December 02, 2008

Cost Per New Customer

Cost Per New Customer is one of the easiest metrics to measure, hence, it is beloved by many marketers.

The marketer spends $1,000, yielding 25 new customers. Cost Per New Customer is measured as ($1,000 / 25) = $40.00.

The marketer compares CPNC across all marketing activities, seeking to maximize activities with a low CPNC.

A metric that yields a better result is Profit Per New Customer, or PPNC. In order to calculate PPNC, we need two additional metrics.
  1. Average Order Value --- the average amount that a new customer spend when placing a first order.
  2. Profit Factor --- visit your finance department, and find out how much demand (independent of ad cost) flows through to profit.
Here's an example.
  • Marketer spends $1,000 on a marketing program.
  • 25 new customers are acquired.
  • The average order value is $150.
  • 40% of demand flows-through to profit.
  • PPNC = ((25 * $150) * 0.40 - $1,000) / 25.
  • PPNC = ($3,750 * 0.40 - $1,000) / 25.
  • PPNC = ($1,500 - $1,000) / 25.
  • PPNC = $500 / 25.
  • PPNC = $20.00.
In this example, the marketer generated $20.00 profit for every new customer acquired by the marketing program. This is good performance! Take this information to your finance department, and ask for more money!

In most cases, marketing for new customers results in a loss. Let's assume that instead of 40% of demand flowing-through to profit, only 20% of demand flows-through to profit. Now see what happens to the calculation:
  • Marketer spends $1,000 on a marketing program.
  • 25 new customers are acquired.
  • The average order value is $150.
  • 20% of demand flows-through to profit.
  • PPNC = ((25 * $150) * 0.20 - $1,000) / 25.
  • PPNC = ($3,750 * 0.20 - $1,000) / 25.
  • PPNC = ($750 - $1,000) / 25.
  • PPNC = -$250 / 25.
  • PPNC = -$10.00.
In this case, the marketer lost $10.00 profit acquiring each new customer. This may be ok, however. Calculate how much profit customers generate over the next twelve months (or longer, depending upon your payback window).

If the customer generates $20.00 of profit in the next twelve months, then things are fine, because we are willing to lose $10.00 of profit now in order to gain $20.00 profit in the future.

We also look at the sensitivity of profit per new customer. If we believe that the economy will be 20% worse next year, we can run our analysis assuming decreased productivity.
  • Marketer spends $1,000 on a marketing program.
  • 20 new customers are acquired (25 * 0.80 due to the economy).
  • The average order value is $150.
  • 20% of demand flows-through to profit.
  • PPNC = ((20 * $150) * 0.20 - $1,000) / 20.
  • PPNC = ($3,000 * 0.20 - $1,000) / 20.
  • PPNC = ($600 - $1,000) / 20.
  • PPNC = -$400 / 20.
  • PPNC = -$20.00.
If the economy is twenty percent worse next year, our PPNC drops from -$10.00 to -$20.00. We would calculate the long-term value for this customer segment, assuming a 20% drop in the economy, and if we generated at least $16.00 of profit, we could continue to execute this marketing program. (NOTE: Math correction from earlier post, thanks to Harry Joiner!)

As you can see, Cost Per New Customer (CPNC) is a good thing. Profit Per New Customer (PPNC) is even better!

UPDATE 12/7/2008: A new post contains a link to a spreadsheet that allows you to calculate these metrics for your marketing activities.

8 comments:

  1. It would be great if someone could create a app that would auto-calculate this?

    ReplyDelete
  2. Okay: Great post. I built this into my HP-17B2 handheld calculator as a routine. I'm dangerous.

    BUT: When you derive your PPNC adjusting for the economic downturn, you say "PPNC = ((20 * $150) * 0.20 - $1,000) / 25."

    Shouldn't the "20" and the "25" in this equation both be "20"?

    Thanks!
    Harry Joiner
    EcommerceRecruiter.com
    As seen in "Internet Retailer" magazine

    PS - I'm relatively new to this industry (less than five years). Is "flow through to profit" just a fancy way yo say "gross profit" or EBITDA? What's the customary way to calculate this figure?

    ReplyDelete
  3. oops! my typo: I wrote "... just a fancy way yo say "gross profit" ..."

    "YO" should be "TO."

    Harry

    ReplyDelete
  4. Harry, you are correct, and the correction has been made, with proper attribution!

    ReplyDelete
  5. Awesome! Now, what are the answers to my follow up questions: 1.) Is "flow through to profit" just a fancy way to say "gross profit" or EBITDA? And 2.) What's the customary way to calculate this figure?

    Thanks, as always, for the great education!

    Harry

    ReplyDelete
  6. Flow-through to profit includes all p&l elements other than marketing expense and fixed costs.

    For instance, an online brand might sell $100. Of the $100, $20 is returned, leaving $80 of sold merchandise.

    Then, the company paid $50 for the merchandise, leaving $30 of gross margin.

    Finally, the company paid $11 to pick/pack/ship the merchandise, with $19 of profit left.

    The flow-through rate is 19%, $19 / $100.

    Many catalogers call this rate the "contribution" rate, or the "variable profit" rate.

    The calculation is similar across catalogers and online marketers --- most folks do something of this nature.

    ReplyDelete
  7. GREAT INFO! THANKS!

    Final question and then I'll leave you alone: When catalogers discuss these expenses, do they discuss them in percentage terms -- or dollar amounts per sale (as you have done)?

    Harry

    ReplyDelete
  8. My clients tend to state Profit Per New Customer (PPNC) as a dollar value. They tend to state the Profit Factor (PF) as a percentage.

    Catalogers may use different terms for profit factor, "contribution" comes to mind as a common term.

    ReplyDelete

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