Discerning Data

Let’s start with the obvious fact: every major ad platform has its own reporting tools. When we throw additional third-party tools into the mix, like the ubiquitous Google Analytics, the complexity only increases.

All this to say — there is a ton of data available to us, and this can be extremely overwhelming — making it easy to end up focusing on the wrong things.

Too often, rather that focusing on the essential business management metrics, people end up focusing on their account management metrics instead, like: cost per click (CPC), click-through rate (CTR), cost per thousand impressions (CPM), etc.

We want to be crystal clear about something… account management metrics only matter within the context of business management metrics.

Stick with me here, it’ll be a challenging road but, at the end of it, you’ll understand why internalizing this distinction is critical for success in paid traffic.

There are only three metrics you need to know to manage an online business intelligently. If you understand these three metrics, you understand the economics of your business. They are:

We will go through each one individually, and then I’ll give them some context to weave it all together.

Ready?

CPA is Cost Per Acquisition — meaning, this is what it costs you to acquire a paying customer. Any expense related to gaining that customer belongs in this metric.

AOV stands for Average Order Value — this means the average amount spent by the customer when they place their first order with you. If they buy multiple items in that first sale, great… all of that qualifies. If they buy in multiple, separate transactions, then the first sale is the only one that belongs in this metric.

LTV is Lifetime Value — it represents the average of all purchases made by a customer over the lifetime of their relationship with your company.

Let’s clear up one point about LTV before we proceed…

Lifetimes are generally pretty long. I don’t expect you to wait 50 years to calculate this number. Maybe you opt to cap your measurement at 3 years. That’s fine. What we are looking for is the average over a reasonably long period of time — and you will have to determine for yourself how long that period ought to be.

Let’s look at some examples to help solidify the meaning and relevance of each of these data-points:

Example 1: We launch a paid ad which leads directly to a sales page with a low cost product or service (the offer). The base offer costs $50, and we have a $25 order bump, and a $100 upsell embedded in the cart flow.

To keep things simple, let’s say the ads are only costs incurred for this campaign. Whatever number our expense is — that’s the CPA. For this example, we’re going to say it costs $1 per each person who clicks the ad and lands on the sales page. If we have a conversion rate of 1% that means that for every $100 we spend on ads, we generate 1 paying customer.

This means it costs us $100 to acquire that customer. So, our CPA is $100, but we don’t know if this is a good or bad number until we look at the rest of our data.

Continuing with this example, out of 100 customers let’s say half of our buyers choose to purchase the bump offer, and 25% of them choose to purchase the upsell. Here’s what that math looks like:

100 customers buy the offer: 100 X $50 = $5,000
50 customers buy the bump: 50 X $25 = $1,250
25 customers buy the upsell: 25 X $100 = $2,500

To calculate our AOV, we take the totals, add them together, and divide by the number of customers (100).

$8,750 / 100 = $87.50

I know, so far it isn’t looking too good for our example. By these numbers we have a net loss of $12.50 per customer acquired — but we aren’t quite done yet. In order to complete the picture we still need to calculate the LTV.

Assume we have 3 back-end offers that we sell over time (via a series of email campaigns) at a price of $300 each. On average, 25% of our customers buy one of those offers within the first year. Our LTV math will look like this:

25 people buy one back-end offer: 25 X $300 = $7,500
Divided by the number of total customers (100): $7,500 / 100 = $75

Now that we have these numbers in hand, we can calculate the economic health of our business.

We spent $100 to acquire a customer who spends $87.50 immediately (AOV).

We now know that a customer, on average, will spend an additional $75 within the first year.

Yes, we lose $12.50 to acquire the customer, but that “loss” isn’t so bad when we consider that they will spend $75 in that first year — meaning, we end up with $62.50 in profit, on average, per customer.

Let’s extrapolate a bit and say we acquire 1,000 customers in a year…

We spend $100,000 to acquire the customers
We recoup $87,500 immediately with the first sale
We generate an additional $75,000 in the first year.

