Planning your business finances can be something of an overwhelming task. Let’s face it, getting this wrong is not just a matter of missing out on some profit here and there. Even small errors can influence the trajectory of your company in the long term.
This is why it’s so important to be cognizant of all contributing factors to the finances of your operation.
One of the primary elements here is your cost per acquisition (CPA). This is the calculation that shows how much each conversion costs. It’s an important factor to consider when preparing marketing campaign budgets, pricing your services, and forecasting revenue.
It may seem like a niche metric, but establishing a target CPA can be a practical tool to help your company stay profitable.
Image Source: Pexels
The Basic CPA Equation
Your target CPA is how much you want to spend (on average) per conversion. This should be the amount you can spend per conversion to stay at the profit level you desire.
The simplest way to work out your target CPA is by utilizing a basic formula. It’s a relatively simple process to perform once you have all the relevant data to hand. However, many businesses fail to do this at the outset of marketing campaigns because it’s perceived as yet another mathematical formula to attend to.
Nevertheless, taking a little time to get it right is worthwhile. The most basic data you need is as follows:
- The average transaction value of each conversion;
- Cost of production for items or services;
- Fixed business operation costs for each product or service sold;
- The profit level you’re aiming for with each sale.
To calculate your target CPA, you then
- take the average transaction value and subtract the costs of production and fixed costs (per unit). This shows you the highest CPA you could spend to break even.
- further subtract the target profit level from this amount. This gives you your target CPA – the amount you can spend per conversion while earning your desired amount of profit.
The equation for this would be:
Avg. Transaction Value – Cost Per Unit – Target Profit Per Unit = Target CPA
Most businesses want to at least triple their money from marketing expenses. So if you don’t know your Target profit per unit, you could simply divide the Average Transaction Value – Cost per unit (which is the gross profit per unit) by 3.
Target CPA example
Imagine you sell a toy frog for £3, and it costs £2 to make. You want to earn at least 50p profit per sale.
Before you start advertising your toy frog online, you work out your Target CPA so you can easily tell whether your advertising is hitting it’s goal or not. You use the Target CPA equation:
Avg. Transaction Value – Cost Per Unit – Target Profit Per Unit = Target CPA
Putting your figures in you get:
£3 – £2 – £0.50 = £0.50
This means that as long as your CPA stays at 50p or lower then you’ll be hitting your goals.
Lifetime Value
The above target CPA equation is for direct sales. This means that you are selling a product and aren’t expecting people to come back again for a second purchase.
If, however, you are building customer loyalty, and expect they will come back again and again then instead of Average Transaction Value, you can use Lifetime Value to calculate your Target CPA.
For this the equation would be:
(Avg. Transaction Value – Cost Per Unit – Target Profit Per Unit) x Avg. No. of Units Bought = Target CPA
Note: In this version of the equation you need to take into account the average number of units bought per customer too.
What this means is you work out the average amount you expect to earn per customer from every future purchase they make due to that initial bit of marketing. By doing this you can increase your target CPA. In online advertising the more you are willing to spend, the more people you will potentially reach, so a higher target CPA can help you gain more customers.
So how it works is:
Increased customer loyalty = More money spent with you = More profit from each new customer
LTV Target CPA example
Imagine you are selling a type of pen that people love once they try it out. The pens sell for $5 and cost you $2 to make. You know that most people will keep coming back and buying more pens, and each customer typically buys about 10 in total. As the pens cost you $2 to make, you think it’s fair if you earn $0.20 per pen.
When you start advertising online, you use the standard target CPA equation:
Avg. Transaction Value – Cost Per Unit – Target Profit Per Unit = Target CPA
This gives you:
$5 – $2 – $0.20 = $2.80
You get some customers this way, but not nearly as many as you would hope. You know that once people try your pen they will keep coming back, so increasing first-time sales is a big deal for you. So you decide to try to use Lifetime Value for your target CPA instead:
(Avg. Transaction Value – Cost Per Unit – Target Profit Per Unit) x Average No. of Units Bought = Target CPA
This gives you:
($5 – $2 – $0.20) x 10 = $28
With this far higher target CPA the sales come pouring in! It may seem ridiculous to spend $28 to sell a $5 pen, but you the increase in sales means an increase in your overall profits. Best of all, you keep your $0.20 per pen profit too – and could even consider increasing it while keeping your overall sales high.
