Cost Out of Context

By Ron Rosenberg

“How much should we spend on marketing?”

“What’s a good response rate on a direct-mail piece?”

“How far apart should we space the e-mails in a promotional campaign?”

These are common questions people ask, and it doesn’t seem to matter If they’re solo entrepreneurs, small business owners, or directors of large corporate marketing groups.

On the surface, these seem like simple enough questions – I mean. you clearly should have an idea of what your budget is; you should be measuring response rates; and you have to make conscious and deliberate decisions about the details of a marketing campaign.

But none of these questions – taken in isolation – provides sufficient information to make reliable decisions. For example, is it reasonable to spend $5,000 on a marketing campaign? Well, it certainly depends on a number of factors:

  • How many people will you reach?
  • How are you selecting the target audience?
  • What is the action you want them to take?
  • How much is the value of their initial purchase?
  • What is their expected lifetime value?

Let's Look at an Example...

If you’re spending $5,000 to reach one person who’s going to make a $10 purchase – and that’s all they’ll ever buy – then it’s clearly ridiculous to invest that much money.

On the other hand, if that same $5,000 is going to be spent on a multi-step, multi-media campaign to 500 finely targeted prospects who have already expressed interest in your product; if that product costs $750 and is usually ordered 5 times per year; if a typical customer continues ordering for 36 months; and if you historically have a 10 percent conversion rate on similar campaigns to similar lists, then it’s clearly a good idea.

In the first case, the best possible outcome is that you spend $5,000 to get back $10. In the second case, the math is significantly better:

  • A 10 percent conversion rate on 500 people equals 50 customers
  • Each customer makes five $750 purchases a year for three years
  • The total revenue from this campaign is 50 people x $750 x 5 purchases per year x 3 years, or $562,500

I would definitely spend $5,000 to make $562,500 in three years, and I hope you would too!

In case you’re calculating the rate of return (and I certainly hope you are!) it’s 112.5 to 1; that is, for every dollar you invest in marketing, you make back $112.50. I don’t know about you, but if I had the data to back up these numbers, I’d run campaigns like this all day long.

In contrast, with the first case we looked at, the ratio is reversed and seriously unfavorable: you invest $5,000 to get back $10, for a ratio of .002 to 1. That means that for every dollar you invest in this campaign, you get back two tenths of a penny.

So What About "Response Rates?"

This is one of the dangers of considering cost out of context. Let’s take a look at another example, this time with the question of the “ideal” response rates for a marketing campaign.

If you pay attention to articles from the direct-marketing field, you can find all sorts of guidelines and “rules of thumb” about what constitutes an acceptable response rate for a given type of campaign, perhaps 3.5 percent.

In the second example we covered above, we used a conversion rate of 10 percent. This is a very aggressive number, since it refers to the number of people who purchased, and not the number of people who may have only responded to request information or register for a webinar before actually purchasing. In a typical situation, these numbers would be hard to believe. In this case, though, we have two pieces of information working in our favor:

  1. The campaign is directed at a highly targeted list. If you truly understand your market and tailor your marketing to directly address their pressing issues, you can and should expect a better response than just firing off a single post card to a random group of people or businesses. And it’s not all that difficult to get targeted lists – starting, of course, with your own internal customer, client, or member database. But even looking externally, if you determine that your ideal customer is a 45-year-old Army veteran who plays golf left-handed with a six handicap and drives a purple AMC Gremlin, you can get that list of people. Sure, it won’t be a very big list, and it might take some effort and expense to compile it, but if those are truly the characteristics of your ideal prospect, then how many of them should you be able to convert? That’s right – all of them!
  2. We didn’t pull the 10 percent conversion number out of thin air – if you remember, we said that this was a measured and observed historical number. That means that we tried it, measured the results, tested it again several times, saw similar results, and determined that we could continue to present this campaign to similar groups and get similar results.

But what if we didn’t get a 10 percent conversion rate. What if we only got one percent? That would instead be 1/10 of the total return, so instead of $562,500, it would be $56,250, still a good return on a $5,000 investment, at 11.25 : 1, meaning that for every dollar you spend, you get back $11.25. Still a good deal, and one I'd try to replicate as often as possible.

It Depends...

The bottom line is that the answer to many marketing questions is, "It depends."

  • It depends on the characteristics of your market
  • It depends on you competitive environment
  • It depends on the general economy
  • It depends on your own financial considerations

Essentially, it depends on the context within which your business is operating. If you're going to enjoy sustained success, you have to understand your environment, establish meaningful and reliable metrics, and never take cost out of context.