The Arithmetic of Getting Leads

Published in Target Marketing

Every dollar invested in marketing must have a payback. Think of yourself as a marketing portfolio investment manager. For every dollar you spend, there must be a high return on investment.

 

Controlling marketing costs and generating the highest possible return on your marketing investment should be your driving motivation when you decide to create and manage a lead generation program.

 

Even though there are other good reasons why you go through the added hassle of two or more steps to generate, qualify, and convert leads to sales, the driving reason should be to generate the greatest return on marketing investment when you use a lead generation program.

 

You’ll likely use lead generation programs for one of two reasons:

1. You’re selling an expensive product and before you mail the expensive brochure, disc, videotape, or other marketing materials you need to make sure your prospect is truly a lead.
2. You have salespeople making sales calls and you help them utilize their time better, have a higher close rate and make more money by generating qualified leads for them.

 

Oversimplified lead generation measurement involves counting your leads and dividing them by the cost of the program to give you a cost per inquiry (CPI). But that doesn’t tell you the whole story. There are a host of other considerations, all which impact the arithmetic, such as:

• Cost to fulfill each inquiry. You must have a complete plan of action and materials to send to every inquiry. Remember, too, that when you produce volumes of leads you have to fulfill them. It won’t do you a nickel’s worth of good to generate "tire kickers", so factor in your added cost of generating worthless leads.
  
• Conversion rate. Whether the conversion comes from the expensive fulfillment package you have mailed or from a sales person, the percentage of conversions has a dramatic impact on your bottom line profits.
  
• Average purchase amount. If you use a sales force to sell products or services which can result in frequent purchases, the average sale per customer has a dramatic impact on what you can spend on marketing. Future purchases measured over a long-time basis add significantly to your profitability.
  
• Freebies or discounts. Are you including a free premium item? Discounted price? Other costs to acquire the sale?
  
• Sales call costs. Sales calls are expensive and can be $400 or more each. Reducing the number of calls to close the sale is a powerful reason to use lead generation programs.
  
• The second and all subsequent contacts. What happens when someone inquires about your product and you mail a fulfillment package but generate no response? Does that inquiry fall into a black hole never to be found again? Or do you contact them over and over until it doesn’t make financial sense to pursue that lead?

 

Establish Your Performance Objectives

Would you ever invest any of your personal money in a mutual fund or other investment vehicle without first examining its track record and knowing its performance potential? It’s always advisable to establish benchmarks to measure your program before you start. You will understand how much money you can invest in generating leads to meet your profit objectives when you create an Allowable Market Cost table.

 

Let’s examine Allowable Marketing Cost tables for two different lead generation programs.

1. A product sold directly to the end-user (no sales person is involved).
   
2. Generating leads for sales people.

 

Example One: Direct to the End-User

In the first example, an item sells for $1,500. Since most of us will require some convincing to part with $1,500, we need a lead generation program to acquire a list of qualified inquirers, mail an expensive fulfillment package to those inquiries, and convert a percentage of them to customers.

Table 1 outlines an Allowable Marketing Cost model to provide you a guideline for what your marketing program must generate in gross inquiries, and net converted buyers. Completing this table will help you determine how much you can invest, how the cost of your inquiry package, premiums, and other expenses impact the numbers, and it establishes benchmarks for what your marketing investment must produce to meet your objectives.

 

TABLE 1

Line	Item	Revenue or Cost	Percent Incidence	Revenue/ Cost Per Purchase
1	Average Product Sale	$1,500.00		$1,500.00
2	Shipping Revenue	$25.00		$1,525.00
3	Gross Sales	$1,525.00		$1,525.00
4	Returns		10%	$150.00
5	Returns Processing Cost	$50.00		$4.00
6	Net Sale Per Customer			$1,371.00
7	Cost of Goods Sold	$1,500.00	30%	$450.00
8	Shrinkage	$450.00	20%	$90.00
9	Order Processing-Initial Order	$5.00	100%	$5.00
10	Credit Card Bank Fee @ 4%	$1,371.00	80%	$43.87
11	Premium Cost	$25.00	100%	$25.00
12	Bad Debt	$1,371.00	2%	$27.42
13	Customer Service	$5.00	25%	$1.25
14	Overhead	$1,371.00	8%	$109.68
15	Shipping Expense	$17.00	100%	$17.00
16	Sub-Total Costs			$769.22
17	Cost Contingency	$769.22	10%	$76.92
18	Total Costs			$846.14
19	Inquiry Fulfillment Cost Each	$10.00
20	Inquiry Conversion Percentage		15%
21	Percentage Not Converted to Sale		85%
22	Total Inquiry Fulfillment Cost Absorbed per Customer			$56.67
23	Contribution to Marketing & Profit			$468.19
24	Profit Objective Before Taxes	$1,371.00	20%	$274.20
25	Allowable Marketing Cost per Customer			$193.99
26	Promotion Cost per Thousand (/M)	$700.00
27	Required No. Converted Orders/M			3.6
28	Required Conversion Response Percent			0.36%
29	Inquire Conversion Percentage			15%
30	Required Gross Inquired Response Percentage			2.41%

Line 6 provides us with the net sale per customer of $1,371.00, because returns are assumed at 10% and there are related costs to process every returned item.

