Patrick Biddiscombe walks through calculating how much you can spend per click by working backwards from customer lifetime value. If a customer is worth $2,700 over six years and your conversion funnel is 7% and 10%, you need about 143 clicks to break even at roughly $19 per click.
Questions this video answers
$500 per year.
6 years.
$50 per year ($300 over lifetime).
$2,700.
7%.
Chapters
The goal of any ad strategy should be to get a positive return on your investment, which comes down to whether you're getting more revenue out of the ad campaign than the cost that you're putting in. So how can you determine what your ad spend should actually be to get the most return on your investment? To start answering that question, we'll need to understand the bidding system used by the ad networks. So what's a bid? A bid is the maximum amount of money that you're willing to pay for a desired action on your ad. If it sounds like an auction, that's because it is an auction. Ad networks have limited amount of ad space. And to determine whether your ad or the ads of your competitors are shown to your target audience, they run an auction to see how much each advertiser is willing to pay for that ad space. Think of it like an auction. The highest bidder wins. Let's say that you bid $10 for a click on your ad, and the next highest bidder only pays $5 for a click. Each ad network will only make you pay the lowest amount possible to win the bid. In this example, you might be willing to pay $10, but in reality, you'll only have to pay $5.01 to win the bid. Winning this auction, in addition to the overall quality of your ads, will determine how your ads are displayed on the different ad networks. So how should you determine what your maximum bid should be? To do that, we'll want to work backwards from revenue generated by your final bid. We're about to look at an example from a hypothetical B2B company. But the thought process can be applied to any industry. Be sure to keep that in mind. Let's say that you run an IT solutions company and you want to advertise for your upcoming webinar on network security. Fantastic. Let's do some math. The first thing that you'll want to do is to calculate your lifetime value of your customers. There are a number of ways you can do this, but to get a simple average, here's how you could calculate it. Take the yearly revenue your average customer brings you and multiply it by the average lifespan of that customer. Throughout this example, we're going to do calculations using dollars. But the same logic applies for all currencies. So if your average customer pays you $500 a year and your average customer stays with your company for six years, we can say that the average lifetime value of a customer is $3,000. But let's not forget how much it costs to service a customer. If you Factor in that it costs you $50 to service that customer each year, or $300 over their entire lifetime. As a customer, you can say that your average lifetime value of Your customer is $3,000 minus $300 or $2,700. Since our budgeting goal is to have a positive return on our investment, $2,700 will be our break even point for our maximum budget on our ad spend. Now that you have your average lifetime value for your customers, you can work backwards to see what your monthly advertising budget should actually be. We're going to walk through this example focused on the value of a form conversion, but you can apply the same approach to whatever conversion points that you're optimizing your ads for. So what factors matter in your advertising budget? You'll want to consider two things to figure out your advertising budget, your average conversion rate and your average lead to customer rate. The average conversion rate is the rate at which website visitors to your site convert on a form and become a lead. In our example, this will be what percentage of people clicking on your ad will actually sign up for your webinar. Let's say that for our example, you have a 7% webinar conversion rate. We'll use this approximation for now, but take a look at your own site's traffic to see how your landing pages are currently performing and what your own conversion rate actually is. It's okay to start with a rough estimate and then refine that over time as you start getting real data. So what's an average lead to customer rate? The average lead to customer rate is the rate at which leads become paying customers. In our webinar example, this is the percentage of people who sign up for your webinars will actually become customers later on down the road. You'll need to look at the historical data for your campaigns to determine the specific number for your own business. But for our example, let's say that your lead to customer rate is 10%. So if 10 people sign up for your webinar, you can expect that one person will become a paying customer. Once you start getting real data from your specific ad campaign, you can start adjusting your estimates to reflect reality. You have a lot of stats assembled now. 7% is your average conversion rate or the percentage of website visitors coming from your ad that will convert into a lead on your landing page. 10% is your average lead to customer rate, or the percentage of people who signed up from your webinar that will eventually become a paying customer. $2,700 is your lifetime value or how much each of those customers is worth to your business. Now you can work backwards to figure out what an ad click is actually worth to you. If you divide one new customer by your lead to customer rate, you'll see that we need 10 webinar signups to yield one new customer. Next, divide the number of webinar signups we need by the average conversion rate. Using our 7% conversion rate, we find that you only need roughly 143 clicks on your ad to generate one new customer. If that customer is worth $2,700 to you, we can start to calculate how much you should spend on each click of your ads. If we ignored all other costs of acquiring a new customer, then your breakeven bid would be your customer lifetime value divided by 143 the number of clicks that you need to generate one new customer. This means that you could bid $19 per click on your ad and break even. Now, let's say that you launch this ad campaign, run the webinar, and you want to understand how well your digital ads actually performed on revenue 90 days later. This is where return on ad spend comes in. Also known as roas, Return on ad spend is a calculation that helps you understand the actual return on investment for your advertising. To calculate roas, take the revenue driven by a campaign and divide it by the amount of money spent on that campaign. These insights can be used to prioritize the types of ad campaigns that bring in the highest return on investment. In the future, as you continue to iterate on your advertising strategy, you'll be able to determine how long you need to run your ads in order to reach your goals and and what your daily ad spend should actually be. For that result, the advertising networks are making it easier to determine how you can manage your ad spend, but the exercise that we just went through is a great way to determine your advertising objective, what achieving that objective is worth to you, and how all of that fits into your overall marketing goals.
