Whether you use a paid search vendor to execute your pay-per-click programs or you manage the channel internally, there’s a good probability your cost per acqusition model is probably off – especially if you’re in a subscription or continuity business.

To illustrate the point, let’s create a coffee company that manufacturers coffee grounds packaged in monthly shipments that ship every month to the consumers. Having gotten a name on GoDaddy and starting Black Beans Burn and created a Google AdWords account, we’re in business. For every bag of coffee we charge $40 for the month supply and is priced as such on the product detail page. As the manufacturer and distributor, you’re fortunate enough to enjoy a 50% gross profit on your product. In compiling your CPA and return on investment strategy, you think:

I have a 50% margin on a $40 product, leaving me approximately $20 to acquire a customer and be break-even and get one more unit in the marketplace.

So in hopping on AdWords, all of your campaigns are adjusted to hit a high water mark of $20 for cost per acquisition. Unfortunately, the mail order coffee vertical is pretty crowded and you’re struggling just to stay on the first page of Google and your ROI is reflecting that.

And here’s the problem. The math is being calculated prematurely. This is a continuity business and the revenue from the entire program is being measured off the first purchase instead of the life-time value (LTV) of customers on that product. Turns out BBB Coffee is a pretty excellent, so excellent customers are staying on the program an average of 18 months. All of a sudden we realizing that customers buying $40 bags, eighteen times comes a nice $720 LTV per customer. So let’s change that revenue input from $40, to $720. Similarly, we’ll need to scale our gross costs by a factor of 18. That theoretically means we can afford a maximum CPA of $360 on AdWords and still be break even, which is hell of a lot more wiggle room than $20.

The Lesson

Don’t undervalue your business model and make sure your search engine marketing partners and employees are indoctrinated into your business model so they can calculate smart CPA and ROI goals.

Tags: AdWords, Analytics, Cost Per Acquisition

This entry was posted on Tuesday, May 5th, 2009 at 8:59 pm and is filed under Daily Deuce. You can follow any responses to this entry through the RSS 2.0 feed.