How Much Is Too Much?
Give me the proverbial nickel for every time I’ve heard someone say “This advertising costs too much!” and I could have afforded to buy the exclusive rights to Brad & Angie’s twin pics. Clients practically go into cardiac arrest when they find out it costs $32,000 a month to run 6 spots a week on the 6 o’clock news. It is pretty easy to get sticker shock when you see that a sixty-second radio commercial on a popular Los Angeles station could cost you a thousand bucks. Each. Or when you realize that a newspaper ad in your city barely bigger than a Hershey Bar will cost a couple thousand dollars. It’s easy to automatically think that’s a lot of money. Now here’s the important question for you, the advertiser: Does the ad actually cost too much?
So what’s the answer? The savvy advertiser will tell you that the cost of the ad is not the issue. What’s important is the return that the ad will bring. If you were charged even as much as $40,000 for a sixty-second radio commercial that generated enough sales to make you a profit of $50,000, then would the $40,000 be A LOT? The answer is NO! Of course not! You’d be a fool not to beg, borrow, or steal the $40,000 so you could make the $50,000 profit! Try getting that kind of return in the stock market!
So how do you think that these big companies can afford to spend 3 million dollars for a thirty-second TV commercial during the Super Bowl? You know that an enormous amount of people will see it—enough to make the return on investment a good deal.
The point is simple; you’ve got to figure out how much money an ad will make you before you draw a conclusion of whether or not it costs too much. So how do you do that? It’s actually pretty easy. Here’s a simple process for determining the Return on Investment, or ROI, of an ad.
First, you’ve got to know how much profit you make on each sale. So if you buy something for $50 and sell it for $100, your gross profit is $50. With me so far? Step two is to figure out what your closing ratio is. If, on average, you close one sale for every four people who inquire, that’s a 25% closing ratio. If 9 out of 10 end up buying, then your closing ratio would be 90%. This is simple math. Now, figure out what your break-even is. Do this by taking cost of the advertisement and divide it by the amount of gross profit per sale. Remember, we already figured out what your gross profit is a second ago. So how much do the ads cost? If the ads cost $1,000 and your average gross profit is $50, that means you’ve got to make 20 sales to make back the $1,000—that’s your break-even point. In this example, it’s 20 sales. Fourth and last, figure out the number of leads you need to generate from the ad if you are to break even. To do this, you’ve got to know your closing ratio, which we just figured out also. Let’s say it’s 25%, or in other words, you close one out of four people who inquire. So if you close 25% and you need 20 sales to break even, that indicates that your $1,000 worth of advertising needs to generate 80 leads to break even.
Now I know that all sounds kind of complicated, but it’s actually pretty simple. We just calculated in the example that if the $1,000 ads can generate 80 leads, you would break even. That’s a return on investment of 0. Not particularly impressive, I realize…but hey, let’s START with breaking even so you know the bare minimum you can accept when running an ad. At least you didn’t come up with a NEGATIVE return on investment!
Now, what if your goal is to double your money? What would have to happen to your numbers? That’s right, you’d have to double your lead flow, or in this case, generate 160 leads instead of just 80. That means that if you generated 160 leads, you would generate a profit of $1,000—again, on $1,000 spent. In other words, you’ve doubled your money. Your return on investment is 100%. That’s pretty easy to follow, isn’t it? By way of review, what we’re trying to do is calculate your return on investment for your advertising.
Here are the four steps again. Think about your numbers in your business.
1. What’s your gross profit per sale?
2. What’s your closing ratio?
3. What’s your break even…in terms of number of sales needed?
4. How many leads does your ad need to generate for enough sales to break even?
5. What’s your return on investment on any given number of leads that you generate?
Now let’s take it a step further. Let’s figure out what’s known as the Lifetime Value of a Customer. What if your average customer brings you a $50 gross profit per sale like in the example we just went through? Is that the only time that customer will ever buy anything from you? How many times does that average customer come back in the course of a month, or a year? If your average customer shops with you one time a month and makes you $50 of gross profit every time, that customer is now worth $600 a year—in profit. And if you know that your average customer stays with you for 3 years, now that $50 a month client is worth a tidy $1800.
So now how much would you be willing to spend to accrue that client? What if those were your average numbers, $50 a month for 3 years. From the example earlier (Remember where we broke even with 80 leads and just 20 sales?) now those 20 customers would be worth an astounding $36,000 over the next three years. And it only cost you a thousand dollars worth of advertising. Now your break-even looks a lot better doesn’t it! If you could accrue a $36,000 annuity every time you ran a thousand dollars’ worth of ads, you should mortgage your house and spend as much money as possible on advertising!
Now, a couple of words of advice when figuring your return on investment for advertising. First, always estimate your numbers conservatively—or in other words, on the low side. Always figure on getting a lower number of leads than you’re hoping for and expecting. Always count on a lower closing ratio than you’re used to. If you calculate your numbers using conservative figures, then you’ll do fine if your results are actually lower than projections…and in the event that you do as well as you had initially hoped, you’ll just make more money than you expected.
Let me give you a real-life example to better illustrate ROI. There is a company who was promoting seminars where they would attempt to sell a service that cost $8,000. When they were starting to do advertising to promote these seminars, the question of how much budget should they allot came up. They wanted to start filling seminars within a week after starting advertising, so they decided that radio would be the best way for them to quickly get the message out about the seminars. When asked how many sales were they planning on generating, they said because of a unique financing plan that allowed them to sell their package on a low-monthly-payment basis, they thought they could sell at least 100 packages in that 5-week time period.
Well, 100 packages is a lot, and they were told that they would have to do at least $15,000 a week for the 5-week period to get the number of leads required to sell that many packages. The man got his calculator out and did some quick math and realized that he had to spend $75,000! $15,000 a week times 5 weeks! That number—$75,000—sounded so huge, it caught him off guard. His idea was to spend just about 5 grand a week, or a total of less than $25,000. Big difference. That’s called “sticker shock.”
So what he did was figure out the ROI, according to the steps previously explained. Again, first, figure out your gross profit per sale. His was about $5,000. Second, figure out the closing ratio. He thought his would be about 20%. So then, how many sales would he need to break even on a $75,000 advertising expenditure? Well, 75 thousand divided by $5,000 gross profit per sale is about 15 sales. Just 15 sales to break even. So if his closing ratio was 20%, he’d have to generate about 75 leads to break even. 75 leads on $75,000 in radio on the right station? Easily attainable. The last thing to do would be to figure out how many leads he’d have to get to reach his goal. His goal is 100 sales, and his closing ratio is 20%. That means he’d have to generate about 500 leads. That seemed fairly reasonable on a $75,000 budget. He’d generate a total gross profit on the deal of $500,000…and if you subtract out the $75,000 advertising cost, that’s still a healthy gross profit. His attitude toward the $75 thousand changed instantly.
Well, do you see how that works now? Just run through your numbers and you’ll know how much money is a lot of money when it comes to advertising. Then you can write all those big, fat advertising checks with a smile on your face.
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