The marketers of yesteryear often used to joke that they knew that half of their advertising budget was wasted – they just didn’t know which half it was. You could throw up incredible billboards, newspaper ads, and TV commercials, but it was almost impossible to tell which avenue was actually driving sales.
In contrast to this, barring some complex multi-touch ad attribution issues, the marketers of today have a very different problem: too much information.
If you wanted to, you could drill down to the most microscopic details on Facebook: does this or that emoji in our ad copy get better results? Do 30 second or 15 second Instagram stories get more clicks from 30-year-old women? Should we be using images of models or of products? The list of metrics that you can dive into is nearly infinite.
Although the minutiae can lead to incredibly effective three millimetre changes when deploying an ad budget at scale, in most scenarios this level of detail is overkill.
Instead, effective ecommerce operators need to look at their business through the lens of the Pareto Principle: by focusing on the 20% most important metrics, they’ll be able to disproportionately create 80% of their business’s growth.
Cost per acquisition
Your cost per acquisition is the amount, on average, you spend to acquire a new customer.
In SaaS (Software as a Service), the incremental cost of a new customer is minimal because there’s no cost to create an additional instance of your software. You pay your cost of acquisition, but you don’t pay any incremental “manufacturing” cost.
Because of this, you’ll often see SaaS companies burn money for the sake of growth-at-all-costs, and then when they’ve captured a strong position in the market, they’re able to prioritise profitability.
In ecommerce, since you’re selling a physical product, there’s an incremental cost to create a new product for each additional customer. That’s why ecommerce businesses have to factor in their cost per acquisition and all associated costs of goods sold – you can’t just monopolise the market and raise prices across the board like a software company can.
Effective ecommerce operators need to keep a pulse on their cost per acquisition across all paid channels to ensure that they still have a healthy margin after factoring in product costs, and the price at which they’re selling.
If every sale you make is losing you money, you have a scarily unsustainable business model. In these cases, you’re betting that your cash reserves will keep you afloat until customers come back, repurchase/pay subscriptions over a period of time, and ultimately become a profitable transaction for you.
Note - although it seems self-evident, it’s important to remember that ecommerce businesses are not software companies. As it becomes more and more expensive to reach customers through paid channels like Facebook and Google, companies like Brandless and Outdoor Voices have become the ecommerce poster children for broken unit economics.
The lifetime value of a customer is used to describe the estimate of how much revenue (on average) a customer will generate for your business during their time as a customer. However, this can be a difficult one to calculate.
Your best bet is to either look at historical averages if you have them or industry comparables if you can source them. Regardless, if you can build a business with a high customer lifetime value, it allows you to plan a more long-term relationship with your buyers.
For example, you can introduce some flexibility into your cost per acquisition – hopefully never to the point of losing money on the first sale – because you know that each customer may be worth 10x that initial acquisition cost in the future. It also allows you to justify high-touch customer service decisions early on: free returns, sizing exchanges, etc, because you know that a happy customer today will be worth significantly more in the future.
Of the traffic that you’re driving to your site, you need to understand what percentage of them add a product to cart; once added to cart, what percentage of them reach checkout; and once at checkout, what percentage of them will actually purchase. Your conversion rate looks at the percentage of customers that complete a desired action.
By understanding your success rate at varying levels of the funnel, you’ll be able to understand which levers need to be pulled. For example, if your purchase conversion rate is double the average in your industry, perhaps you’re being too selective in the traffic you’re letting in, and you may need to widen your top of the funnel so that you’re not leaving money on the table.
Average order value
Depending on the type of product you’re selling, you may have an easy revenue multiplying opportunity by increasing your Average Order Value or AOV, which is the sum of all products that the average customer checks out with.
If all else is equal, by implementing an up-sell or cross-sell solution that increases how much the average customer is purchasing, you may be able to increase your revenue without changing any other top of the funnel metrics.
If you’ve chosen a niche where you have the opportunity for vertical or horizontal expansion, your return rate is another significant revenue multiplying opportunity.
Instead of spending money to acquire customers from cold paid ads, you can leverage channels like email, SMS, or just organic loyalty to incentivise customers to come back and purchase more products.
This allows you to get the most bang for your Cost-Per-Acquisition, and has the opportunity to increase your net profit per customer as long as you can continue to introduce new product lines. This is another metric that can make a material impact on your bottom line without changing any top-of-funnel metrics.
Instead of getting lost in the weeds, reconsidering a few metrics will allow you to make the most significant difference possible to your bottom line.
Depending on your ad budget and how quickly you’re able to collect data, you should limit your experimenting to one of these levers over a specific period. For example, once you’ve established your baseline AOV, spend a month testing an up-sell solution, and then you’ll understand what impact that change made to the business in a vacuum.
Once you know what to measure, scaling is often just a game of various three millimetre changes.
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