January 21, 2008

Online Marketing And Optimal Investment Strategy

Next time you're meeting with an online marketing executive, ask the executive how much s/he is willing to spend to acquire a customer.

You might hear one of three different answers:
  • We want each individual marketing activity to perform at or above break-even.
  • We want the sum of all marketing activities to perform at break-even.
  • We want the long-term value of customers to exceed what it costs to acquire a customer.
Which answer is "best"?

Each strategy has advantages.

In the short-term, executing marketing activities that don't lose money protect the short-term profit and loss statement.

In the long-term, losing money in the short-term that is offset by sales and profit over the next few years makes the most sense.

I frequently use a one-channel Multichannel Forensics spreadsheet to play with different scenarios for clients.

Here are results for each investment scenario, simulated over five years using the data entered in the spreadsheet:

Results Of Three Simulation Runs: Long-Term Profit





Worst Sum Of All Maximize

Segment Activities Lifetime

Is Break/Even Is Break/Even Value




Variable Profit $433,358 $469 ($899,172)
New Customers 26,926 53,735 73,824
Profit per New Customer $16.09 $0.01 ($12.04)




Incremental Profit $433,358 ($432,889) ($899,641)
Incremental Newbies 26,926 26,809 20,089
Incremental PPNC $16.09 ($16.15) ($44.78)




Total Business Demand (in Millions)

Year 1 $35.7 $41.1 $45.1
Year 2 $36.3 $44.4 $50.4
Year 3 $35.6 $46.7 $54.9
Year 4 $34.9 $48.5 $58.6
Year 5 $34.4 $50.1 $61.9
Sum Of Years 1 - 5 $176.9 $230.8 $270.9




Total Variable Profit (in Millions)

Year 1 $6.4 $6.5 $6.0
Year 2 $6.6 $7.2 $7.0
Year 3 $6.5 $7.6 $7.8
Year 4 $6.3 $7.9 $8.5
Year 5 $6.1 $8.1 $9.1
Sum Of Years 1 - 5 $31.9 $37.3 $38.4

Take a look at the incremental statistics. The first strategy generates $16.09 profit per new customer. Incrementally, the second strategy generates $16.09 profit per new customer, followed by a loss of $16.15 per new customer. The second strategy acquires double the customers of the first strategy. The third strategy generates customers at a profit of $16.09, then a loss of $16.15, then a huge loss of $44.78 per customer. The third strategy generates nearly three times as many new customers as the first strategy.

Now look at the long-term demand/profit trajectory of each strategy. The first strategy nets $35.7 million demand and $6.4 million variable profit in year one ... culminating in $34.4 million demand and $6.1 million variable profit in year five. In other words, this business is being starved for new customers in the long-term.

The second strategy (break-even new customer acquisition, in total) yields $41.1 million demand and $6.5 million variable profit in year one ... culminating in $50.1 million demand and $8.1 million variable profit in year five. The strategy actually generates more profit in year one (as new customers re-order), and results in rapid growth through year five.

The third strategy (lose a ton of money in new customer acquisition) generates $45.1 million demand and $6.0 million variable profit in year one ... with $61.9 million demand and $9.1 million variable profit in year five.

What matters to the online marketing executive is this: Given a choice between marketing investment strategies, you are generally best-off, in the long-term, to lose money in the short term on your marketing strategies. In other words, you are likely to have the best long-term success in your paid search and portal advertising strategies if what you lose investing in new customers is offset with future profit that exceeds what you lost acquiring the customer.

Many times, these are not the answers that executive leadership wants to hear. The profit and loss statement must work this year, right?

Your job as an online marketing executive is to run simulations that illustrate what happens to your business, long-term, when marketing spend is not allocated as generously as it could be.

Your simulations will become even more important when our recessionary environment throttles the organic online growth rates that propelled this channel into prominence.

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