Here’s a marketing secret you may not know: the Cost of Acquisition metric should be at the forefront of any marketing program. It is the primary method of determining the validity of marketing scenarios and, as such, is the most important metric in new business development.
Some examples of inappropriate — albeit quantitative — metrics are listed below:
- In local businesses
- The amount of calls an individual salesperson made
- The amount of phone calls generated off of an advertisement
- The number of walk-ins generated by a promotional scenario
- The number of unique visitors to a site
- The number of attendees at a workshop or dinner meeting
- In a local division of a national business
- The amount of leads regularly received
- The amount of leads coming from a home office
- The amount of calls received caused by an outbound push of product
- The number of unique visitors to a site
- In national businesses
- The number of calls generated to a call center
- The number of attendees at a webinar
- The number of responses to an email blast of opt-in individuals
- The number of unique visitors to a website
There is nothing wrong with any of the above measurements in and of themselves. The problem is that, all too often, they are used to evidence the effectiveness of an advertising campaign, a marketing ploy or the like. The above types of metrics cannot successfully be used to quantify financial success. They can be effective in quantifying brand development, which is highly important to a cash positive business. However, when attempting to generate quarterly free cash flow, a cash flow model needs to be utilized as opposed to a branding model.
Generating free cash flow
The number one financial responsibility of any business is to generate free cash flow. Free cash flow is the funds generated by a business that exceed the cost of operating the business, including its tax liabilities. In most situations, once free cash flow is generated, management is tasked to do one of the following:
- Expand the business
- Reduce debt
- Generate a return to shareholders
In most scenarios where I am called in to help, the client does not have the desired amount of free cash flow. As such, I have spent a good deal of time learning how to work with a limited source of funds to increase cash flow so that management can best move forward with one or more of the goals discussed above.
Over time, I have recognized that the fiscal Bible for business in these scenarios is the study of and adherence to the reduction of the Cost of Acquisition. Below, I offer a very simplistic approach that can be used to analyze a current business model.
For this example, I’ll use a simple situation to which most financial services professionals can relate: attracting a group of individuals to a local retail presentation. We have seen myriad variations on this occurrence, including:
- Bank seminars for local business owners
- Local realtors / mortgage brokers attracting certain groups such as first time homebuyers, investment property buyers, etc.
- Local doctors explaining their expertise in a certain procedure or type of surgery or physical therapy
- Local financial planners and insurance agents offering long-term care dinners, retirement workshops, college planning workshops and the like
Whichever scenario fits for you, simply put it into the formula to begin.
Next: How to calculate costs
Once a scenario is determined, there are two paths to follow. First, we must quantify all hard costs used in developing the marketing of this presentation or advertisement or promotion. Fixed costs include any costs that are directly tied to the promotion in question. Sample costs include:
- All associated payroll costs
- Marketing costs, i.e. mailings, emails, phone calls, direct mail, etc.
- Production costs
- Advertising costs
- Travel and entertainment expenses
The second path is somewhat more difficult to quantify. The second path is that of soft costs. These are costs such as:
- Opportunity costs
- Loss of focus on other opportunities
- The cost of allocation of resources toward the venture
All too often these soft costs get overlooked, especially if the scenario is one that has historically been utilized. In other words, if a bank holds a quarterly luncheon at a local restaurant, some segment of unallocated payroll is used to manage the invitation / RSVPs / menu / details of setup and the like. In any business, these costs are an example of the costs most overlooked.
Add your best soft cost estimate to your already totaled hard cost. By bringing these two sets of costs together, you can now quantify the actual cost of the scenario.
Candidly, most people have not taken into consideration their soft costs and by this point have given up, as it is hard to admit how much time is unallocated in what a manager perceives to be his or her budget for the issue at hand. Additionally, many times we have seen those in internal operations get caught in the quagmire of either not wanting to admit to their department or to other departments how much time and energy goes unallocated to such events.
If you’re still hanging in there, the next step might well cause even more frustration. When calculating COA, only one metric counts: how many people actually write a check. This comment is counter to virtually every marketing document in vogue today. However, the reality is getting more “likes” on Facebook will not help your quarterly cash flow. Viral marketing, however valuable it may be, is a long-term prospect, not one that will help establish the quarter’s profit.
Take only the number of entities that paid for services as a result of the test scenario. Take that number and divide it into the amount that the scenario cost, and you’ll have the Cost of Acquisition for the project at hand.
Now you have a metric by which all potential scenarios should be run. Filtering the scenarios through the COA metric requires each proposal to stand on its own. Thus, no decision becomes a personal one or one that should need to get buy-in from individuals, group think or the like.
Moving forward, it is incumbent on every manager or executive to determine how to minimize COA, thus maximizing profit and, coming full circle, maximizing free cash flow. Below is a quick real life example that came out of a presentation made to several thousand financial planners.
A case study
Dr. Smith has built a successful practice over five years using an annual marketing budget of $30,000. He spends $10,000 annually on quarterly presentations for those approaching retirement. These quarterly presentations bring in roughly 260 attendees per annum. Attendees show up at a local college auditorium for a 1.5 hour presentation after a catered meal. On an annual basis, Dr. Smith sees roughly 83 out of his 260 attendees back at his office for a free follow-up meeting to gather financial information. After the first meeting, assuming mutual buy-in, there is a free second meeting wherein Dr. Smith reviews his financial proposal with the prospect. From this meeting, Dr. Smith is, on average, profitable off of 16 new clients per year.
After a conversation with his assistant, Dr. Smith came up with the following assumptions:
|Dr. Smith hourly rate||$175.00|
|Assistant hourly (including benefits)||$21.88|
|Presentation travel, setup & tear-down||4 hours|
|First personal presentation||1.5 hours|
|Second personal presentation||1.5 hours|
|No. of first personal presentations||83|
|No. of second personal presentations||24|
|Total hard costs||$10,000|
|Soft costs, Dr. Smith|
|Marketing development (16 hours)||$2,800.00|
|Seminar development (20 hours)||$3,500.00|
|Seminar attendance (16 hours)||$2,800.00|
|1st personal presentation (124.5 hours)||$21,788.00|
|2nd personal presentation (36 hours)||$6,300.00|
|Soft costs, Assistant|
|Printing/mailing (12 hours)||$263.00|
|Seminar attendance (16 hours)||$350.00|
|Total soft costs||$37,800.00|
|Annual new clients||16|
|Cost of Acquisition||$2,987.50|
Working with Dr. Smith, new approaches were put into place that lowered the front end hard cost and, just as importantly, the enormous soft costs that he was incurring. By doing this, Dr. Smith was able to see a significantly larger set of individuals at a lower cost, thus dramatically reducing the Cost of Acquisition and increasing free cash flow.
When originally speaking with Dr. Smith, he had stated that his annual marketing costs were $10,000. As one can easily see, the actual costs were almost five times the budgeted amount.
While this is a quite basic and simplistic view of the Cost of Acquisition metric, entities find that the continuing application of the metric satisfies several needs. First, the amount of free cash available for executive distribution will increase. Second, decisions based on a more scientific method increase the efficiencies of the organization’s economics. Third, as resources can be preserved from inefficiencies within the organization, the reallocation of said resources into more efficient usages will exponentially propel the organization in a more positive direction. As with the application of any metric, it is important that the Cost of Acquisition be reapplied on a periodic basis in an attempt to maintain appropriate focus.