“HOW MUCH!”
I hear these two words loud and clear almost every day. And they’re usually followed by a long period of silence.
The reason for this outburst is that I’ve just told a client that a small business card size advertisement in a popular newspaper or magazine can easily cost over a $1,000. Or that a sixty second commercial on the radio could set them back more than $2,000. Or that building and optimizing a website can create a dent of $5,000, $10,000, or more than $20,000 in their bank account.
After they’ve recovered from the shock, I go on to tell them that the cost really isn’t very much at all. And what they need to take into account is not how much the advertising costs, but how much return it will bring.
Let’s look at it differently: If you paid $10,000 to build and optimize a website, and that website generated enough sales to make you a profit of say, $20,000, would $10,000 be too much to spend?
The answer, of course, is NO, it would not.
This is why big corporations don’t bat an eyelid at spending millions of dollars on advertising each year. They know that enough people will see their advertising to make their yearly advertising costs seem like a bargain.
What big businesses understand, and many small businesses fail to grasp, is that you have to work out how much money your advertising will make you in profit, before you decide whether it costs too much or not.
But how do you do that?
Here’s a step-by-step process I use to help my clients work out whether the cost of advertising is too much, or whether they’re getting a bargain.
Step one
Work out how much gross profit you make on every sale. For example, if you buy the product you sell at $50 and sell it for $100, your profit is $50.
Step two
Determine your closing ratio. Say you close, on average, one sale for every four people who respond to your advertising, your closing ratio is 25%. If you close 9 out of 10, it’s 90%.
Step three
Figure out your break even point. Divide the cost of your advertisement by the amount of gross profit in step one. For instance, if your ad costs $1,000 and your gross profit is $50 that means you need to sell 20 products to cover the cost of the ad, or break even.
Step four
Work out the number of inquiries you need to break even. To do this you need to take your closing ratio – the number of people who buy your product after they’ve responded to your advertising. Let’s say it’s one out of every four people, or 25%. if you close one out of four people and you need sell 20 products to break even, then your $1,000 advertisement needs to generate 80 leads.
While it may sound a little complicated, it’s actually quite simple. All I’ve done is used simple math to work out how (in this instance) a $1,000 advertisement needs to generate 80 inquiries to cover the amount you paid for it.
Of course, we’re all in business to make a profit so breaking even isn’t going to cut it, so let’s take it a step further.
Say, you want to double the money you invested in your advertising. What happens to the numbers then? You have to double your inquiries. In this case, your advertising must generate 160 leads instead of 80 – 160 leads will generate a profit of $1,000. This is where it starts to get interesting because the return on your investment is now 100%. You have doubled your money.
But let’s take it even further. Let’s work out the lifetime value of one satisfied customer.
For arguments sake, let’s say that an average customer generates a profit of $50 per sale. Will that customer only ever buy from you that one time? I hope not. How many times will they come back in the course of say a year, and buy from you again?
Let’s say they buy from you once a month, and you make a profit of $50 every time they buy, your average customer makes you $600 a year.
And, if they continue to buy from you over the next two years, the $50 they spend a month is now worth $1,200. Three years and it’s worth $1,800, and so on.
Now, work out your profit using the numbers we calculated earlier – 80 inquiries and 20 sales. If you keep all 20 customers coming back once a month for three years, your $1,000 advertising spend has generated you a profit of $36,000.
And, if every $1,000 advertisement generates the same return on investment ($36,000) your advertising has paid for itself many time over, and generated you a huge profit.
So, now do you think that advertising costs too much? I doubt it.
Go ahead, work out your numbers!
A word of caution
When calculating your figures, calculate on the low side. Then you’ll still do OK if your results are lower than you expected. And, if you do better than you thought… well you’ll get that dream vacation you’ve been promising yourself!
Julia Hyde
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