Note: When working at a larger scale it’s likely that your cost per unit will go down too as you can bulk purchase materials etc. This will increase your potential target CPA further.
Enjoying this post? Register now for your free monthly roundup email >
The Contributing Factors To Consider
A simple CPA equation is a great tool. But as mentioned it’s important to treat it as the basis of your target CPA calculation, rather than the entire process. After all, marketing in business is rarely straightforward. There are additional factors you need to consider that may add to or subtract from the CPA for each campaign.
These include:
Marketing Methods
The methods you utilize for marketing can differ between campaigns. Inbound marketing and outbound marketing have very different impacts on a campaign strategy. While inbound is focused on longer-term organic brand building, outbound is more targeted toward capturing immediate engagement.
As such, the approach to CPA calculations for the former may become smaller as your reputation builds and time goes on, while the latter may be relatively consistent. Inbound marketing can be a more effective long-term investment.
As such, it’s wise to consider the balance of benefits from different methods when calculating your target CPA.
Customer Loyalty
The intentions of your campaign can also be a contributing factor when determining a target CPA. This is especially relevant when a campaign needs to inspire customer loyalty. When starting out, you can just apply the direct cost of conversion in these instances. However, the goal here is to make sure the initial costs of marketing result in repeat patronage over a period of time.
As such, the average CPA from all your consumers will reduce along the timeline of their relationship with you. Indeed, later down the line, you may find word-of-mouth from loyal customers starts to lower your CPA further.
This is assuming you are still advertising to customers who are becoming more and more likely to buy from you. This is a good tactic to keep your product front of mind. You should segment out these “warm” customers and target them with a low CPA, while trying to find new customers with a separate target CPA campaign using the tips mentioned above.
User Experience
In most cases, you’ll find that the better user experience (UX) your marketing materials offer, the better conversions you gain. Web accessibility is a particularly vital consideration when designing your online materials, both from an ethical perspective and usability standpoint.
If visitors aren’t able to easily navigate your menus or your website is incompatible with assistive technology, you could lose a chunk of potential acquisitions.
Making accessibility improvements to your site can both widen your demographic engagement and your company reputation. As such, the price of these adjustments may need to factor into your target CPA in the interests of longer-term engagement.
If people are less likely to convert, you’re going to need to spend more to get enough customers.
The Question of Accuracy
Given that there are various contributing factors to determining a CPA, good quality data is vital to reaching the most actionable figure. However, some of the contributing elements that are based on results may come much further down the line.
Indeed, some components — such as consumer loyalty or brand reputation — can be based on the whims of quite fickle consumers. So, how accurate should your target CPA be to be effective?
The answer is simple, but also quite frustrating. Your target CPA should be as accurate as you can possibly make it. As with any other area of your business, there is always some element of guesstimation when it comes to forecasting and planning.
Aim to be solid on the relatively unchanging costs. Be clear about your production costs per unit or service and average conversions from similar campaigns. For the aspects you want to guesstimate, base these on good market research where possible. The closer you can get to a realistic CPA, the better you’ll be able to budget and plan.
An important influencer of your accuracy is the regular reassessment of your target CPA. Perform this every few months or between campaigns if you’re switching up tactics significantly.
You’ll gain better data on your costs and conversions over time. You also don’t want to wait until your profits are suffering before you make changes to your CPA and your marketing strategy.
Conclusion
Establishing a target CPA can help keep your marketing budget in line and assist other areas of business financial planning. There’s a relatively simple equation, but it’s important to understand there can also be other contributing factors. Marketing methods, loyalty, and user experience improvements may impact how high you’re willing to push your CPA.
Accuracy can help you make the best decisions, but you should be cognizant of the need for frequent reassessment. It takes some time and research, but a good target CPA is a valuable tool.