How much should you spend on marketing?
You would have heard it said that you have to spend money to make money, but knowing how much to spend on marketing can be tricky.
Many people believe that you should allocate 10% of your budget to marketing, but that’s a myth. Smart businesses will be outspending their competitors on advertising because they know how much they CAN spend and where to spend it to make sure it’s worth it.
The ‘correct’ amount to spend will vary, but there are two important concepts to understand that will help you figure out how much you should be spending and whether the type of marketing you’re spending it on is a good investment.
The two key numbers
The first concept is the Customer Lifetime Value (or CLV), which means how much that customer is worth to your business over the average time of a customer.
The second important concept is the Customer Acquisition Cost (CAC), which refers to how much it costs your business to gain that customer.
To figure out your acquisition cost, take the amount you spent on marketing and divide it by the number of new customers that marketing brought you. For example, say you spent $100 on an ad, and as a result got 5 new customers. That would make your CAC =$20. That is, it cost you $20 to get one customer to come to your business and buy something.
Using the numbers
To determine whether your marketing spend is wise, you need to compare these two numbers.
If it costs you $100 in advertising to gain a customer that will be worth $1500 to you over their average life time then it is pretty clear that you can continue doing that marketing to the extent that your cashflow allows it.
The ideal ratio it really depends on the type of market and how competitive it is. If you have a monopoly in your category, your acquisition costs could be quite low, but if your market is very competitive then it will likely cost you a lot more to acquire new customers.
Tracking their spend to determine yours
What you want to do is get that acquisition cost per customer down as low as you can so you’re making more profit. However, that cost needs to be proven. To accurately determine your CAC you need to track it. Sometimes the lifetime value of a customer is not what you think it is. Often you might find that smaller customers actually turn out to be more valuable than the big spenders because they end up spending more over time. So it’s important to know what your customer’s lifetime value is so you can accurately determine whether the amount you spent to acquire them was more or less than their worth to you. You want to drive down that cost by spending your marketing dollar smarter.
Some businesses might view money spent on advertising as a risk – putting money out there to try and get some back. But if you understand these two concepts it’s not much of a risk at all. When you know that your customer’s lifetime value is more than your acquisition cost, the marketing cost is an investment. You need to think about marketing as a bid to gain a customer, not just a sale.
The other thing you need to take into consideration is cashflow. You need to know the timeframe in which your business needs to see the return on investment from your marketing. Understanding these two numbers will help you decide what you can afford to spend on marketing.
In the future we’ll be talking about how to measure radio as a marketing tool and how you can use radio to build your brand and gain long term customers.