March 3, 2022
What Should My Cost Per Lead Be?
How Cost Per Lead Affects Your Marketing Strategy
It’s easy to fall into the trap of asking the question of “how much should we spend on marketing” or “We should spend x amount of dollars on marketing” without fully thinking through the decision behind if your ad dollars will truly be effective in terms of helping you obtain your lead goal.
Let’s face it as humans we often throw out arbitrary numbers based on “industry benchmarks”, “gut feelings” or the budget “finance gave us.” If you’ve experienced this you’re not alone, but what I can say is, there’s a methodical way of justifying the budget you need to reach the goals you seek.
That method starts with identifying your target Cost-Per-Lead (CPL) goals before creating your budget or setting performance expectations. CPL should never be created based on broad benchmarks but rather needs to be individualized to your business, which will make marketing decisions around budget easy to make while opening your mind to new marketing channels you may not have thought of before.
For instance, let’s say you sell a product at $100 & determined based on industry insight that your CPL should be $30 per customer, when using Instagram you have been able to consistently hit this CPL, but in this instance you are limited to who you can Reach. If you were to run on Pinterest, you could reach even more customers but the CPL is $40, if you stick to your budget, Pinterest is $10 above your CPL limit which means you wouldn’t consider the channel. However, if you were to opt for a more aggressive strategy with slightly slimmer margins you would be able to acquire more customers faster.
Using arbitrary numbers can limit your view on what channels can be effective, but calculating your CPL, Customer lifetime value, and average profit for customers will help firm up your CPL numbers and give you further insight.
How to calculate Cost Per Lead
Before calculating your cost per lead there is a few metrics your going to want to fully understand before coming up with your final CPL numbers. Here’s a few questions you should ask yourself.
What can I afford to spend per lead?
Before calculating your CPL you need to know how much you can afford to spend on getting a new customer. This requires you to have an understanding of not just the first purchase your customer will make, but the average of all purchases a customer could make through the life of them being your customer. This is called customer lifetime value.
Let’s say you ran a landscape business, a customer purchases a weekly $50 maintenance plan after clicking on your Google Ad. If you only counted the first purchase as revenue attributed to your Google Ads then you would just attribute $50. In reality a your customers use your service for three months which brings in a minimum of $600! You wouldn’t want to value your customer at $50 would you?
No sir/mam, realizing the true lifetime value of a customer would allow you to have a much higher CPL thus being more competitive in getting your ads clicked on.
Calculating Customer Life Time Value (CLV) and Why It’s Important?
Calculating CLV can be complicated but we broke this down with a simple formula.
(Average monthly revenue per customer / churn rate) = CLV
Let me break this down in an easy example. Imagine you are a Marketing Specialist for a company that sells landscaping services. Your average revenue per month is $100,000 from 500 customers which means on average you make $200/month per customer.
Churn rate is slightly more complicated but is necessary to complete our equation. You can subtract the number of reoccurring customers in a given month from the total number of customers. That means if you have 500 total customers and 450 repeat buyers the churn rate would be .10 (10%)
Using these numbers as an example and filling them into our equation would get us an average customer lifetime value of $2,000 ($200 / .10 =$1,000) which means on average a customer will spend $2,000 with your company.
Calculating Average Profit Per Customer and Why It’s Important?
Congrats, You’ve figured out your CLV, now it’s time to get an understanding of what your true profit margin is. To do this it’s important to have understood the cost of producing or servicing your product/service for the full lifetime of the customer.
As an example, if you sell landscaping services and each house you work on costs you $50/month in labor and on average a customer uses your service for three months, then $150 is your cost of goods sold.
You also need to factor in other costs that your business needs to operate such as equipment, rent, utilities, etc. Let’s say this costs your company $10,000/month when added, if you have 200 customers then you can divide this cost across all customers which is $50 per customer.
By understanding your costs are per customer per month you can use the equation below to calculate our average profit per customer.
CLV – (Average Monthly Costs Per Customer / Churn Rate) = Profit Per Customer
Using numbers in our examples discussed in this article we would calculate using our CLV of $2,000 then factoring our costs (Labor of $50 & overhead of $50) which comes out to $100 per customer. During the lifetime of the customer, we can assume costs work out to $1,000 ($100 / .10 = $1,000).
You then subtract that number from your average CLV and you get $1,000 in profit ($2,000 – $1,000 = $1,000). In theory, as long as your company doesn’t spend more than $1,000 to produce the customer you are in the black.
How to find out what you can afford to spend on a lead?
Now that you know how much you can spend to acquire a new customer, it’s time to back in the numbers to figure out what you can spend per lead. After all, we know that turning every lead into a customer is not realistic. Calculating what your company can afford to spend on marketing leads uses the following formula.
Profit per customer * (Monthly sales closed / Monthly leads) = Maximum cost-per-lead
If our landscaping business gets 50 leads per month and closes 10 of them then the company can afford to spend $50/lead, beyond this number means they will be losing money on each client.
So, how much should I spend on marketing?
This question is entirely based on your growth strategy for your business, if your plan is to maximize the profit you could change your target CPL goal to $25, this will also mean that you will get fewer leads on most ad networks but as long as you cover the churn rate you will still see some growth.
If you aim for a higher CPL let’s say $75 you may acquire more customers taking a hit in the beginning but you and your team may be able to instead upsell customers on new services which then grow your company and covers your advertising costs.
The most important aspect of this exercise is that you are armed with the knowledge to understand how a budget needs to be centered around your business numbers – not arbitrary ones. As a rule of thumb, you want to complete at least 50 conversion events in a given measurement period 30 days to effectively leave learning phases of ad networks and continue to optimize to preferred results. So one last formula should give you a bare minimum place to start.
(50 Conversions x CPL = Minimum Monthly Budget)