Lines 7-17 have itemized assorted costs, such as the cost of goods (30% of the product selling price in this example), shrinkage (20% of returns), order processing, credit card fees, cost for a premium, bad debt, customer service, overhead, shipping expense, and a cost contingency for unplanned expenses.

On line 19, the assumed cost to fulfill each inquiry is $10.00. This assumes you have produced a high cost item for fulfillment such as a videotape and/or a very expensive brochure. Line 20 assumes that 15% of the leads who inquire will actually convert to purchase.

It also is recognized on line 21 that 85% of your inquiries did not convert to purchase, so on line 22, the full cost of inquiry fulfillment must be absorbed by those customers who bought from you. This cost is $56.67 per converted customer.

To illustrate how this cost was determined, if the fulfillment cost per inquiry is $10, and there were 100 inquiries, the total inquiry fulfillment cost would be $1,000. If 15% of those 100 inquiries converted to sale (15 buyers), the remaining $850 cost must be absorbed by those 15 buyers for a cost of $56.67 per buyer. This a cost often overlooked when creating lead generation programs. The cost of fulfillment for unconverted leads must be absorbed by converted leads.

In this example, the contribution to marketing costs and profit objective is $468.19 per customer (line 23).

Quick explanation of contribution: Hold a dollar bill in your hand. Fold back a section of it to pay the cost of goods. Fold back another section to pay for fulfillment. Fold back another section to pay for overhead. What’s left of your dollar bill is allocated to cover profit and marketing costs. Cost of goods, fulfillment and overhead tend to be fixed costs. The only variable costs and percentages you have flexibility changing in great measure are profit and marketing cost.

If your profit before tax objective is 20%, then you must take $274.20 from your contribution (line 24), leaving you an allowable marketing cost of $193.99 per customer (line 25).

Assume you are using direct mail to generate leads and your mailing costs are $700.00 per thousand. Based on an Allowable Marketing Cost of $193.99 per customer, you must generate 3.6 converted buyers per thousand mailed.

But you can’t stop here because you must factor in your conversion rate which increases the gross response you need to make your objectives. In this case, the planned conversion is 15% (line 19, and repeated on line 29). Now you must calculate the gross inquiry response rate, which in this case increases your required response to 2.41%.

Look at it another way: if you mailed 1,000 pieces of mail and 2.41% responded, you would have 24 inquiries. Of those 24 inquiries, 15% of them are 3.6 paid orders for a net converted response of .36% of the original 1,000 mailed.

Bottom line: To make this objective pretax profit of 20%, you must generate an inquiry response of 2.41% from your mailing, and 15% of those must convert into sales.

Let’s look at what happens when we change a few assumptions:

• If we leave our inquiry fulfillment cost at $10.00, but we increase our conversion from 15 to 20%, our required gross response drops from 2.4% to 1.6%. A significant drop.
• If we reduce our mailing costs from $700.00 to $600.00 per thousand (leaving inquiry fulfillment at $10.00 and conversion at 15%), then our required gross response drops from 2.4% to 2.0%.

 

Clearly, costs must be kept under control. Creating and using an Allowable Marketing Cost model prior to your efforts will help you evaluate not only your costs and conversions, but your offer and pricing as well.

 

Example Two: Leads for Sales Force

In our second example, we’ll examine the dynamics of the numbers in another business where sales people are deployed and a lead generation program has been created to generate and qualify leads to make the sales people more productive.

 

Like the prior example, it is important to determine what must be generated in response. It’s also important to understand that when you introduce the element of a sales force (as compared to selling your product directly to your end-user), there are situations where you lose control of the numbers. Nevertheless, having benchmarks in place will help establish performance objectives.

 

In Table 2, there are many similarities to Table 1. But typically when a sales person is used to sell the product, it is because the product is more involved and the average purchase will be substantially higher. It’s also likely conversion rates will be higher.

 

The primary differences between Tables 1 and 2 are:

• In this example, we will factor a customer’s one-time purchase and long term value. For this example, we will assume the definition of long term is one year, and the customer could purchase four times during the year.
  
