Customer Conversion Ratio—The Number Businesses Live and Die By
How Much Do Your Customers Cost?
On average, how many people visit your store, website or place of business without buying anything? How much time and effort must you spend on each new prospect before they become a client? Once they become a customer, how often will they buy, and how much? How long will they continue to buy from you? How much does it cost you to win a new customer over, or to keep an existing one?
As a small business owner, you must know the answers to these questions in order to make intelligent marketing and advertising decisions. Before you spend valuable time and money trying to attract new clients, you’ll first need to determine how much it will cost to actually acquire them. Not only that, but you’ll also need to calculate the average lifetime value (or income) that new client or customer will ultimately generate. Why? Because understanding how to effectively focus your marketing and advertising dollars could make the difference between cost-effectively attracting new clients or foolishly squandering precious resources.
Cold, Hard Numbers And Spending Money
For example, let’s say you spend $1,000 on radio advertising. From that, you get three new customers each spending $200 for your service or product. After calculating and subtracting the cost of delivering your product or service (overhead and expenses), you wind up with $100 profit per customer. $100 x 3 new clients = $300 of profit resulting from the radio ad. This means you spent $1000 dollars to make $300 dollars, losing $700 in the process. This type of poorly thought-out marketing is not going to keep your business afloat for long.
Of course, should you discover the radio ads attract on average 12 new clients, or twenty, or one-hundred, then the initial $1000 investment in the ad may prove to be very cost-effective indeed. But ask yourself, is a $1000-dollar ad or marketing campaign really going to have the effect you’re hoping for, or is something less amazing and more realistic bound to happen?
Time is another factor you must consider when determining your average cost of acquisition. After all, a satisfied customer will probably buy from you again and again, not just once. So what if your average client stays with you for five years, and each year nets you $100 in profit? This longer-term perspective paints the radio ad in a much better light. Since the lifetime value of each new client averages $100 x 5, or $500, three new clients should bring in (on average) $1,500 in profits. In this scenario, for every $1,000 you spend, radio brings in $1,500 in profits. After subtracting the price of the ad, you’ve made $500 of profit at the end of five years. That’s not a bad return on your investment, right?
Wrong. You spent $1,000 in advertising to get back $1,500, and it took you five years to do so. That means you really only made $500 over five years, or $100 a year. That works out to be about 8.5% annual compounded interest, and while making any profit is a good thing, the fact remains that you could have invested that same $1000 somewhere else and seen a much better return in those five years.
Customer Conversion: It Really Is That Simple
Hopefully this makes it easier to understand the factors that affect your cost of acquisition, and sheds some light on the hidden traps and pitfalls you may encounter while converting prospects to customers. Just remember to carefully consider each investment you make, keep detailed records of costs and revenue, and be willing to pull the plug on investments that don’t pay off. Don’t be afraid to follow your gut instinct, but know it can sometimes lead you astray. As a wise man once said,
“Staying levelheaded won’t keep you out of trouble because our brains like to lie to us. We look for patterns to help us make good decisions, and sometimes we see things that simply aren’t there. Good investors educate themselves and use data to guide their decisions – not just their brains.”- Warren Buffett
By David Tower and Eric S. Streeter