5 Step Marketing Budget Process - Part 2 How Not to Run Out of Money
July 28, 2020 at 5:30 PM
by Ben Rose
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5 Step Marketing Budget Process - Part 2 How To Not Run Out Of Money

In the first article in this series, we covered business goal setting as part of the budgeting process. In this step in the series, we will dive into some financial considerations that may constrain the marketing budget. As a reminder, this is the full process.

5 Step Marketing Budget Process

  1. Business Goal Setting
  2. Finance Constraints
  3. Total Marketing Budget
  4. Working Non-Working Budget
  5. Channel and Funnel Strategy

This part of the process is where all of the cards are laid on the table where candid discussions uncover how much growth the business can stomach and how quickly. We’ll cover customer acquisition costs (CAC), CAC to LTV ratios, payback periods, available funds, and touch on total vs. channel level CAC. This article can get dense at times. If you just want to know “what’s the what”, skip ahead to Putting It All Together. Otherwise, read along and have fun nerding out with me. :)

Customer Acquisition Costs

Customer Acquisition Cost, or CAC, is the cost it takes to acquire a new customer. Sounds simple enough, right? There are, however, some nuances that should be considered. Channel CAC is calculated at the marketing channel level and usually includes only media spend and the customers that can be attributed to that channel. The results of this calculation depend highly on the attribution model used - and that is a whole ball of wax for another conversation. Total CAC includes other types of marketing costs - creative, fees, referrals, but also includes all new customers, even unattributed conversions which are usually labelled as “organic”.

The advantage of using Total CAC is that it is less sensitive to marketing attribution models. The disadvantage is that it is more sensitive to external factors, for example, COVID-19, which is depressing conversions for some industries (live entertainment, brick-and-mortar retail) while lifting others (online entertainment and education, subscription services).

Customer Lifetime Value

Customer Lifetime Value (CLV) is the average expected per customer profit over their lifetime as a customer. In its simplest form, the calculation is:

CLV = (avg revenue per customer per period) x (avg number of periods) x (profit margin)

Your periods may be measured in months or years. For this series, we will use months. Here’s a quick example.

Your subscription business sells a monthly $30 box of products at a 50% profit margin. Your average customer renews the subscription 5 times for a total of 6 months of transactions.

CLV = $30 x 6 x 50% = $90

For every customer acquired, your subscription business makes $90 in profit. I’m sure you can see where this is going. How much should you spend to acquire a customer?

CAC : CLV Ratio

The CAC to CLV ratio is the ratio between how much it costs to acquire a customer and the expected value of that customer. Continuing with our subscription business example, let’s say it costs an average of $60 to acquire a customer for this business. The CAC : CLV ratio is $60 : $90. Congratulations! As long as the CAC is less than the CLV, you have a profitable business model.

If your business has acquisition costs that are higher than lifetime volume, there are four avenues you can attack to improve this ratio: lower customer acquisition costs, increase average order value, increase retention, or increase profit margin. Improving this ratio is worth its own article, but for the example at hand, we’ll proceed to calculate the payback period.

Payback Period

The $60 : $90 suggests a 50% profit margin which sounds like quite a healthy business. So why not put every available dollar into customer acquisition? The answer is payback period. The payback period is the number of periods it takes to recoup your acquisition costs. Our subscription business breaks even at 4 months on a per-customer basis. 50% of the acquisition cost is recouped by month 2.

Applying this concept across all acquired customers requires the inclusion of a retention curve to get a better understanding of each month’s payback amount. This retention curve shows the percentage of customers renewing in each period.

Now we expand the example from acquiring a single customer to acquiring 1,000 customers and applying the retention curve from above. At a $60 CAC, that means we spend $60K to acquire 1,000 customers. As you can see, the payback period is now between the 5th and 6th month. This can make a big difference in the monthly balance sheet as marketing budgets grow.

How to Run Out of Money

This is where the rubber meets the road. Money in the bank or the lack thereof. The chart below assumes the business has $1M in available funds to invest in marketing and that each level of monthly spend acquires customers at a $60 CAC. Spending $100K per month leaves plenty in the bank, but does little to grow the business. Spending $500K per month drops available funds to 25% of total$0 mid-year and yields more return. Spending $1M per month puts the most money in the bank at the end of the year, but there is an 8 month period where the account is up to $1.1M in the red. Additional investment would be needed to spend at this level.

This scenario assumes a stable CAC and LTV. CAC varies with the amount of spend, and an imbalance between upper and lower funnel tactics often causes CAC to increase. Here you can see the compounding effects of a 10% change in CAC. Retention rates change LTV and have similar impact.

For this reason, it is beneficial to add guard rails around CAC and LTV. This could be expressed as

“This business will maintain a CAC:LTV ratio of 1:1.4 or better.”

Using the ratio as a frame allows CACs to increase along with LTV, which can open up more expensive customer acquisition channels or longer-term brand investments.

Putting It All Together

Of course, the marketing spend does not - and usually should not - have to be the same for each month. By controlling the flow of spend to line up with seasonality and product launches, we can maximize returns without incurring additional debt. This sample budget below adjusts to major product launches and business seasonality.

Here we have a budget that takes into consideration our primary non-marketing constraints:

  1. Don’t run out of money
  2. Maintain a CAC:LTV ratio of 1:1.4 or better
  3. Account for product launches and seasonality

Okay, I know this article was super-dense, but it is well worth it to get a better understanding of how and why CAC and LTV influence marketing spend. In the next article, we will build the top-level budget to match the goals established in Part 1 of this series and also cover stretch goals and contingencies.