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Is your marketing spend growing your top line at the expense of your bottom line?

Updated: Jan 8

Every business is built on the concept of marketing your product or service. We saw forty years ago the power of word of mouth as the best form of advertising. Still is. A customer telling their neighbor about your mouth watering ribs or how great your new SaaS application performs is a powerful endorsement. It was not long ago when advertising in your neighborhood monthly was a fantastic way to reach your customer who lives three minutes from your store. Our small town in Colorado went from a single monthly local magazine to eight monthly “local magazines” over the past 30 years.

Our small town went from a population of 8,000 in 1989 to 80,000 in 2023. Now the mailbox averages eight to ten local magazines every month depending on how you count them. They focus on local families and local news. Some just send an envelope full of coupons and nothing else. Then of course come the target ads, the one that claims to relate to the “local customer need.” Others are thicker local newspapers full of news about the county, local town, and what is happening with local government. Even the Sunday paper has a whole bunch of local magazines ads that spill out after you open the paper. 

Then came the internet, the digital age, Twitter-X, Facebook, You Tube, and Tic Tok. This was followed by the Great American Funnel. Not the cake, but the tried and true method of capturing your customers interest and spinning it into a purchase order. In order to start the funnel, the world of marketing evolved into using push through technologies, GEO fencing, just in time messaging, and of course the wonders of Artificial Intelligence. At what point do all of these marvels of marketing technology just become a zero sum game? If we all have access to the same “marketing marvel” does it not just nullify the whole idea? Are you constantly reinventing your marketing program just to maintain market share? All of the above costs are marketing costs including the cost of developing your brand.

What is the magic bullet for marketing in today’s new age of marketing? Even more challenging for many is what is my real “customer acquisition cost.”  Some firms and business owners are just more savvy. They may be quicker toward adopting newer innovative technologies.  Then again if sending push through messages through Twitter (X) was a game changer, then each of us would see one hundred push throughs per day. It works really well if you are a Food Truck with a cult fan base that devours your fish tacos and you are telling your fans where you will be at lunch hour. It may not matter if you are a lumber yard with a new stockpile of Brazilian Cherry wood. 

 Is marketing really about the latest A.I. spin, or does it reveal itself after one simple question?

The famed Shark Tank investor Kevin O’Leary started asking the question years ago:

“What is your customer acquisition cost?”

As a self-described math guy, I offer the deep dive follow up question:

“How are you calculating your customer acquisition cost?,” which is really just an extension of O’Leary’s mantra marketing question.

After co-founding five companies, I have learned the marketing lesson five times. Marketing strategies are changing all the time. They often evolve over time. They always cost money and contain internal and external marketing expenses. Can you separate your marketing spend such that you have confidence in measuring your new customer acquisition cost? Does it optimize the bottom line or is it swallowed up in that catch all category known as SG&A costs, sometimes just simplified as just G&A costs. Before pondering this age old and often elusive concept, let us check in with the accounting world to see how marketing is expensed (or capitalized) on the P&L.

“Absorption costing allocates fixed overhead costs across all units produced for the period. Variable costing, on the other hand, adds all fixed overhead costs together and reports the expense as one line item separate from the cost of goods sold or still available for sale.” (Investopedia. 12-20-2022). While this may be great to complete your P&L, it has little to do with your new product roll out because your marketing costs are being expensed against what you are already doing. 

We note that internal marketing costs like payroll for the marketing department will see charges within the fixed expense category while incremental marketing spend on a specific ad campaign will show up as variable, related to a new product offering. While this may be following a best practice accounting methodology, it does little to tell you what your incremental or total marketing spend is really doing for your business.

Now let's review all of the costs absorbed in what is termed “marketing cost”.

“Marketing costs are all of the expenses a company incurs in order to sell, promote, develop, and market its brand. These expenses can include advertising, software and services, personnel, and content creation.” ( 12-8-2022). 

It is easy to see how the “customer acquisition cost” can vary widely depending on the moment in time the calculation occurs, how your brand development cost shows up on the P&L, and whether or not they have been recorded under R&D from previous quarters. A smaller company or a start up clearly makes this question much easier to figure because there may not be other products competing for expense allocations on the P&L. Either way, determining your acquisition cost per customer or per unit could vary widely depending on how far back in the development cycle the calculations go, and whether or not the calculation is based on accounting principles or just uses the incremental marketing spend used to advertise a new product. Lastly, is an old customer buying again a new customer or old customer for purposes of determining “customer acquisition cost.”

