The CPA Equation: What Clients Don’t Always Understand

Posted on by Jay Habegger

Do your clients always understand the reality of cost per acquisition (CPA)?

Consider what one of my sales reps went through recently with an account. There were two weeks left in the quarter and he was behind. We waited in the lobby of one of our large auto insurance clients to meet about increasing the budget on their customer acquisition campaign or at least throwing more of the budget our way.

Secure this incremental spend and the rep made his goal for the quarter.

An assistant escorted us to a conference room with no windows. There were three people in the room. Rob, the CMO, was there along with his VP of digital advertising and a media planner. Pleasantries were exchanged.

We’d been doing business together for the past year. They used display for customer acquisition. Our cost per acquisition (CPA) was the lowest of any partner on their media plan, and the volume of business we did with them had steadily increased.

The meeting was going well.

“I’m going to put you guys in our Q2 plan for an additional $1M,” the media planner said.

My sales rep was visibly relieved. He was going to make his number.

“I have just one question,” said the CMO. “We’re trying to carefully manage our CPA so I assume that number will be unchanged with this additional budget?”

My sales rep’s body language changed again. He tensed up. He glanced at me, his eyes pleading for me not to say what he knew I was about to say. He needed this deal.

Acknowledging my sales rep’s distress with a glance, I leaned forward and looked Rob directly in the eye.

“Are you shifting the $1M from non-performing partners to us?” I asked.

“No, this is new spend that we’re putting into the market to increase the number of insurance applications we get in Q2,” Rob replied.

I glanced again at my rep; his entire expression begging me to tell Rob what he wanted to hear.

“Rob, your CPAs are only going up.”

My sales rep emitted an audible groan. The CMO was not thrilled.

This is not a unique situation. Many CMOs and agencies want to spend more, and acquire even more customers—while simultaneously expecting the cost of acquisition to stay flat, or even go down. Sadly, it doesn’t work this way.

Investing more in customer acquisition, while keeping media execution efficiency constant, guarantees that your cost to acquire each marginal customer is going to increase. The reason for this is that your media has to work harder to acquire the more marginal prospects. Your lowest CPA, on the other hand, is going to be associated with acquiring those customers who are already pre-disposed to buy from you. As you work to acquire more difficult-to-influence-prospects it costs more to influence them and convert them into customers.

You can conduct your own thought experiment to test the concept. Imagine you own an ice cream truck on the boardwalk of a beach on a hot summer day. The easy prospects flock to the truck when they hear the tinny melody. To get those beach goers that want ice cream a little less, you may have to wait around for a while until they get the urge to amble over. To get still more customers, you might send somebody to walk the beach wearing a sign-board and shouting, “Get your ice cream!”

What media and price promotions would be needed to get everybody on the beach to buy an ice cream? Even the most expensive promotion you could do—free ice cream for all—probably wouldn’t get everybody off of their beach blanket.

Auto insurance is no different. The easy prospects might be people who have other automobiles insured by the company, kids getting their first policy and using the same insurer used by their parents, friends of employees and other prospects with a connection to the company. As you move out from these easy targets, the cost to influence customers increases. Then, at some point, you’ve influenced all the easier prospects and now you have to do really hard things, such as convincing the son of an employee of your competitor to insure with you instead of the company that put them through college.

Unfortunately, most businesses need to influence the hard to influence prospects in order to grow. There usually aren’t enough “easy wins” to meet shareholder expectations. In mature markets, such as the market for toilet paper and many other CPG staples, the only growth available may come from the really hard to influence customers: convincing another brand’s loyal customer to switch.

So how does a CMO know the maximum CPA that their business can tolerate? When do you stop investing dollars in customer acquisition?

Conceptually, the answer for a company focused on profitability is simple, if not always easy to calculate in practice: the marginal cost of customer acquisition should equal the lifetime marginal contribution of the customer. Put another way, a CMO should be willing to spend in acquisition expense what the company is going to earn from having the customer. This is essentially breaking-even on customer acquisition expense at the margin. However, since this equation is only true at the margin, all of the easier customer acquisitions, the “easier wins,” are profitable and thus the enterprise is profitable.

Of course, there are situations where shareholders are focused on growth at any cost, and in these situations there is no limit to what a CMO should spend on customer acquisition. All talk of maximum CPAs is out the window and the challenge is how to deploy enough promotion dollars to get everybody off the beach. Think free ice cream.

This made Rob the CMO (remember him?) see the reality of the situation.

“You know, we probably need to think about segmenting our tactics by degree of difficulty on the prospects they are trying to influence,” he told his digital VP, before instructing his media planner to sign off on the deal. “Our search and retargeting should be held to the lowest CPA targets. While we can tolerate a really high CPA on our conquesting tactics.”

“Diminishing marginal returns,” he said. “Of course.”

Jay Habegger is CEO of programmatic agency owneriq.

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