I spent the first five years of my career at Goldman Sachs before making my way to HowAboutWe in 2010 as a community manager. After a few months, I was working within the HowAboutWe financial model, monitoring the cash we spent on ads and the money we were making back, which quickly segued into taking the lead on HowAboutWe’s advertising spend. Over the last 2.5 years, I’ve added three people to my team and expanded from primarily handling search ads to overseeing an integrated, multi-channel advertising effort that drives a meaningful percentage of HowAboutWe’s traffic.
Over the course of my time here at HowAboutWe, I’ve learned a simple truth: paid acquisition — done well and for the right product — provides a relatively predictable and controllable way to acquire users. Success in this field requires a comprehensive understanding of your customers, creativity, comfort with analytics, domain knowledge of advertising channels, operational efficiency, negotiation savvy, a habit of continual learning, and comfort with risk and failure.
Failing is a great but expensive way to learn, which is why it’s important to be aware of pitfalls. This our first installment of a series identifying many of the most common paid acquisition mistakes people make, and (more importantly) how to avoid them.
Mistake: Not knowing how much money is in the banana stand.
Your goal as an advertiser is to generate a positive return-on-investment within a certain period of time.
Return on investment (ROI) = the amount of money you expect a customer to spend with you over their lifetime (lifetime value, or LTV) minus the amount of money it costs you to acquire a customer (cost per acquisition, or CPA).
Generating positive ROI therefore means you spend less money acquiring customers than they spend with you. On the other hand, if your CPA is greater than your LTV, you’re losing money on every paid user you acquire, before even factoring in operational costs.
Knowing your customer’s LTV and your CPA is the difference between, as our co-founder Brian likes to say, knowing whether you have a time-bomb or a cash-printing machine on your hands. Unfortunately, neither LTV nor CPA is necessarily easy to measure. Here’s why:
On the LTV side, small variations in inputs can cause big differences in revenue over time – for example, a subscription business with a $10 per month fee and an 80% month-over-month renewal rate will generate $50 in revenue over 5 months, but that same business with a 75% renewal rate drops the time that people are paying you to just 4 months and results in just $40 in revenue – a 20% difference. Another wrinkle is that your customer’s LTV isn’t necessarily all happening from the first subscription (or the first purchase, if you’re in ecommerce).
Another example: repeat purchase rates over time are difficult to predict, but could result in meaningful swings in your LTV. A simple example: if someone comes to your site and buys $500 of stuff upfront but then never buys again has an LTV of $500 whereas someone who buys $25 a month for 5 years has an LTV of $1500. If you only look at the first purchase of each of these customers you’ll miss the nuance of the second customer and lose out on $1000 worth of LTV.
On the CPA side, the uncertainty is similar, mostly because of the element of time. Most of the people you send to your site won’t pay you immediately – they’ll take time. Let’s say you expect the people that pay you within 24 hours of signing up represent 25% of the total number of people that pay you from any given cohort of users. Let’s say you spent $1,000, and 10 people pay you within 24 hours. From there, you’d expect 40 people total to pay you over time, implying a CPA of $25. Change that 25% to 30%, and you’re now at just 33 people paying you and your CPA has jumped to $30.
You won’t be able to put a pin in either of these numbers, but having a sense of the potential range of outcomes will still be key in guiding your acquisition strategy. For example, if you think your LTV is $100-150 you’ll want to keep your CPA goals much lower than if you think your LTV is $1000+. Two companies at opposite ends of the spectrum here are Zynga (lots of very small transactions buying digital goods, games rise and fall quickly in popularity = low LTV) and American Express (people hold credit cards for years, AmEx earns a fee on every single transaction, customers often pay an annual fee = high LTV).
It’s important to understand this first, despite the many questions that are probably at the top of your mind: ie, where to run your ads, how much you should be spending, best practices for getting up and running, etc. It’s easy to get bogged down in the details without taking a hard look at the bigger picture, but taking a step back will help shape you into a more effective advertiser.
Forthcoming posts will walk through how to set a budget and how to maximize spending efficiency, ensuring you have the best possible shot at establishing a CPA below your LTV. Stay tuned.
Contributed by Kate Huyett VP of Acquisition, Retention, and Revenue at HowAboutWe