Understanding CPA
CPA (Cost Per Acquisition) is the average cost of acquiring a customer. Variations of this exist and it is important for marketing teams to be aligned on what they are referring to. CPA is mostly used within a specific digital marketing channel at a campaign level. In this context CPA actually often refers to the cost per tracked conversion within an ad platform such as Meta Ads. It can be used at account, campaign or even ad level.
It is important to differentiate between CPA in ad platforms and a blended CPA. This is calculated as the total customers acquired divided by the total ad spend (blended ad spend) across all paid marketing. This is often referred to as CAC (customer acquisition cost). It is important to note that these metrics are looking at customers acquired and not total orders. Many brand owners will use the terms incorrectly when they are actually referring to CPO (Cost per order).
How To Establish Your Target CAC
To establish your target CPA you should follow the following steps:.
Calculate your margin on an average order. To do this you ideally have a large sample of representative orders on your store. If not you will need to work of assumptions based on your product price points
Start from your net average order value (AOV excluding VAT)
Subtract your average costs of selling (COGS, shipping, platform fees, anything else incurred as a direct result of fulfilling orders)
This gives you your CM2 (Contribution margin 2 or how much profit you have after fulfilling an order)
This CM2 margin is your breakeven CPO. If you spend this much to acquire an order you will make no profit and no loss.
The last step is to apply a multiplier to this CM2 based on the repeat purchase rate you expect from an acquired customer. If you have LTV or cohort anaylsis data that can provide an accurate multiplier of how much more revenue and margin your customers drive beyond an initial purchase use this. Otherwise if your product is unlikely to be purchased multiple times you should stick with CM2. If you are a subscription or high repeat business such as fashion or beauty you can assume a higher multiplier. Research LTV (lifetime value) metrics from competitors and other companies in your industry for more accuracy.
Once you have followed these steps you will know your breakeven CAC. How much you can afford to spend to acquire a new customer to breakeven after x months based on their LTV and repeat purchases over x months/years.
But for a business to be viable, it needs to be making profit on the customers it acquires, not just breaking even.
How Much Profit To Build Into Your Target CPA
The profit you will make will be the difference between your actual CAC and the margin you make on an acquired customer.
Some startups aim to acquire customers and sacrifice profit at the expense of volume. This is to allow them to achieve a scale at which costs can be reduced and better margins can then allow it to improve profitability in the future. In the process their growth can be leveraged to obtain funding and provide the cash to fuel the initial unprofitable growth.
This may take some modelling of different scenarios as the absolute profit you make will be a result not just of profit per order but also the volume of orders. In an ideal world you can acquire customers at the lowest CPA possible or even without any marketing spend at all.
However the reality is that to grow your business you need to balance margin per order and a target CPA which allows you to grow brand awareness and reach new customers.
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With VC funding and other key sources of startup funding have on the decline in recent years, knowing how to scale an e-commerce profitably has become increasingly valuable.
At Purpose Digital we have a track record of achieving just that for our clients. By establishing and understanding the unit economics of e-commerce businesses, we can make sure growth is controlled and achieved with cash flow and profit targets.
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