Like many startups, we’re experimenting with traction channels to discover what will drive our next stage of growth. But before we could test user acquisition, we had to answer an important question.
How much should we spend on this stuff?
We didn’t want to waste cash on frivolous ads or channels that weren’t working. We needed a benchmark help understand what was a good buy, and what wasn’t.
Today, we’re sharing our process with you! Here is the step-by-step guide we’ve used to confidently calculate what we should spend on customer acquisition and the tools that have helped us along the way.
Ask Three Questions.
For a SaaS company, there are three main questions you need to answer before you create a budget for acquiring new customers.
1. How much do your paying customers spend throughout their lifecycle?
We’re talking lifetime value or LTV. RJMetrics has a nifty calculator for this, but here’s a quick and dirty formula.
(Revenue per paying user per month * Gross Margin) / Churn
Gross Margin is what’s left after you’ve paid for COGS, or the cost of goods sold, such as support and hosting expenses. Churn is the percent of people that leave, unsubscribe, or in other words stop paying for your service on a monthly basis.
2. What percentage of people that signup actually pay you?
Many SaaS companies offer a free trial or freemium plan, so not every signup becomes a paying customer. You’ll need to calculate your Signup-to-Paying Conversion Rate to know what you can pay for a signup.
Signed Up / Started Paying
3. What percentage of folks that visit your website sign up?
You can calculate this Signup Conversion Rate with a simple funnel. If you’re using landing pages in your ads, use the landing page conversion rate.
Visited Site / Signed Up
For an e-commerce company, you can merge the third and second steps because you’re not giving away anything for free! You’d just calculate
Visited Site / Completed Purchase.
If some of your campaigns target in-between conversion events (like capturing lead information for a newsletter), then your two calculations might look like:
Visited Site / Subscribed to Newsletter Subscribed to Newsletter / Completed Purchase
Of course for mobile apps, you’ll be looking at app installs to rather than website views.
Now that you’ve calculated your three inputs: lifetime value, signup to paying conversion rate, and signup rate, you can easily calculate how much to pay to acquire new customers and to get a click through to your website.
Cost Per Acquisition Formula.
There are two main metrics advertisers use to report their costs: Cost Per Acquisition (CPA), or the amount of media dollars you need to spend to get one sign up, and Cost Per Click (CPC), or how much you pay when someone clicks through an ad to your site. Let’s start with CPA. It’s a two part formula for those of us that offer freemium products.
1. How much can I spend to acquire a paid customer?
CPPC = Cost Per Paying Customer LTV = Lifetime Value (from question 1)
CPPC = LTV / 3
A third of LTV is on the higher end of what you’d want to spend for one paying customer, but it’s fine for when you’re experimenting with new channels. After all, you’ll still be making money if your customer acquisition costs are lower than your LTV. However, when you find a channel that works, you’ll want to optimize for a lower CPPC that’s closer to
LTV / 5.
2. How much can I spend to acquire one signup?
CPA = Cost Per Acquisition CPPC = Cost Per Paying Customer CR = Signup to Paying Conversion Rate (from question 2)
CPA = CPPC * CR
If some of your signups are on a free plan or trial, this additional formula factors that into the cost to acquire a single signup.
One caveat – some companies have enterprise plans that are much more expensive than self-service plans. In this case, you might want to factor in conversions to enterprise when paying for a regular old signup.
CPA = (Self-service CPA) * (Percent of organic signups that turn into enterprise customers) * (LTV of an enterprise customer / 3)
Calculating Cost Per Click.
Often times, your advertising platforms will make you choose a maximum bid for a click, rather than letting you pay for actual signups. This is where your Signup Conversion Rate from question 3 comes into play, since it calculates the likelihood that someone who clicks through your ad will convert.
How much can I spend for one click to my website?
CPC = Cost Per Click CPA = Cost Per Acquisition CR = Signup Conversion Rate (from question 3)
CPC = CPA * CR
There you have it folks – a very good baseline for what you should be spending on customer acquisition. Check out this Google Spreadsheet to input your own numbers, and calculate your own costs!
Optimizing Per Channel.
For example, people who find you via Google Adwords might pay you more money overtime than people who come from Twitter. As an advanced marketer, you’re going to want to evaluate the LTV of signups from each channel, which will change what you can spend to acquire customers via that channel.
Just plug the channel LTV number into the equations above, and you’ll be good to go. Also, make sure you’re getting enough traffic to make these calculations significant. Here is a tool to calculate how much you need.
You can compare if the costs are too high and the LTV too low for a specific platform compared to your baseline and cut it from the budget. Or, if you find a bargain channel, you can pour on the cash.
Tools That Can Help.
To get the most bang from your marketing bucks, you’ll want to consider optimizing the conversion rates we discussed. Optimizely, Leanplum (for mobile), and Taplytics (also mobile) are some good A/B testing tools to improve your website and landing page copy, design, and conversions.
Event-based email and push notification services like Customer.io, Outbound, Vero, and Kahuna can help you move users through the activation funnel with personalized, timely communication and increase your Signup-to-Paying conversion rate.
If you’re running a ton of campaigns, keeping track of conversions and spends can get tricky. Mobile App Tracking and Convertro help marketers make sense of their entire media budget and see which channels are performing best. Google Analytics also has solid attribution reporting.
Segment is the easiest way to capture the data you need to calculate customer acquisition costs, and then send your conversion events to all of these tools. If you integrate Segment into your app or website once, then you can flip a switch to integrate any of these services. Your time is money, and we’ll save it.
I hope you found these tips helpful! If you have any other suggestions, share them with @segment on Twitter!