Optimize Against Customer Value Instead of CPA

Things were looking great for DTC and e-commerce brands for a while there. When everyone was locked inside their homes during the pandemic the e-commerce channel was suddenly flooded with new customers and ad platforms like Facebook and Google were goldmines for acquiring new customers on the cheap. 

Those days are over. Yes, the e-commerce channel is still growing. But so is everyone’s CPA and CAC. Customers have returned to stores, iOS is messing with ad tracking, and ad prices are on the rise. So acquisition channels are no longer the goldmines they used to be. 

To adapt to this challenging reality and grow their profits, companies need to move away from the CPA approach in favor of a strategy that factors in customer value.  As one head of e-commerce executive recently said to us, “If it’s more expensive to acquire new customers, then I want to spend my money acquiring ones that will make us the most money.” 

This is a customer centric approach to marketing – managing your business and marketing against your best customers.

Customer Have Different Value

One of the fundamental premises at the core of customer centricity is the idea that customers all have a different value to your business. Your best customers will stay with you longer, purchase several products over time, recommend your products to others, etc. Some of your less valuable customers will make only a few purchases and then disappear. The variation in these values is often measured by a customer’s lifetime value (CLV).  

Customer lifetime value has been defined in several ways in the business literature. At Zeenk, to keep it relatively simple we define customer lifetime value as the amount of net revenue you can expect to generate from a single customer over a period of time. The net revenue is the cash you receive on the order less the cost of the goods you sold, less other costs you may incur in providing the product, and finally reduced for the return rate.

Optimizing Against CPA And CAC Metrics Is Flawed

Many marketing executives will often measure the “effectiveness” of their programs based on average cost metrics like CPA, Customer Acquisition Cost (CAC), etc. and allocate their budget accordingly. For most businesses, this is not profit maximizing because it does not factor in the value of the customer that is acquired which can lead to lost profits.

Let’s unpack CPA and CAC a little bit to see how they are different and require some care to measure correctly. Cost per acquisition (CPA) is a metric that is broadly reported by analytics platforms like Zeenk, and is computed on all the major advertising platforms if you provide them a conversion event.  The CPA is the amount  spent in a period on some subset of your advertising channels divided by the number of orders that have occurred where the users who placed those orders were tracked to have been exposed to that advertising.  

Average CAC is straightforward and you don’t need anything except Excel to compute it.  To get the average CAC for a month just pull the orders for a month and figure out how many unique customers placed those orders.  Remove any customer who ordered from you before.  Then download your total advertising spend for the month and remove the cost of any campaigns that were used to message or retain already existing customers.  Divide these two numbers and you have an approximate average CAC.  However, to go deeper and really look at a single customer’s CAC you need a more sophisticated analysis.

While these 2 metrics are useful because they give marketers an idea of how efficient their media spend is, neither provides insight into the quality of the customers that have been acquired or the long term value each will have to their business.

Let’s look at a simple example where a customer buys $100 worth of goods in a single order and the company charges a flat fee for shipping but incurs a variable cost for shipping the product.

So this customer is expected to generate on this single order $44.50 in cash. That cash has to pay for the cost of acquisition for that order and leave you some operating cash to pay for your expenses.

So now suppose one customer will buy once and leave. That customer is only worth the above.

Suppose another customer if they buy, may buy again 8 times out of 10 in the next three months.  A little math shows that this customer is likely worth $131 over the next 12 months and will likely be worth even more over a long period of time.  

This illustrates why you want more of these customers and want to align your marketing, product choices, and operations to acquire, retain and service your highest valued customers. This is not to suggest that you should completely ignore or fire a segment of your customers, but your investment in them should be more commensurate with their value.

Optimizing Against CLV

Paying $20 to get a $200 customer is great. But paying $200 to get a $20 customer is not so great. Segmenting customers based on their value versus their costs (to acquire and retain them) will allow businesses to optimize the performance of their marketing spend to achieve results more like former and grow the profits.

Optimizing retention strategies: Contrary to popular belief, the customer is not always right.  The “right” customer is always right.  Once you identify which of your customers will make you money, versus lose you money you can tailor the appropriate CRM and Customer Services resource to retain profitable customers. Again, we are not recommending that businesses neglect lower valued customers. But you should not invest the same amount of capital and resources to retain them as you do your higher valued customers.

Optimizing acquisition strategies: CLV, and CLV vs CAC analysis can be leverage several ways to optimize your acquisition strategies:

• Look-a-like segments. You can examine the attributes of your profitable customers, ex- geo, demo, product purchase, ad channel, creative, etc. and build a look-a-like model to create a pool of prospective targets.
• Optimization signal. Brands can set up CLV in the brand’s ad channels, like Meta, to use as an optimization signal for ad campaigns. This would feed information back to the ad channel on an acquired customer so their algorithm can auto adjust the targeting to find more optimal prospects and avoid less desirable ones.

Summary

Measuring marketing campaigns based on CAC or CPA is still an effective way to gauge the efficiency of your marketing efforts. However, without factoring in customer value it is difficult for brands to optimize their spend towards profitability.  Adopting a customer centric approach and managing your marketing spend against customer value instead of CPA will enable brands to better optimize the performance of an omni-channel strategy, enable them to bring on more profitable customers and potentially limit the amount of new customers that inevitably cost them money. In addition, optimizing towards customer value will be more financially beneficial to e-commerce companies in the longer term.