A Simple Explanation of the Math Behind 7 Common Marketing Metrics
A Simple Explanation of the Math Behind 7 Common Marketing Metrics:from HubSpot's Inbound Internet Marketing Blog
There's this misconception that marketers don't know how to do math. Instead of debating whether there's any validity to that statement (because that debate is ridiculous), let's help any marketers out there that aren't confident in their math skills. How? I figured we could start by explaining the math behind some common metrics we use every day -- or at least every month.
Whatever career path you choose in the marketing world, it'll do you a world of good to have an understanding of and level of comfort with the math behind the metrics you cite every month. These metrics allow you to assess the health of your marketing team, and show a more tangible impact of your team's activities. Armed with this information, you'll be able to make better decisions in long-term strategy, planning, and budgeting of your team, and walk into any presentation with the CMO or CEO and talk to these numbers with confidence. (Hint: We know the C-Suite cares about numbers like these because our own CMO Mike Volpe told us so in this blog post, "The 6 Marketing Metrics Your CEO Actually Cares About.")
A Note About These Metrics
Before we dive into explaining these metrics and the math behind them, I’d first just like to say that there is no one, best way to calculate these formulas -- any MBA you know will tell you that. Based on your specific business and the industry you operate in, you may want to tweak these formulas to better represent the conclusions you’re after. The metrics I’ve handpicked below are accepted, time-tested formulas in the marketing world, and a good place to start from.It's paramount you and your team are consistently using the same formulas for any metrics you're tracking across your organization. If your company has already been calculating and recording a metric with historical data, be sure to research what the exact formula is that they are using to measure, so everyone measures the same way.
Marketing ROI
Return on Investment is one of the most important metrics for marketers to be aware of. After all, we need to know how the effort and dollars we’re putting into our marketing campaigns is affecting our bottom line.There is common debate about whether marketers should use sales revenue or gross profit (also called gross margin) as the structure for calculating their ROI. Traditionally, ROI can be calculated as:
Investment
First let’s talk about vanilla ROI. ROI is calculated as:
Investment
Investment
Let’s take an example. Let’s say over the past 6 months Rubber Ducky Factory Inc. has spent $5,000 on freelance writers for blog posts. These posts brought in 150 leads, converting at a rate of 10%, generating 15 customers. These 15 customers had an average order size of 800 rubber ducks. Our rubber ducks have a COGS of $1 each, and sell for $2.50.
(15 orders * 800 rubber ducks * $2.50/duck) - (800 rubber ducks * $1/duck) = $29,200.00
($31,200.00 - $5,000.00) / $5,000.00 = 484%
(Tip: You may also calculate Gross Profit as Gross Revenue * Profit Margin = Gross Profit)
Marketing Expense to Revenue
Marketing Expense to Revenue is a similar metric to Marketing ROI, but provides a different perspective. For this metric, we are going to focus on total marketing expenses, including salaries of the marketing employees. This metric shows you how much you're spending on marketing compared to how much revenue is generated by the company. This metric is for a Marketing Manager or Director's perspective to see the overall allocation of their department in respect to overall revenue generated.Marketing Expense to Revenue is calculated as follows:
$ Revenue Generated
$1.4 million
Customer Acquisition Cost (CAC)
This metric is also known as Cost of Customer Acquisition (CoCA). There are a variety of ways to calculate CAC. It is best to split up CAC by channel, so you can clearly see the direct costs of acquiring a customer from each of the channels your company focuses on.Number of New Customers
As an example, let’s say we spent $450,000 between our sales and marketing teams last quarter, and we acquired 45 new customers. This would calculate to a CAC of:
45 customers
CAC is an important metric to have. It serves as a base for the next two metrics we will cover that are critical for a business to know: Time to Pay Back CAC and LTV:CAC.
Time to Pay Back CAC
Time to Pay Back CAC is a metric that tells you the number of months it takes your company to earn back the CAC you spent to get a new customer.In businesses where customers pay one time upfront, this metric is not necessary as it should be 0, i.e. the customer’s upfront payment is greater than CAC. Otherwise you are losing money on every customer.
However, in businesses where customers pay a monthly or annual fee, it is best to aim for Payback Time to be under 12 months. This means that if you break even on a customer after 12 months, from then on you start making money from the customer.
Here’s how to calculate Time to Pay Back CAC:
(Revenue Per Month for Avg. Customer - Expenses Per Month for Avg. Customer)
Let’s use our $10,000 CAC figure from the last example, and calculate our Time to Pay Back CAC. Let’s also say our average customer has a monthly revenue of $1,200 per month, costing us $250 per month in COGS and $300 per month of a combination of technical support and training, totaling $550 in Expenses Per Month for the Average Customer.
($1,200 - $250)
If you're running a business where customers pay monthly or yearly, it's critical to evaluate your churn rate. If your average customer sticks around less than your Time to Pay Back CAC, you’re in trouble because if you’re not yet operating at a loss, you will be soon. Two strategic ways to approach this is to reduce your CAC, or increase the average number of months a customer sticks around. You may also look into increasing the price of your product, or decrease expenses associated with an average customer.
LTV:CAC
LTV:CAC is another important metric to calculate for your business. Calculating LTV (Life Time Value) is a lengthy and industry-specific process that calls for an entire post on its own, so I won’t get into it today; I'd recommend you talk to those MBA friends of yours, or someone working in Finance of Operations within your organization, if you're curious about the ways LTV can be calculated. However, I’d like to just briefly mention the importance of your LTV:CAC ratio.Calculating LTV:CAC is as simple as it sounds:
Customer Acquisition Cost (CAC)
Average Lead Close Rate
Average Lead Close Rate evaluates the health of your funnel, all the way from the top to the bottom. No business has a perfect funnel, and it's important to look at your funnel on a consistent basis to encourage activities that will nudge it in the right direction.For a given month, calculating Average Lead Close Rate is:
Leads in a Given Month
As an example, let’s say we had 3,000 leads in February, which converted to 25 customers:
3,000 leads
For companies with a long sales cycle (6+ months), this metric can become unreliable. This is due to the fact that if you were generating 100 leads per month a year ago and 10 of those leads closed today, but today you're receiving 1000 leads per month, the close rate looks like 1%, but it's really closer to 10%. Fortunately, closed-loop marketing software allows you to track lead close rates based on the month they were generated.
Net Promoter Score (NPS)
What is Net Promoter Score? I’m glad you asked. NPS is a customer loyalty metric developed by Fred Reichheld, commonly used in customer satisfaction research. Many organizations, including HubSpot, use Net Promoter Score to assess the happiness of their customers.We send an NPS survey to a group of randomly selected customers every quarter to benchmark our relationship with our customers. In its simplest form, an NPS survey simply asks: How likely is it that you would recommend [Our Company] to a friend or colleague?
The responses are divided as follows: Customers who answer 0-6 are “Detractors”, 7-8 are “Passives,” and 9-10 are “Promoters.” The goal is to maximize the number of customers who are Promoters in our company.
Armed with these numbers, NPS is simply calculated as:
There are several criticisms about Net Promoter Score being used as a customer loyalty metric. Most criticisms revolve around it being used as a be-all metric for customer satisfaction and loyalty. In my opinion, NPS is used as a snapshot into your customers’ thoughts about your company, and the products or services it provides. It should not be the sole metric that your entire company revolves around to determine your customers’ opinions of your business, but is a great way to assess how you're faring if you monitor the metric continually.
Do you calculate or interpret any of these metrics differently? What are other marketing metrics that you use that you wish you had a better mathematical understanding of?
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