Cost Per New Customer
Cost Per New Customer is one of the easiest metrics to measure, hence, it is beloved by many marketers.
The marketer spends $1,000, yielding 25 new customers. Cost Per New Customer is measured as ($1,000 / 25) = $40.00.
The marketer compares CPNC across all marketing activities, seeking to maximize activities with a low CPNC.
A metric that yields a better result is Profit Per New Customer, or PPNC. In order to calculate PPNC, we need two additional metrics.
- Average Order Value --- the average amount that a new customer spend when placing a first order.
- Profit Factor --- visit your finance department, and find out how much demand (independent of ad cost) flows through to profit.
- Marketer spends $1,000 on a marketing program.
- 25 new customers are acquired.
- The average order value is $150.
- 40% of demand flows-through to profit.
- PPNC = ((25 * $150) * 0.40 - $1,000) / 25.
- PPNC = ($3,750 * 0.40 - $1,000) / 25.
- PPNC = ($1,500 - $1,000) / 25.
- PPNC = $500 / 25.
- PPNC = $20.00.
In most cases, marketing for new customers results in a loss. Let's assume that instead of 40% of demand flowing-through to profit, only 20% of demand flows-through to profit. Now see what happens to the calculation:
- Marketer spends $1,000 on a marketing program.
- 25 new customers are acquired.
- The average order value is $150.
- 20% of demand flows-through to profit.
- PPNC = ((25 * $150) * 0.20 - $1,000) / 25.
- PPNC = ($3,750 * 0.20 - $1,000) / 25.
- PPNC = ($750 - $1,000) / 25.
- PPNC = -$250 / 25.
- PPNC = -$10.00.
If the customer generates $20.00 of profit in the next twelve months, then things are fine, because we are willing to lose $10.00 of profit now in order to gain $20.00 profit in the future.
We also look at the sensitivity of profit per new customer. If we believe that the economy will be 20% worse next year, we can run our analysis assuming decreased productivity.
- Marketer spends $1,000 on a marketing program.
- 20 new customers are acquired (25 * 0.80 due to the economy).
- The average order value is $150.
- 20% of demand flows-through to profit.
- PPNC = ((20 * $150) * 0.20 - $1,000) / 20.
- PPNC = ($3,000 * 0.20 - $1,000) / 20.
- PPNC = ($600 - $1,000) / 20.
- PPNC = -$400 / 20.
- PPNC = -$20.00.
As you can see, Cost Per New Customer (CPNC) is a good thing. Profit Per New Customer (PPNC) is even better!
UPDATE 12/7/2008: A new post contains a link to a spreadsheet that allows you to calculate these metrics for your marketing activities.
Labels: CNPC, Cost Per New Customer, PPNC, Profit Per New Customer
8 Comments:
It would be great if someone could create a app that would auto-calculate this?
Okay: Great post. I built this into my HP-17B2 handheld calculator as a routine. I'm dangerous.
BUT: When you derive your PPNC adjusting for the economic downturn, you say "PPNC = ((20 * $150) * 0.20 - $1,000) / 25."
Shouldn't the "20" and the "25" in this equation both be "20"?
Thanks!
Harry Joiner
EcommerceRecruiter.com
As seen in "Internet Retailer" magazine
PS - I'm relatively new to this industry (less than five years). Is "flow through to profit" just a fancy way yo say "gross profit" or EBITDA? What's the customary way to calculate this figure?
oops! my typo: I wrote "... just a fancy way yo say "gross profit" ..."
"YO" should be "TO."
Harry
Harry, you are correct, and the correction has been made, with proper attribution!
Awesome! Now, what are the answers to my follow up questions: 1.) Is "flow through to profit" just a fancy way to say "gross profit" or EBITDA? And 2.) What's the customary way to calculate this figure?
Thanks, as always, for the great education!
Harry
Flow-through to profit includes all p&l elements other than marketing expense and fixed costs.
For instance, an online brand might sell $100. Of the $100, $20 is returned, leaving $80 of sold merchandise.
Then, the company paid $50 for the merchandise, leaving $30 of gross margin.
Finally, the company paid $11 to pick/pack/ship the merchandise, with $19 of profit left.
The flow-through rate is 19%, $19 / $100.
Many catalogers call this rate the "contribution" rate, or the "variable profit" rate.
The calculation is similar across catalogers and online marketers --- most folks do something of this nature.
GREAT INFO! THANKS!
Final question and then I'll leave you alone: When catalogers discuss these expenses, do they discuss them in percentage terms -- or dollar amounts per sale (as you have done)?
Harry
My clients tend to state Profit Per New Customer (PPNC) as a dollar value. They tend to state the Profit Factor (PF) as a percentage.
Catalogers may use different terms for profit factor, "contribution" comes to mind as a common term.
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