How Much Should You Spend on Advertising to Get a New Customer?

Advertising MoneyA large pizza around Boston usually costs less than $15.  If it’s a cheese pizza, the cost of the ingredients is relatively low, so let’s assume that the profit on the pizza is $10 (for simplicity we can ignore the indirect costs).  How much can the pizza shop owner spend on advertising to get the customer?  Even though $10 is not a lot of profit, you might be surprised by how much money can be spent to get that new customer.

Lifetime Value

In order to figure out how much money a pizza shop can spend to get a new customer, we have to think about the average Lifetime Value (LTV) of a customer.  The LTV is the amount of profit you make from a typical customer over the entire lifetime of your relationship.  For a pizza shop, this number can actually be very high.  I personally order a pizza about once every week and half and I have been ordering pizza from the same shop since I moved into my house 5 years ago.  If I’ve averaged 34 pizzas a year for the past five years, they have made about $1,700 in gross profit from me (and still counting).  If you can approximate how much money you make from an average customer, you’ll have your LTV.  For pizza, in a book called The Service Profit Chain, professors from Harvard Business School actually estimate that a loyal Domino’s Pizza customer has an LTV of $4,000!

Determine Your Ideal Scenario

Once you have an idea of how much gross profit you might make from a typical customer, you need to figure out what percentage of that amount you would ideally be willing to spend to get that customer.  You have other costs that are not included in the gross profit and ultimately as a business owner you need some profit to be left over for you to take home some money.  Every business is different, so you need to figure out how much profit margin you can afford to give up while still making a profit that is acceptable to you.  For this article, if we just take 20% of the LTV that means that Domino’s can theoretically spend $800 on marketing to get a new customer.  All of a sudden, it starts to become clear why Domino’s can afford to spend so much money on TV advertising!

Apply Reality

Domino’s has one important thing that most small businesses lack – a huge amount of money.  Most businesses (particularly as they are getting started), can’t afford to spend the equivalent of $800 per new customer.  The reason why is simple; you have to pay the $800 up front to get the new customer, but you won’t make your first dime of profit until 80 pizzas later.   The unfortunate reality of it taking time to extract all of the value from loyal customers is a fundamental reason why many small businesses take a long time to ramp up.  They have to limit their spending.

Figure out how much you can afford to spend and then experiment with different types of marketing to see if you can get new customers below your target cost to acquire them.  Google AdWords, Postcards, Daily Deal Sites, are all effective for some businesses (and ineffective for other businesses).  The only way to figure out what will work for you is to have good measuring tools in place.  Experiment, measure, and refine.

Get To Work

So now you have a methodology to try to determine how much you can spend on advertising for your small business.  There are of course many free or nearly free things you can do in marketing as well, but if you have some budget available, advertising can be a great tool to accelerate your business growth. The only remaining item on the checklist is to go out and do it!

Image credit: 401(K) 2012

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