The New Customer Engine, Part I
There’s a well-known saying you’ll hear echoed from the halls of corporate America to the smallest businesses. Heck, you’ve probably heard it on Shark Tank more than a few times.
“Sales solve all problems.”
Like most quippy one-liners, this one leaves out a rather important modifier – “profitable” sales solve all problems. It’s profitable revenue you’re after, not just any revenue. As a business, much of your success story (or otherwise) will be determined by how well you understand and solve this problem. It should go without saying that if it costs $1.25 to earn a dollar, things won’t end well – unless you’re a Silicon Valley startup anyway 😉
There are many individual reasons businesses succeed or fail. Yet the one common denominator successful ones share is their ability to acquire new customers profitably.
I won’t lie to you and say this is an easy task. If it were, everyone would do it and it would lose its value anyway. But we live in a highly, crazy-competitive world. Go look up your business category on Yelp and I’ll bet you’ll find dozens of competitors within just a few square miles of you. Having a better product or service is a start but (maybe unfairly) not the determining factor in most business success. What is?
It’s your ability to convince strangers to do business with you.
Think of your business like a custom-built car. You chose the wheels, the interior, the color, the stereo system and so on. Sure, some ‘cars” are nicer or bigger than others but each is its own unique creation with the potential to get from Point A to B.
Yet amazingly, so many businesses overlook the single most important component – how to make the ‘car’ actually move! It’s the one component that cars don’t roll off the assembly line with. It’s the one thing they need to keep moving at all times. Sure, you might get a nice downhill run and coast during your ‘honeymoon’ phase, but beyond that there one real, proven answer to power your business for the long haul.
The answer is adding fuel to the engine!
For every business I know of, that fuel comes in the form of new customers. Stop adding new customers and you may coast for awhile but you’ll surely end up stalled by the side of the road eventually. I’ve seen it too many times to count. If marketing is the oil, advertising is the gasoline. (read about the difference here).
OK, how much should your business spend advertising to acquire these new customers? The Small Business Administration (SBA) publishes some guidelines on what they consider an appropriate budget for marketing and advertising. The SBA recommends spending 7 to 8 percent of your gross revenue for marketing and advertising if you’re doing less than $5 million a year in sales and your net profit margin — after all expenses — is in the 10 percent to 12 percent range. That means a $750K (annual sales business) should spend about $52K per year.
Based on seeing up close and participating in the successes and failures of hundreds of businesses of every type over the past 20 years, this isn’t very helpful nor accurate on a small business level. I think these numbers are A) generally too high for most small/medium businesses and B) doesn’t take into account your cost of acquiring each new marginal customer. Profitable revenue, remember!
The good news is, there are some pretty concrete answers once you understand your Marginal Customer Value (MCV).
In short, this is the actual profit value over time (one year is a safe bet) of each new customer added to your pool of existing customers. This is the critical first step in determining how much you can and should spend to fill your businesses fuel tank and power it down the road. The first step is to determine what a new customer is worth to you in the next 12 months…
Barney’s Burger Joint
- $20 Average sales ticket
- – $6 Cost of goods (30%) Cost of Goods: I have to pause here because this is such an important point. Your rent, insurance, bank loan, and in many cases even payroll are NOT relevant here! You will have these same expenses whether you generate this new customer or not. What matters is the tangible, marginal cost of providing your product or service.
- $14 Net profit/visit
- X 1.5 AVG customer visits per month
$252 Annual Net profit for this marginal customer!And keep in mind, if you provide a quality product or service and oil the marketing machine, you’ll keep many of these customers for far longer than one year – making them more profitable over time!
With this hugely important data in hand, you can next decide what it’s worth to you to acquire this customer. While technically spending $251 might make strict financial success, that’s clearly not a good idea. After all you do care about profit margin too!
A smart, safe investment is about ⅓ the profit value of each new customer.
So let’s explore some possibilities.
Let’s say your business has about 1,500 regular customers (visiting 1.5X avg/month that’s about 92 tickets per day x 25 open days) and is breaking even or even making a small profit. That’s about $540,000 annual gross revenues. Now let’s assume each new customer, like the example above is worth about $252 annually to your bottom line (profit, baby!). Would it make sense to spend $75 to acquire that customer? Sure it would! Adding just 10 new customers per month with this math equals about $16,380 in net, new profit annually. TRY THE CALCULATOR HERE!
With the figures above, that would equal an advertising investment of about $450 per month. SEE YOUR OWN HERE. On the business example above, that would be roughly an annual advertising expenditure of just ONE PERCENT of annual revenues! If you’re just starting out, ramp that up to 2% and it not only makes short-term financial success, it will get you to and beyond break-even faster. Even more exciting is that by month three you should be in positive cash flow for an investment of this level. I’ll bet you’d do this 10x if your financial means and the market allowed!
Looking at your advertising budget in this way is a smarter, more profitable way of building a business that thrives, rather than just survives. No one starts a business to create a job for themselves – that’s nuts!
Trying to make your business run by pushing it down the road is cheap for sure. But it’s also crazy slow and you’ll soon enough get tired of seeing other cars whiz by you. Why are they whizzing by? They’re keeping their fuel to their businesses engine topped off – ensuring they never run out of the precious commodity. And there are A LOT of ‘cars’ on the road these days. Customers have lots of choices. Actively investing in acquiring their attention and their business is not only a smart investment (provided you stay under the MCV), it’s the only realistic path toward growing your business beyond its current state.
Yet, the single biggest mistake by businesses (that often proves fatal) is a refusal to invest the money to add new customer fuel. This is financial insanity! The good news is you can avoid the #1 reason businesses fail (not enough customers/revenue) by investing in acquiring these customers in smart, financially solid ways.
Next up: the best ways to invest these resources in advertising that can deliver on this sound financial gameplan.