something valuable at a fair price and they’re happy about it. Get good value out of your marketing strategy.
All of this should be culminating into illumination for how you’re actually spending your money, the value that each customer brings, and a roadmap for how your company can crush its goals.
To lower your customer acquisition cost and make more money through strategic marketing, contact us today for options.