After many months of development and testing, your new product is finally ready to hit the market. The CFO has earmarked funds for marketing, but how will you know if your marketing campaign will be a good investment?
When it comes to purchasing decisions (whether personal or in business), to determine if something is a good investment, we can perform a simple cost-benefit analysis (CBA).
Now, when running a CBA analysis, it’s easy to get confused with a flood of possible metrics, like incremental sales, nominal payback, discounted payback, NPV, and IRR (among others). However, for this example, we’ll use the nominal payback period since it’s most fitting in the context of a marketing campaign.
Furthermore, since marketing campaigns are typically measured in shorter time increments (i.e. months rather than years), we’ll opt for a nominal payback instead of discounted, allowing us to ignore the time value of money.
Let’s dive in…
What IS ‘Payback Period’ and how can we MAXIMIZE it?
In the context of a marketing campaign, the payback period is the time it takes for the campaign to earn back the initial investment by way of additional sales (i.e. earnings) generated by the campaign.
For example, if a 6-month marketing campaign costs $6,000, the payback period is the break-even point at which we generate enough new sales to recover our initial $6,000 investment.
In the case of a marketing campaign, the shorter the payback period the better, since we want to recover our initial investment and reinvest the funds into future campaigns.
Moreover, a shorter payback period indicates how successful and effective our campaign is at acquiring new customers.
Lastly, if the payback period is attractive (i.e. shorter), we’ll likely want to double down and invest additional funds into the existing campaign (i.e. an efficient customer acquisition flywheel, whereby adding new funds simply accelerates the rate at which new customers are acquired).
Run the Numbers
Let’s run the numbers for our example organization, assuming a simple B2C SaaS application.
Let’s assume we charge customers a fee of $7.95/month (or $59.95/year when billed annually)––if ever charging a monthly fee, make sure to always include an annual option––this will help significantly with cash flow.
Now, let us assume we want to invest $6,000 into a 6-month marketing campaign to promote our new annual payment option of $59.95/year.
Furthermore, based on historical campaign data (or test marketing if you’ve never run a campaign), every $100 we spend on digital marketing results in roughly 8,500 views/impressions (CPM). Of those 8,500 impressions, our average click-through rate (CTR) is 2% (i.e. 170 people click through to our sales page). Finally, of those 170 people, on average 5% convert into paying customers (i.e. a conversion rate of 8.5 people).
NOTE: After the first few weeks of marketing, you should have gathered some strong initial data on CPM, CTR, and Conversion.
Let’s summarize this data into a table for easier viewing:
From this data, we know we can expect 8.5 new customers from every $100 spent on marketing.
Next, we can determine the approximate length of time needed to recover our initial $6,000 investment (i.e. nominal payback period).
For example, if our campaign spends $6,000, and we acquire 8.5 new customers for every $100 spent on marketing, we can expect approximately 85 new customers each month (assuming we spend $1,000/month).
Moreover, with each new customer generating $59.95 in revenue, 85 new customers will generate $5,095.75 per month in revenue (i.e. $59.95 x 85).
If we put these numbers into our Net Cash Flow table, it looks like this:
Next, we can calculate our Cumulative cash flow values to determine our break-even point:
Therefore, as we can see from the chart above, we will break even during month 2 (in precisely 1.18 months) by dividing our initial $6,000 investment by our $5,095.75 in monthly cash inflow.
Caution: It’s all based on assumptions
As with all financial projecting, keep in mind that everything here is based on assumptions. We cannot predict how well our advertisements will perform, and our marketing efforts will require ongoing A/B testing to optimize for CPM, CTR, and Conversion.
However, based on preliminary marketing data, and estimating that we will recover our $6,000 marketing investment after only 1.18 months, this provides significant reassurance when deciding whether to implement the campaign.