Frank’s Fridges: The Case of the Deceptive Cost Per Customer

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Written By: Kurtis Hardy

Embodied within successful business modeling comes the necessary tracking and analysis of marketing campaign effectiveness. After all, considering the wealth of information presently available to leaders (campaign traffic, revenue generated, customers acquired, etc.), the ability to accurately decipher important markers from data collected in evaluating a firm’s efforts remains essential. 

Traditionally, marketing teams calculated campaign influence through cost per lead or web registration results as a measure of achievement. But while insightful, fails in drawing imperative conclusions concerning the business as a whole. Luckily, applying only minor adjustments within these commonplace equations provides capability to evaluate one’s entire business model. 

The simplified computation of old divided the cost of an individual campaign, by the total number of new product sold (or revenue, email addresses collected, etc.) over that particular timeframe. For example, if a $500 campaign resulted in 20 new leads, the cost per lead equaled $25.  

A robust evaluation, however, includes more comprehensive expenses utilized from sales and marketing attributed over the course of the campaign. Inclusions then occupy more than the cost of the campaign, but expenditures of impacted employee salaries, any tools (equipment) utilized, social media expenses, and even amounts concerning website maintenance. 

This certainly complicates our previous example. Considering these additional expenses, cost per lead could easily double. Dependent then on product forecasting and traditional lead time, company leadership may deem this once successful campaign to point to failure. However, the additional insights realized through this enhanced equation, allow for improved evaluation of business configuration and appropriate pricing.


Line of classic colored refrigerators

CASE STUDY – FRANK’S FRIDGES

For reference, imagine the creation of a new business named Frank’s Fridges that specializes in selling refrigerators. Similar to retailers such as Lowe’s or Home Depot, the firm completed deals with GE, Maytag, and Whirlpool, to sell their appliances in-store. With prominent competition selling product at an average price of $1,500, Frank eyes a price tag of $1,250 in an attempt to undercut the market. As a materializing new start-up, 250 appliances sold would equate a contented $300,000 in first-year revenue. 

Staffing of pertinent sales and marketing resources will begin understandably lean. In order to advertise and ultimately help move product, the firm plans to hire two marketing assistants to steer campaigns and appropriate messaging. Concurrently, two account executives will control the sales floor and manage order operations. For simplicity, assume average salaries of $40,000 and individual team expenses nearing $20,000, culminating in $200,000 of total sales and marketing expenses. 

Come year end, the team successfully unloads 250 refrigerators, achieving $300,000 in revenue with an expected $100,000 margin before additional company overhead. Upon first glance, operations are considered a success as revenue exceeded expenses. Yet, additional analysis is required in determining a true sense of business stability. 


CASE ANALYSIS

Company performance is always a matter of perspective. All too often, business leaders concentrate on the short-term, scrutinizing financial performance surrounding a monthly, quarterly, or annual interval. Most business valuation concepts, however, spotlight keys and metrics that point toward long-term results. 

Take our case with Frank’s Fridges. Considering the $200,000 cost of total sales and marketing, divided by the 250 appliances sold, the average cost to acquire one customer equates to $800. Revenues clearly outpace expenses, resulting in an estimated benefit of $425 per unit sold ($1,250 price – $800).  

The difficulty is that business assessment and company evaluators alike do not base valuation decisions on this singular instance. Instead, true organization model performance is determined when the revenue received from a particular customer doubles this cost of customer acquisition metric. 

Therefore, in Frank’s case, it is not the individual sale of a single refrigerator that matters. Rather, at what point will he earn $1,600 ($800 x 2) from a particular customer. This then becomes a conversation surrounding lead time. Considering refrigerators carry an average appliance lifespan nearing 10-15 years, Frank’s business output would actually be discouraged as the time to sell a second unit to that customer would be over a decade. 

Luckily, all hope is not lost. Acknowledging product lead time and competitive pricing will remain key metrics in determining position, initial analysis must first encompass intensified scrutiny of all sales and marketing expenses. In fact, if these metrics equate to more than half of the revenue you wish to achieve, your model is likely broken. Either revenue projections are far too low, or more likely, opportunities exist to cut cost. 

Imagine if Frank only hired three employees and cross-trained each to cover multiple responsibilities. The subsequent drop in a $40,000 salary, bringing our total cost down from $200,000 to $160,000, significantly alters our cost to acquisition. In this singular (admittedly dramatic) edit of expenses, acquisition outcome falls from $800 to $640. 

In realizing this new acquisition cost, the firm is suddenly much closer to doubling benefit in a lone purchase. In fact, an increase in price from $1,250 to $1,280 allows Frank to double this benefit, as well as continue to exist below market standard. Admittedly, competitive dynamics may not allow much alteration in this realm. But as Frank initially held price $250 below average, available space to navigate was created. 


In summary, the cost to acquisition calculation becomes an effective evaluator of one’s business model. In revising a simplified equation that focused on a single campaign, the supplementary considerations resulted in a robust product and business model analysis. 

The most prosperous models benefit from not only doubling customer revenue over individual cost to acquire, but manage to consistently reproduce. Consider software-as-a-service products, for example, whose costs to acquire first-time buyers are generally high. Revenue, however, is obtained through annual subscription fees, supplying regular benefit back to the company. 

These three powerful indicators of price, cost, and product lead time, must be continually reviewed for possible improvements and ability to streamline. The combination of which is key in setting a company structure that is not only successful, but consistently profitable. In understanding this more-robust interpretation of the cost to acquire equation, leaders will more definitively gauge company performance and set proper strategy moving forward. 

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