Blog 2
Apr 28

CPA vs. LTV: Which Model is Right for Your Business

If you want to sell anything, there’s a place to do that online: your website. But, to get people to your website to buy, you need to market it to your target buyer. That part’s obvious. How you market it, and more importantly, how much you spend marketing it, is a little less clear.

Understanding how much to spend on acquiring each customer should be easier in the digital world. After all, you have all the data at your fingertips ready to be analyzed so you can optimize your spending. Just one look at the numbers and you can see where you’re getting the best return and where you should stop investing, right? Not quite.

There are two basic marketing models for e-commerce that you must consider when choosing how much and where to market your products: Cost-Per-Acquisition (CPA) and Lifetime Value (LTV).

You’ve likely heard about each of these models before, but how well do you understand the difference? How well can you distinguish which model is right for your business? Knowing the answers to these questions is key.

Which E-Commerce Marketing Model is Right for Your Business?

Understanding which e-commerce marketing model is right for your business is surprisingly simple: You just need to understand how your customer buys.To determine which model is right for your business, you need to look at your buyer’s journey. Do your customers tend to go in a cycle, making repeat purchases from you?

To determine which model is right for your business, you need to look at your buyer’s journey. Do your customers tend to go in a cycle, making repeat purchases from you?

Screenshot taken on the Kissmetrics blog May 2017

Or does your customer take a more linear approach? In other words, do you sell a one-and-done type of product, where most customers will only buy once from you, or rarely?

Screenshot taken on May 2017

The answer to this question is relatively straightforward. If you sell cosmetics (a consumable product), your buyers will need to continue making purchases from you for as long as they choose to apply make up. However, if you sell furniture, chances are your customers are only filling their home once and don’t need to frequently return to your e-commerce store.

With your buyer’s journey in mind, you can determine whether CPA or LTV is right for your business. Let’s take a closer look at each to help you uncover the answer.

Cost Per Acquisition

CPA is most often used for one-time sales. That’s because, if you use the CPA e-commerce marketing model, your product must be profitable on the first sale. You cannot rely on future income to make up for the cost it takes to bring the customer to your e-commerce store.
This goes beyond looking at profit margins. You must look at the bigger picture to understand if you’re truly profitable with each sale.

Download Our Ecommerce Profitability Calculator

A CPA Case Study

To clarify why, consider the case of a store that sells patio furniture via the website. The store might have a table priced at $1,000 and a profit margin of 35%. That means for each sale, they profit $350.

Now consider the marketing side of things. To know if the furniture store can be profitable on the first sale, you must also know how much it costs them to bring the customer into the store and to the point of purchase. If the average cost per click is $5 and the conversion rate is 4%, their CPA is $125.

Now, subtract that cost from the profit margin to get the return on investment for each sale. $350 in profits minus $125 in the cost it takes to acquire the customer means the furniture store is left with a gross profit of $225.

Why it Works

In the above scenario, we focused on making sure the average cost per click and projected conversion rates still left the store profitable. If they didn’t, we’d have to reevaluate how the store marketed online.

CPA is ideal for one time buyers because it means the store can be sustainable over the long run. It’s a model that lends itself to scaling based on attracting new buyers rather than building a loyal base of customers.

Lifetime Value

LTV focuses less on individual sale profitability and more on acquiring the customer, as well as getting them engaged with your brand. In other words, LTV focuses on how much the customer is estimated to be worth for the lifetime of them doing business with you. This approach leads to a greater lifetime value, which leads to more money that you can make with each sale.

There’s a natural time between when you acquire a customer until when you become profitable. At Digital Trax we call this “the float.” With LTV, you’ll be in the red for a period of time before you start becoming profitable.

Here’s an example of what “the float” could look like for you.

If you spent $10,000 on marketing and got back $8,000 in profits, you’d still be down $2,000 dollars, right? Over the next three months, however, the same cohort of customers that brought you the $8,000 of profit return to bring you another $5,000 of profit. Your initial $10,000 investment actually yielded a $3,000 profit over an extended period.

In this model, you don’t have to worry about breaking even or profiting off the very first sale. You can float your money over several months with the expectation that you’ll soon get it back from repeat business. Up front your marketing will cost more than you’ll profit, but as long as the average customer brings in enough profits over their lifetime with your business, you’ll have a profitable, scalable company.

Download Our Ecommerce Profitability Calculator

Your Buyer’s Journey Determines Your Marketing Model

As with most things in the marketing world, your buyer is in charge. Let their journey from discovering your business to pulling out their credit card (sometimes multiple times) determine how you market your product.

If you’re taking the LTV approach, you can be more aggressive on the front end knowing the lifetime sales will make you profitable on the backend. If you need to take a CPA approach to how you market your product, you’ll need to use more discretion when it comes to how and where you promote yourself.

With the right marketing model in mind, you can bring in more sales and bigger profits.