We spent $100,000 to make $162,500 over the course of the year, which is fairly close to doubling our investment. Granted, these numbers are simplified to illustrate the point, but I bet you understand…

That initial $12.50 “loss” per customer doesn’t mean a whole lot in the face of our projected long-term profits.

Note: You ought to know, getting one’s CPA and AOV to break even is like creating the fabled Philosopher’s Stone. If (somehow) you can make it happen, you’ll perpetually generate customers for free — which is why most marketers consider it to be the holy grail of direct response marketing. It is much more common for businesses to acquire customers at a small “loss” (as illustrated in our first example) because, they know the lifetime value of their customers.

Hopefully this helps illustrate how knowing this information can allow you to make these kinds of decisions wisely. We aren’t done yet though!

Let’s look at one more example, because, paid traffic works even if it doesn’t lead immediately to a sale. In our next example, we will look at front-end lead generation instead of the goal of an immediate sale.

Example 2 — Assume we have a Wabbit EDU styled presell flow which leads to an opt-in. Once a visitor opts-in, they receive a story-driven email sequence over the course of 7 days (one email each day). At the end of the sequence, they are presented with a $300 offer.

Regardless of whether they purchase or not, they will still receive our weekly email newsletter — which, over the course of a year, will present them with three additional offers priced at $500 each.

For the sake of simple math, let’s say we spend $5 per lead. Our conversion rate for the first offer is 5%, and an additional 5% buy at least one of our other offers within the first year. Finally, our total ad spend to acquire these leads is an even $1,000.

If our cost per lead is $5, then spending $1,000 will acquire 200 leads.

Our conversion rate is 5%, which means that of those 200 leads, 10 of them bought our $300 offer within the week — generating $3,000 in sales.

Let’s say that throughout the rest of the year, another 5% purchase one of our $500 offers — generating another $5,000 in sales.

First, to calculate our CPA, we take our total ad spend divided by the number of acquired customers. In the case of this example, we spent $1,000 to generate 200 leads, and 10 of them made a purchase.

$1,000 divided by 10 customers equals $100 per customer acquired, so our CPA is $100.

Calculating our AOV is simple because there are no upsells or other offers, just the one at $300. This means our AOV is $300.

The same is true for our LTV. On average, 5% of our leads will buy one of our $500 offers over the course of a year, so our LTV is $500.

Let’s summarize our math for example 2:

We spent $1,000 so, we represent that as a negative number.
We gain 200 leads with a conversion rate of 5% for our initial $300 offer.
We have a conversion rate of 5% for our $500 offer over the course of one year.

Here’s the equation:

-$1,000 + (10 X $300) + (10 X $500) = $7,000

This means we’ve spent $1,000 to generate $8,000 — leaving a gross profit of $7,000.

I’d happily own this business all day long. That’s a 700% return on investment!

If you’re saying to yourself “yeah, but my business model doesn’t fit these examples,” that’s perfectly fine. Understanding these concepts, and the framework we use to calculate the economic health of our business, are what matters most.

How much do you spend to generate awareness for your business?
How many customers do you generate with these efforts?
How much does each customer spend initially?
How much does a customer spend, on average, over the course of a year (or however much time is appropriate for your business)?

Once you have those numbers it becomes relatively easy to understand the financial health of your business from the perspective of customer acquisition, and to do so with reasonable accuracy.

If you have your own data to plug into these calculations, your assignment for this section is to gather that data, and do the calculations for your own business.

These three numbers are guidelines that can help you find direction. Unless you have a large amount of data for a large number of customers over a long period of time, do your best to refrain from over-focusing on decimal point precision. In many cases, it is unnecessary to be so precise.

Ultimately, the goal of any business is to provide so much value that the AOV and LTV becomes high enough to make the CPA effectively irrelevant.

This section can be challenging. Take your time.

If you have questions, ask in the comments section at the bottom of the page.

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