As someone who’s been working in the marketing industry for over 15 years, I’m always surprised by how many small business owners don’t know their cost per lead and cost per sale. Cost per lead and cost per sale are two of the most important metrics that a business can have in its possession. Without them, it’s impossible to tell whether you’re falling into a profitable business model.
Contrary to what most people assume, more leads isn’t always a good thing. If you’re paying too much per lead or you’re not profiting enough from your sales, you’re going to run into some major problems. It’s hard to sustain a business that’s not generating enough profit. Calculating and monitoring these metrics will help you determine what you need to adjust in order to continue to run and grow your business.
In this article, we’ll explain what these two metrics are, how to calculate them, and how to use them to improve your business model.
A Basic Guide for Understanding Cost Per Lead & Cost Per Sale
No matter what you’re selling, there’s inherently a cost per lead and a cost per sale. Even if you’re just making an educated guess on how many leads and sales dollars you generate and coming up with an estimate, these are important metrics to have. You need to know how much money you’re spending in order to calculate your gross profit, or how much money your business actually makes each year after expenses.
Understanding your gross profit is crucial to analyzing your company’s financial performance. Every business must generate a substantial gross profit in order to survive. Knowing your cost per lead and cost per sale ultimately helps you figure out whether your current business model is sustainable for the long term.
Now that you understand their importance, let’s take a closer look at each metric.
What Is Cost Per Lead?
Cost per lead is essentially the amount of money you spend on marketing to obtain a lead. Knowing your cost per lead helps you understand if your campaigns are working and how effective they are.
How to Calculate CPL
In order to calculate your cost per lead, you need to know your entire marketing budget for a year. Once you have that number, subtract any marketing expenses that are used for building long-term brand equity and other expenses that aren’t designed to generate sales. Then, take that number and divide it by the number of leads you generate each year.
Cost Per Lead = (Annual Marketing Budget – Qualifying Expenses) / Number of Leads Generated Each Year
What Is Cost Per Sale?
Cost per lead is extrapolated from cost per lead. Essentially, it’s how many leads it takes to generate one sale.
Why It Matters
Many times, inexperienced or new business owners take no time to understand their cost per lead and cost per sale. They think that as long as money is coming through the door, it’s good money. Meanwhile, they’re paying an extravagant amount of money for that lead and they’re barely making any money off the sale. They have to generate three to four times the number of sales they would need to if their CPS and CPL were lower just to stay in business. Essentially, they’re working much harder than they should.
How to Use these Metrics to Improve Your Business Model
If you know your cost per lead and cost per sale, you can calculate the margin you’re making on your sales. This will help you determine whether your business model is sustainable. While all markets vary, profit margins generally fall between 5% to 20%. 10% is about average, and anywhere above is considered to be very good.
Once you understand your cost per lead and cost per sale, you can work on ways to increase your profit margin. This could include reducing costs, increasing sales, or raising your prices. For example, if your margin is 20% and you’re able to increase the sale price of your total product by 10% then you’ve probably just increased your profit margin by 50%.
The bottom line is, knowing these figures can help you figure out some simple adjustments that can vastly improve your business model.
— Nick Woodward, Transcending Strategy Founder & Owner
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