As Internet marketers, our number one objective is to utilize online marketing to boost company revenue by means of increasing sales. If you are like most marketers, you are spending money across a variety of online channels to generate conversions. So, knowing it is our responsibility to generate revenue via these channels, it is also safe to assume that most advertisers know their cost-per-acquisition (CPA) threshold, or how much they are willing to spend in order to have a potential customer submit a form, purchase a product/service, or complete whatever action they have deemed necessary to achieve their objective. After all, knowing this number ensures we can effectively allocate and measure marketing dollars and therefore prove an initiative’s value to company leadership.

However, this is not a safe assumption. Many advertisers not only do not know their CPA threshold, they don’t understand its value or how to calculate it for their organization. As an Internet marketing agency, we bring value to many of our clients by helping them establish just this. Given that, we thought many of our readers would find great value in the insight and guidance we can provide in regards to setting your CPA threshold.

Your actual CPA is determined by dividing total spend for a given time period by the amount of conversions during the same time period.  In Internet marketing this most often means media spend/conversions.  If you are using an agency or third party tracking tools you may also factor those variables into the numerator of the equation. A company’s CPA threshold is unique to its product and/or service offering and can be influenced by a variety of factors including their internal goals, the value of the final sale, average order value, close rate and profit margins.

The following is an elementary example of how one might determine their CPA threshold. Let’s say a realtor is selling a property at a non-negotiable price of $1,000,000 and that she knows she’ll make $50K in gross revenue when the sale is generated. Based on historical data, she is confident that she will close 1 out of every 10 leads generated (she’s really good!) and decides to invest $10,000 in a banner ad campaign to promote the listing.  Given her close ratio, she can safely set her CPA threshold at $1,000.

In comparison, consider a cosmetics retailer who sells a variety of beauty products at varying price-points. Assuming the average order value is $40 and they need to maintain a return on advertising spend (ROAS) of 500%, it can be determined they should not spend more than $8 (40/500%) to acquire a new sale.

Once you have determined your company’s CPA threshold, you can use historical data and/or assumptions to evaluate whether various channels will be within the spending cap. Say, for example, the above retailer is launching a cost-per-click paid search campaign. Let’s assume the campaign will receive 7,500 clicks and 10% (750) of those will convert. Additionally, the total campaign cost is $5,000. By dividing $5,000 by 750, we can now see the CPA is $6.66 for this campaign. Because they have already established their CPA threshold is $8, they know that this initiative will successfully contribute to their marketing mix. By using the below formula, we also see that this campaign yields a ROAS of 600%, which also meets the advertiser’s minimum requirement.

Revenue/ Advertising Cost =ROAS

[40*750]/5,000=6 (600% ROAS)

As you can see, it is fundamental that every organization establishes their CPA threshold in order to establish a benchmark for your marketing ROI. It helps marketers to make quick and informed optimization decisions, as they can quickly measure the effectiveness of a campaign and make the necessary adjustments to regain their ROI if need be. Additionally, if campaigns are acquiring conversions within your CPA threshold, and therefore are effectively contributing to revenue generation, marketers can shift more budget to the said medium and capitalize on the investment.

This entry was posted on Monday, February 1st, 2010 at 6:14 pm and is filed under Banner Advertising, Internet Marketing Strategy, Paid Search (PPC), Uncategorized. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.