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Profitable Marketing Programs Part 2: Figuring Break Even Point
In Part 1 -- http://www.websitemarketingplan.com/online/profit.htm -- I discussed how to consider both long term and short term profitability in your marketing programs and assumptions that go into conducting a break even analysis. Here in part 2, I will look at three different break even formulas. Figuring Break Even Point To figure the break even point, you should know the program's expected response rate, the program's expected conversion rate, and the lifetime value of a new customer. In the formulas below, the response rate and conversion rates should be expressed as a decimal (Examples: 1%=.01. One-half percent=.005). The lifetime value should be expressed in dollars. For more details, please read Part 1 of this article. Figuring Break Even Point Based on Lifetime Value The lifetime value formula requires you to make assumptions about how many times a customer will purchase from you over a period of time (usually around 18 months to two years) and the average profit on each sale. For average profit, start with your total sales dollars and subtract cost of goods; distribution costs; advertising and marketing expenses; and any other variable expenses related to making product and filling orders. You may also want to figure income taxes into the equation. Divide the average profit number by your total number of transactions. You can then figure the lifetime value using this formula: Lifetime Value = (Average # of purchases over lifetime) X (Average $ profit from each sale) If you are paying for the program based on customer acquisition (i.e. you only pay if a lead generated by the program converts into a customer), you generally want to pay less than the lifetime value per customer in order to make a profit. As an example, say on average you make $20.00 profit from each sale. Also, on average, a customer will buy from you 1.5 times over the course of two years (here, the "lifetime" is considered two years). Multiplying the two figures, that means each new customer will generate $30.00 in profit for your business. So, you break even on the program at a cost of $30.00 for each new customer. Pay Per Click (PPC) Break Even Point But what if you are paying on a pay per click (PPC) or pay per action (PPA) basis, a certain amount for each lead the program generates? In this case, you are paying for all of the leads (or visitors) who do not purchase as well as those who do. You therefore have to factor in the conversion rate to find your break even point: Pay Per Click Break Even = (Expected conversion rate) X (Lifetime value) Continuing the example above, the lifetime value of each new customer is $30.00. Also, on average, 1 out of every 200 leads (clicks or actions) generated from the PPC or PPA program convert into customers for you. $30.00 times .005 is .15, or 15 cents. In other words, each click or action is going to be worth no more than 15 cents to you. If you have a two-step process to help improve conversions, you multiply in the conversion rate of the intermediary page (if you are generating leads or action for more than one program on your intermediary page, don't forget to factor all of them into your conversion rate). For example, if your PPC ad lands on a lead-generating page that sends 13% of visitors to the sales page described above, and the sales page turns 5% of those leads into customers, then you multiply the lifetime value by both conversion rates: $30.00 times .13 times .05 = .195, or 19.5 cents per click or action. In that case, you would want to pay no more than 19.5 cents for each click or action. CPM Break Even Point What happens if you are paying per thousand exposures (in other words, CPM - a flat rate for each 1,000 subscribers, visitors, or email addresses exposed to your message)? Now you should consider response rate as well as conversion rate and lifetime value. To figure out your break even CPM: CPM Break Even = 1,000 X [(Response Rate) X (Conversion Rate) X (Lifetime Value)] To profit from new customers gained through the program, you must pay less than your break even amount. Before making final decisions, however, consider other factors the break even analysis does not address. Any additional internal resources required to implement the program, for example, are additional costs. Remember, too, that profit impact goes beyond the purchases your new customers make. New customers gained by word of mouth (originating from but not a direct result of the program), increased awareness due to the promotion, and increases in off-line sales are indirect benefits of the program. In the long run, these all result in additional sales. Opportunity costs may come into play as well; consider if you could better use your time and money to implement more profitable programs. With each marketing program you implement, if you are aware of your break even point -- the point at which the program becomes profitable to you -- and make decisions based on those profits, your business will grow. Publication Guidelines: When publishing this article on the Internet, please make at least one URL in the "About the Author" resource box clickable. Also, please notify Bobette Kyle of publication (articles @ websitemarketingplan.com). Copyright Bobette Kyle. All rights reserved. Bobette Kyle draws upon 12+ years of Marketing/Executive experience, Marketing MBA, and online marketing research in her writing. Bobette is proprietor of the Web Site Marketing Plan Network, http://www.WebSiteMarketingPlan.com, and author of the marketing plan and Web promotion book "How Much For Just the Spider? Strategic Website Marketing For Small Budget Business: http://www.HowMuchForSpider.com/TOC.htm
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