• Sales call costs have been factored into the total marketing cost

 

In lines 1-5, this model assumes there will be four purchase opportunities over the course of this one-year long-term purchase relationship. But it also assumes that not all customers will return to purchase a second time. In this example, it is assumed only 50% of the buyers return (line 2). Seventy-five percent of the 50% remaining purchase a third time (line 3), and 90% of those buying a third time will purchase a fourth time (line 4).

 

If we started with 100 customers, after one-year there would be 34 remaining customers with cumulative purchases of 221.2, or an average of 2.2 per starter.

 

This table also has an additional column to compare one-time purchases to long-term purchases. Column E reports results from a single purchase, whereas Column F reveals long-term results.

 

Since sales people are involved, we assume the average purchase to be $5,000. Many of the same types of costs from Table 1 are noted in Table 2 on lines 9-16, except those which do not apply in a traditional mail order situation. Like Table 1, inquiry fulfillment costs are calculated on lines 17-20. Conversion is assumed to be 15%, meaning that each inquiry has to absorb $66.67 in inquiry fulfillment costs.

 

Sales calls are assumed to cost $400 each, and its assumed it takes 4 sales calls to close the first order; 7 during the course of the first year relationship (lines 17-20). This leaves a contribution of $1,028.33 toward the first purchase, and $3,162.71 when spread over four purchases. After deducting the assumed 20% profit before tax, this leaves an allowable marketing cost of $38.33 for the first time purchase (line 26, column E), but justified to $972.33 (line 26, column F) if spread over a year’s worth of purchases.

 

With a cost of $700.00 per thousand by mail (line 27), a gross response of 12.1% is required for the first purchase (line 31 column E), or .48% (line 31, column F) over the course of the year.

 

Why the wide spread? Because once the customer is acquired, the cost to keep the customer is dramatically reduced. It’s no wonder you read a lot about long-term customer value and developing long-term customer relationships. These numbers prove long-term value is far more than theory.

 

TABLE 2

Line	Number of Purchase	Retention Percent	No. of Customers	Cumu- lative Purchases
1	First Purchase	100%	100	100
2	Second Purchase	50%	50	150
3	Third Purchase	75%	38	188
4	Fourth Purchase	90%	33	221
5	Avg. Purchases/ Customer			2.21
		Revenue or Cost	Percent Incidence	Rev. or Cost 1st Purchase	Long Term Rev. or Cost
6	Average Purchase	$5,000.00		$5,000.00	$11,062.50
7	Cancelled Orders		1%	$50.00	$110.63
8	Net Sales per Customer			$4,950.00	$10,951.88
9	Cost of Goods Sold (30% of Sales	$1,500.00	30%	$1,500.00	$3,318.75
10	Premium Cost	$25.00	100%	$25.00	$25.00
11	Customer Service	$25.00	100%	$25.00	$25.00
12	Overhead		8%	$400.00	$885.00
13	Delivery Expense	$100.00		$100.00	$221.25
14	Sub-Total Costs			$2,050.00	$4,475.00
15	Cost Contingency		10%	$205.00	$447.50
16	Total Costs			$2,255.00	$4,922.50
17	Inquiry Fulfillment Cost Each	$10.00
18	Inquiry Conversion Percentage		15%
19	Percentage Not Conveted to Sale		85%
20	Total Inquiry Fulfillment Cost Absorbed per Customer			$66.67	$66.67
21	Sales Call Cost	$400.00
22	No. Sales Required to Close First Sale		4	$1,600.00
23	No. Sales Calls Required Annually		7		$2,800.00
24	Contribution to Marketing & Profit			$1,028.33	$3,162.71
25	Profit Before Tax Objective		20%	$990.00	$2,190.38
26	Allowable Marketing Cost per Customer			$38.33	$972.33
27	Promotion Cost per Thousand (/M)	$700.00
28	Required No. Converted Orders/M			18.26	0.72
29	Required Conversion Response Percent			1.83%	0.07%
30	Sales Force Conversion Percent			15%	15%
31	Required Gross Inquired Response Percentage			12.17%	0.48%

Here are results if the assumptions are changed:

• If conversion is reduced from 15% to 12%, the gross inquiry response increases from 12.1% to 15.2%, and 0.46% to 0.60%.
  
• Conversely, if conversion can be increased from 15% to 20%, then response requirements decrease to 9.1% and 0.56%.
  
• If the number of sales calls can be reduced from 4 to 3 for the first sale, then your response requirements decrease from 12.1% to 1.06%. That’s right, from 12.1% to 1.06%. Imagine how your profits can increase if you can reduce sales calls by just one to close the deal!

 

Clearly, the dynamics of any one factor can have a dramatic impact on the profitability of your marketing program. That’s why if you think of yourself as a marketing investor, instead of a marketing spender, you’ll probably watch those dollars a little more closely. And, if you do your homework and develop an Allowable Marketing Cost Table, your marketing investment portfolio will likely look a lot better at the end of the year.