Dissecting Cost of Customer Acquisition

Revenue alone is not a good indicator of a successful e-commerce business. Spending all the money on acquiring new traffic in the hope of getting more revenues is a bad idea. Bessemer Venture Partners (BVP) came out with this revolutionary white paper (PDF) on the ten laws of e-commerce. This is more relevant today than it ever was when a lot of e-commerce businesses are closing down or finding that the investment money is drying up quickly.

One of they key ideas the white paper talks about is that an e-commerce business is in a good shape if its customer lifetime contribution (CLTC) i.e. the total money a customer spent in the store is greater than 2.5 times the cost of acquisition of the customer (CAC) i.e. the total money spent on get the person to buy in the store. The whole idea is to make sure that every customer you get spends much more than what you spend in acquiring her.

While lifetime contribution is easier to understand, the cost of customer acquisition is not so straightforward. There are a number of factors that impact the cost. Its important to understand all these factors and make sure you monitor them regularly. Otherwise, you may be wasting a lot of money or worse yet, computing your cost of customer acquisition wrongly and feeling a wrong sense of security.

In this post, lets look at 5 factors that have a direct impact on your cost of customer acquisition. Some of these may be obvious, while others, not so obvious.

Pay Per Click ads

PPC ads add an obvious cost to acquire customers. While PPC ads are quite well known and widely used, its impact on cost of acquisition, at times, can be underestimated. The key to working out how much money you might end up spending is to understand the funnel effect. While the cost per click on itself may seem inexpensive, when you take the funnel into account, the cost could prove very high.

For example, lets say you are running a $1 per click PPC campaign. Lets say your bounce rate from PPC is about 50% and that your overall conversion is about 1%.

This means you need 100 visitors for 1 customer and 200 clicks to get 100 visitors. That essentially translates into $200 per customer. While $1 per click doesn’t sound expensive, $200 per customer acquisition is definitely not cheap.
So, it is essential for you to understand your funnel and then compute the PPC cost per customer. Paying close attention to bounce rates, landing page optimization, improving conversion rates etc. are key to bring the cost of PPC down.

Sales & Discounts

Its a common practice to offer a coupon or a sale to drive more sales. While there is a popular theory that discounts undermine your store, it could be a great way to close more sales if done right. However going overboard with offering discounts could add a lot of cost to acquire customers.
For example, lets say you offer a 10% discount to all your visitors. If the average size of an order on your store is $50, you are incurring an additional $5 cost for customer acquisition.
This might especially be wasteful if you are giving a coupon to everyone without any sort of targeting. Stores should definitely look into offering promotions without hurting profit margins.

Per transaction costs

Payment gateways and e-commerce hosting providers usually end up taking a cut on every transaction. This is typically in the range of 1% to 4%. This means for every customer, you end up incurring some cost because of your hosting or the secured payment options.
While there are no easy ways of reducing this, figuring out a provider who has better deals for bulk transactions or has a subscription model might be the right way to go.

Cost of support

This is not a direct per customer cost, but it can definitely add a big overhead. Based on how many customers you have you can end up with anything from one person handling email support to a full blown call center support. Even if its just one person handling email support, there is still some time spent on doing this.
Be sure to track closely how much time is being spent on providing order tracking, shipping queries, returns/exchanges etc.

Cost of tools

There are a plethora of tools that are available for e-commerce. Live chat, analytics and behavioral targeting, feedback, survey, email marketing – there are a lot of tools in pretty much every aspect of e-commerce. While most of these tools have a free plan, you may typically end up paying for a few of them. You may not use all of them but a good number of them add a lot of value and you should definitely explore your options and use tools that make sense.

The reason this adds up to cost of acquisition is because you use these tools to either drive more traffic, influence visitors to buy or to convert visitors into customers.

Most of these tools may not add value across the board. So, its important to closely measure how much value did each of them add and compute the return on investment properly.

Summary

Depending upon the kind of products you sell at your store, there could be other things that contribute to the cost of acquiring customers. In order to figure out how successful your e-commerce business is, it is very important to get a very good understanding of every factor that adds up to your cost. Being diligent about measuring these regularly is the key to figuring out what costs to cut down and reduce the cost of customer acquisition.

By Suresh Harikrishnan, Founder/CEO, NudgeSpot.

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