Traditional accounting methods provide guidance on whether or not to capitalize or expense marketing cost so some brand development cost and marketing cost might be amortized over time versus being expensed in a given quarter or year. This will change your customer acquisition cost. Some of these costs may have been recorded over previous quarters and may or may not have major influence over what is truly the all in cost of marketing cost of your existing products or a new product. Once again the business question of what is your “acquisition cost per customer” now faces a number of decisions on how to allocate all of the relevant marketing cost to answer this question. 

The first thing to ascertain on what is the “customer acquisition cost” is whether one is answering this question on Shark Tank or is one answering this question by using GAAP accounting guidelines under a best practice methodology. If your baseline customer base is 10,000 customers and you pick up 6,250 customers, what happens to your “customer acquisition cost”. 

We note if a product is selling for $100 against the period marketing spend of $250,000 it is possible to answer $40 per customer by just using the 6,250 new customers. On the other hand, if half of your new sales are from existing customers, does this not change the calculation? Now you spent $250,000K over a customer base of 16,250 equal to $15 per customer depending on the calculation method used. Which answer is the right one? One might argue they are both wrong. Perhaps the calculation should include the 6,250 new customers and one half the 10,000 baseline customers for a customer base of 11,250 to calculate what might be the best answer. In this case $250,000/11,250 comes to $22.00 as the adjusted calculation. I have seen all three methods used.

For purposes of addressing a potential investor it also depends on when the investor comes into a deal and how many customers are being assumed in the units sold calculation. An investor coming into a deal after $1M was spent in brand development over the prior period may or may not care about past costs as they are putting their own valuation on the company. They will focus on what is needed to move product out of the warehouse and onto the P&L statement. Moreover, they want to see as the units sold increase quarter over quarter, how can scale reduce per unit cost and increase operating profits. Even better, can I reduce my customer acquisition cost?

How then does one answer what the customer acquisition costs are since by definition that answer could change every day depending on unit sales and how past marketing and brand development costs are recorded. 

It also depends on who is asking the question and for what purpose.

Over time the initial brand development cost would be  fully amortized and you will be recording just your incremental marketing spend onto your cost per unit or cost per customer. As you approach 40,000 units sold with the same $250,000 on marketing spend, your customer acquisition cost theoretically drops to $6.25 per unit. Assuming a reasonable manufacturing margin to the bottom line, your $4,000,000 in revenue is now able to cover all of the manufacturing and marketing  cost and leave a profit of ten percent equal to $400,000 for the quarter or the year as an example. But is your calculation based on “incremental new customers” or just cast in the sea of general GS&A category, in this case General, Selling & Admin costs? 

Whether or not this occurs over four quarters or four years, the point is the same. Your customer acquisition cost must include a detailed set of assumptions. You can then answer this “customer acquisition cost” question with confidence.

It might go something like this when sales are at the midpoint of $2,000,000 assuming we have charged off our initial brand development cost, our customer acquisition cost going forward is now $12.50 per unit coming in from a $2,000,000 top line figure, down from $25.00 from the prior operating period. These figures are expensed against our total number of customers at 20,000 for the period. Our forecast is tracking to hit $4,000,000 in the next operating period  dropping our projected per customer acquisition cost to $6.25 cents per unit, allowing us to increase operating profits to $400,000. 

In other words, without defining the baseline sales figures, incremental marketing spend against units or customers, whether or not the calculation is against existing versus new customers, scaled operating expenses, and total sales and marketing expenses for the period, simply throwing out a “customer acquisition cost” figure by itself has little to no value since this will change over time and can vary widely for the same period dependent upon the assumption. It is possible this number could change every day. 

It is important to understand how this number is changing and whether all of the branding and  marketing costs are included. The complete analysis is what makes the number credible. Under the rules of accounting your marketing cost is expensed against your existing customer revenue base, or amortized over a certain expected life, not necessarily isolated as a new customer acquisition cost. Is charging your marketing spending against your existing customer base really revealing what you are spending to get new customers?. 

Moreover,  are you just spending thousands in marketing to maintain the status quo? What would happen if you spent nothing on marketing? Would you be happy losing 5% of your top line revenue but increasing your profits by 7%? Does it make sense to double your marketing spending to gain a 2% increase in profits? Are profits rising because your raw materials are dropping due to scale pricing from your supplier? Is this really why profits went up? Could you have made more money if you cut your marketing spend in half and grew at a slower rate? 

The trick is to find the right blend of marketing spend and return on investment for marketing. If you are increasing your marketing spend and increasing your per unit cost by employing  your marketing plan, your bottom line may be shrinking while your top line is growing. At botdorf research we can help you dial in your optimized plan. Good luck and may your funnel bless you.

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