Entrepreneurs are an optimistic bunch. We ignore what most people look at as impossible challenges and see problems that have solutions. We believe. And work hard. We find a way to make it happen.
But that doesn’t mean that a young company trying to take its great idea to market is a pretty thing to watch. Finding product market fit is difficult even for seasoned marketers. Worse yet, startups regularly struggle to understand how to properly invest in customer acquisition and retention.
Why? Because too few of us have calculated our sales funnel math.
The Secret To Marketing Success Is For Your Business to Make More Money From Customers Than It Costs You To Acquire Them
I know. That’s obvious. Yet in practice, it’s harder than it seems. Many of us have a gut-level desire to come up with fun, creative marketing ideas, throw them against the wall and wait for the revenue to roll in. Even if that works—and that’s a long shot—that doesn’t mean that it will be profitable.
Thankfully, there is a reasonably easy way to build a model around how much you should spend to acquire and retain a customer… and then compare it against your real-world performance to keep you on track.
The concept works like this:
– A certain number of suspects (people in your target audience in general) will become prospects (target audience members that are in-market for what you sell).
– Of these prospects, a certain number will become leads. Sometimes referred to as Marketing Qualified Leads (MQL), these persons have some type of interaction with your company where you know they’re considering a purchase.
– A number of leads will turn into sellable opportunities, or what is typically referred to as a Sales Qualified Lead (SQL). This means that the the lead is directly considering your company’s product or service.
– Of all of your opportunities, you’ll win some and you’ll lose some.
– And of what you win, some will buy from you again and others won’t.
Calculate the maximum you should spend at each stage of the process, measure your real-world performance against those assumptions and optimize the heck out of your marketing efforts to drive costs down. Then you’ll have a profitable and repeatable methodology for generating new business.
How The Heck Do I Calculate My Funnel Math?
OK, this is where it gets a bit harder. First, we need to define three critical key performance indicators. These are:
Cost Per Lead (CPL)
– The average cost to secure a marketing qualified lead.
– Calculated as: CPL = total monies spent on marketing and advertising divided by the number of marketing qualified leads acquired [for any given period of time].
Cost Per Acquisition (CPA)
– The average cost to secure a new customer.
– Calculated as: CPA = total monies spent on marketing and advertising divided by the number of new customers acquired [for any given period of time].
Lifetime Value of a Customer (LTV)
– The average value of a customer over their lifetime in doing business with your company.
– Calculated as: LTV = total revenue made from customers over a period of time divided by the number of customers.
As a startup, you very likely don’t have any historical data to base these calculations on. Therefore you need to do research. Find industry averages and start making assumptions for how your model will operate.
Let me illustrate this with an example.
ABC Company runs a business that sells Service X. It has priced the service at $5,000 per year and contracts require a three-year term; making the anticipated Lifetime Value of a Customer $15,000 (calculated as $5,000 x 3). Its projected profit margin is 50%, or $7,500. Meaning that if it costs the company $7,500 to acquire a customer, it breaks even but doesn’t actually make a profit.
Let’s also assume that market research and testing indicates that it is likely to take 20 prospects to generate one Marketing Qualified Lead (e.g. a 5% conversion rate), three leads to generate an opportunity (e.g. a 33% conversion rate) and that the sales team will win one in four opportunities (25% conversion rate).
Furthermore, the company has conducted research into advertising channels and believes that it should not cost more than $20 to get a prospect to its website—the main point of lead capture.
ABC Company has a goal of generating $1 million in contract revenue in 12 months. How much money should it be willing to spend to acquire and retain a customer?
Let’s do the funnel math!
1. To generate $1 million in contract revenue, ABC Company needs approximately 67 customers. This is calculated at $1 million divided by $15,000 (Lifetime Value of a Customer).
2. In order to win 67 new customers, ABC Company needs 268 opportunities (67 divided by 25%), 813 marketing qualified leads (268 divided by 33%) and 16,260 prospects (813 divided by 5%).
3. At a $20 per prospect advertising cost, its target CPL is $400 (calculated as 16,260 prospects x $20 = $325,200 divided by 813).
4. At a $400 CPL, its Cost Per Acquisition is $1,600 (calculated as $400 divided by 25%).
Isn’t math awesome?
Budgeting Is Just Another Way Of Saying Prioritizing
There are a nearly infinite number of ways to spend resources on marketing and advertising. However, you will never have enough money, staff or time to accomplish everything that you’d like to. Instead, and especially as an early-stage company, prioritize your marketing investments by understanding your funnel math. Doing so correctly enables you to predictably scale revenue without overspending.