JUNE 2010
                                        
Salvaging Millions
Calculating customer acquisition cost

Whenever you are wondering whether you should continue to run an advertisement or whether your last mailer was worth the cost, you need to consider customer acquisition costs.

Customer acquisition cost is not hard to understand, but few businesses do the math required to evaluate their advertising efforts.

I first learned about calculating customer acquisition costs while serving on the board of an Internet games company. At this firm, revenue per employee was fairly low, but the cost of acquiring a customer from certain kinds of promotional efforts was very high.

The calculations go like this. If you mail out 1,000 advertising fliers at a cost of 50 cents apiece, you will spend $500. If you get 20 responses, it cost you $25 per response. But you can’t spend responses; you can only spend sales/profits. Now, if you were able to convince 100 percent of the people who responded to become customers, your customer acquisition cost would be $25. But no one closes all their prospects.

In most businesses, closing 25 percent would be a reasonable rate. So, from the 20 responses, with a 25 percent close rate, you can expect to add 5 customers. Now your customer acquisition cost is $125. WOW. That could still be great if your average sale were $1,500, with a 50 percent gross margin. Simply put, it would cost you $125 to bring in one customer that produces $750 of gross margin.

Now, if your cost to mail those brochures were $1.00 each, then your customer acquisition cost just doubled, to $250.

Without considering the numbers and the lifetime value of the customer in the case of repeat business, it’s impossible to make an intelligent decision about whether your advertising is working.

In my small business consulting, I frequently find businesses that run $1,000 print ads without ever doing the customer acquisition math. Even if the advertisement only resulted in one new customer per time it ran, it still could be a good investment if the new customer contributes enough to profits.


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Ron Sturgeon is past owner of AAA Small Car World. In 1999, he sold his six Texas locations, with 140 employees, to Greenleaf. In 2001, he founded North Texas Insurance Auction, which he sold to Copart in 2002. In 2002, his book “Salvaging Millions” was published to help small business owners achieve significant success, and was recently reprinted. In June 2003, he joined the new ownership and management team of GreenLeaf. He also manages his real estate holdings and investments. You can learn more about him at WWW.autosalvageconsultant.com He can be reached at 5940 Eden, Haltom City, TX 76117, rons@rdsinvestments.com or 817-834-3625 ext 6#.