May 11, 2023

Graphical Depiction of the Relationship

Ok, we all know that as we spend more we get more customers, but at an ever-diminishing rate of return.

The diminishing rate of return is what prevents us from spending into infinity.

The diminishing rate of returns impacts ROAS - causing it to get progressively worse as we increase spend.

Turns out there is a comparable relationship between ROAS and CAC.

Lousy ROAS figures (< \$2.50 in our example) translate to exponentially higher CACs as the law of diminishing returns wreaks havoc.

Interestingly, CAC and Profit per Order (PPO) have a linear relationship, meaning that CACs can be directly converted to PPOs if you know what the Profit Factor is.

In this example (your mileage will vary), a break-even Profit per Order (PPO) corresponds with a CAC of \$40.00.

The fun part of all of this is depicting the number of customers you generate via marketing and how much short-term + long-term future profit you generate. This relationship is illustrated below, and it is a beautiful relationship!

Absolutely delicious!  We add PPO and CLV together, then multiply it by the number of customers generated to yield optimal profitability (short-term + long-term). This happens around 1,450 customers.

Of course, we want to translate 1,450 customers back to ad spend, informing us what the optimal amount of ad spend is. Here we go!

This is what Hillstrom's Marketing Budget Experiments are all about. The optimal amount of marketing spend here is somewhere around \$40,000 to \$60,000.

If we spend \$50,000 on this campaign, here's what campaign results look like:

• Sales = \$146,409.
• ROAS = \$2.93.
• AOV = \$100.
• CAC = \$34.15.
• PPO = \$5.85.
• CLV = \$35.00.
• PPO + CLV = \$40.85.
• Campaign Profit = \$8,563.
• Future Profit + Campaign Profit = \$59,806.
You probably don't like the ROAS you see there.

Where is campaign profitability optimized?

Oh oh.

Campaign Profit is optimized at an ad spend of \$20,000. (PPO + CLV) * Customers Profitability is optimized at an ad spend of \$50,000. Here are your metrics if you spend just \$20,000 on the campaign.

• Sales = \$96,938.
• ROAS = \$4.85.
• AOV = \$100.
• CAC = \$20.63.
• PPO = \$19.37.
• CLV = \$35.00.
• PPO + CLV = \$54.37.
• Campaign Profit = \$18,775.
• Future Profit + Campaign Profit = \$52,703.

Yeah, the two scenarios are quite different, aren't they?

There isn't a right or wrong answer here. There are simply choices and consequences.

• Spend less, be more profitable today, be less profitable tomorrow.
• Spend more, be less profitable today, be more profitable tomorrow.
You can't do both.