Of all the formulas used to describe how customer acquisition works, this identity equation is as simple as it gets:
[Dollars In]
=
[Dollars Out] x [inverse of Acquisition Cost] x [Conversion Rate] x [Transaction Size]
That’s it. When you pay for a marketing campaign with the goal of driving revenue, then everything you need to know simplifies down to Acquisition Cost, Conversion Rate, and Transaction Size. Three distinct characters with unique personalities. Spend time with each of them, give them your love, and you can obtain an increasingly positive ROI (meaning the flow of [Dollars In] to your business grows faster than the flow of [Dollars Out]).
Acquisition Cost. Commonly [Dollars Out] divided by [Total Signups].
Acquisition Cost is the glamour queen of your marketing program – it’s the typical spend to get one person or company to sign up and express interest in your product or service. Acquisition Cost is relatively transparent, it’s straightforward to calculate, and you can flip switches to change it. Therefore, nearly everyone spends time on this lever first. Whereas the other levers increase through optimization, marketers tend to reduce Acquisition Cost as much as they can (technical note: we use the “inverse” of Acquisition Cost to refer to the fact that, all things equal, smaller is better).
Average marketers who starve Acquisition Cost wake up to see the inflow of new customers has suddenly dried up. Great marketers, on the other hand, realize that Acquisition Cost is highly dependent on the other two levers. The three work together: if you cheapen your inbound traffic by flooding Signups with traffic from lousy sources, you can starve Acquisition Cost quickly, but don’t be surprised when you can’t convert and monetize this lower-quality traffic.
On the other hand, you can effectively lower Acquisition Cost with honest effort. One tried-and-true method is to perform keyword expansion on your campaigns. By targeting more long-tail keywords, you can simultaneously lower Acquisition Cost and retain quality traffic. Another subtle method is to increase free sources of traffic to your site. Sources of free traffic include word-of-mouth referrals and high visibility in search engines. These have the benefit of increasing the [Total Signups] without increasing [Dollars Out]. These can be especially good campaigns to build out when you have some time but no budget to spend.
Conversion Rate. Commonly [Total Customers] divided by [Total Signups].
Conversion rate is the workhorse of your marketing program – broadly speaking, it’s the number of people or companies who choose to pay you from among those who express interest. You can have a major impact on ROI by increasing Conversion Rate, but you have to spend significant time testing and optimizing to enact lasting improvements. For each industry, the number of sub-steps from Signup to Customer varies dramatically. This is the proverbial customer funnel that forms the foundation of Conversion Rate.
At LogMeIn, we studied the following: [Signup] to [Trial] to [Quality Trial] to [Customer]. We invented a [Quality Trial] metric to mark high-usage trials once we observed they were more likely to purchase. Of course, you can just as easily apply sub-steps to an offline product. For a candy store franchise such as Lolli and Pops, you may try to acquire cost-effective foot traffic in lieu of signing people up: [Walk by Store] to [Enter Store] to [Customer]. You ought to discover and optimize campaigns around sub-steps that are relevant for your business. Multiplying all sub-step rates together yields Conversion Rate in its entirety.
Average marketers will focus on the overall ratio and ignore intermediate conversion steps. However, great marketers strive to map out, measure, and experiment with various ways to improve on midfunnel metrics. Furthermore, some marketers increase Conversion Rate by reducing the overall number of sub-steps required to convert a Signup to a Customer. However, don’t confuse reduction in the actual number of sub-steps (such as implementing a one-click purchase process) with reduction in tracking existing sub-steps. Reducing steps works when you can identify specific steps in your conversion process that contain unnecessary friction.
Transaction Size. Commonly [Dollars In] divided by [Total Customers].
Transaction Size is the shy cousin of your marketing program – it’s the number of dollars you receive from a typical customer. When there’s a change to Transaction Size, everyone across the business feels it quickly. Honestly, given the opportunity for upside on revenue, I’m not sure why Transaction Size doesn’t figure into marketing strategy discussions more frequently. For instance, pricing is a very complicated matter, yet entrepreneurs and marketers alike often spend little time on it and leave tremendous value on the table.
Many people believe that Transaction Size is a by-product of your target market, difficult to directly control, and risky to mess with. Feed Acquisition Cost and it will bounce right back to its old shape, Conversion Rate slowly and steadily improves with effort, but overreach with Transaction Size and you may lose a segment of your market forever. However, great marketers find a way to test product bundles, add-on purchase incentives, and new price tiers. They uncover ways to increase Transaction Size without jeopardizing the underlying business.
Remember, the healthiest way to drive a positive ROI is to have a superb product that fulfills a critical need in a large and growing market. If your product stinks, the three levers won’t deliver for you no matter what you do. But if your product or service is promising and you’re willing to experiment and live by the results, then spending time individually optimizing Acquisition Cost, Conversion Rate, and Transaction Size will be fruitful to your ROI and your bottom line.
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