CAC, Sales Volume & Business Optimum. How to Set-Up the Ultimate Lead Generation Machine - Part 2

A comprehensive guide to help you take actions and optimize your Customer Acquisition Cost (CAC)

[This article is part of a group of 5 dedicated to provide an insightful guide to online lead generation: “How to Set-Up the Ultimate Lead Generation Machine?”. Part 1: What exactly is lead Generation?; Part 2: CAC, Sales Volume & Business Optimum; Part 3: Metrics, Metrics, TEAMS!; Part 4: Log, Build, Automate; Part 5: Arbitrage Tips & Tools]

In my previous article, I shared a brief yet complete introduction to what is lead generation is. This industry is big, much bigger than people usually think. Lead vendors, agencies and other lead-fueled companies run complex online to offline processes, where Customer Acquisition Cost (CAC) is king. At the end of the day, this industry is all about CAC analysis when it comes to business strategies and tactics implementation. Once you can compute and monitor your CAC, your main focus would then become “How do I optimize my funnel to increase my sales volume and decrease my CAC?”

Most content you will find online covers either how to optimize lead generation marketing campaigns or how to design well, converting website landing pages. But when doing my research, I could barely find any content on how to optimize post lead generation sales processes for instance. Not even mentioning the broader, more comprehensive picture of dealing with the lead generation funnel as a whole.

This article is too long to be shared in one piece, that’s why I decided to split it into 4 parts. Today I will cover:

• Why and How to define a clear business target for your lead generation efforts
• A visual way to look into the CAC formula: the CAC Matrix
• Understanding the interdependence between CAC and Sales Volume
• How to find your business optimum when facing lead generation optimization

OK, here we go!

1. Optimizing your Lead Generation Efforts - What is your Main Business Target?

Lead generation is a very powerful lever to feed your hungry sales team and drive more sales in a non e-commerce, non retail world. That’s the ultimate goal here: scale your business faster providing more sales to your growth strategy, every day, every week, every month. Marketing generates a steady, predictive, scalable high quality lead flow your sales reps are happy to handle. Leads that convert into sales at a cost-effective CAC. The perfect growth machine every VP is looking for.

I know this may sound like wishful thinking. I’ll assume that this is where we want to aim for now.

Before deep-diving into more charts, data and formulas, let’s take a closer look at your business targets - optimize your lead generation funnel to increase sales volume AND decrease CAC. Some actions (optimizations) will by design drive sales volume up and cost down, as I will show later in this post. But generally speaking, hunting for both volume and price at the same time is hardly realistic, therefore it cannot be considered a rational business strategy. Why? Because even if sales and CAC are interdependent, they share no linear correlation, unfortunately.

This is true for many, many businesses. Price and Volume are almost never linearly correlated. Stock exchanges for instance share this pattern: most transactions are made just above or just under the current asset value. In regular operations, no one sells 50% off the market price, as no one buys 50% above. In either way, who would agree to lose that much money when there is a fair third party pricing (the current stock live quotation)? The same goes for the real estate market: all quality-similar houses in the same neighborhood have more or less the same price per square feet. It is true though that these two markets have something in common: they are auction-based.

On the contrary, manufacturing has a completely different approach to volume and price. Usually the more you order, the better price you get. There is a rational behind that: more volume means more manufacturing process optimization, i.e. more productivity gain, and thus a better margin rate for the manufacturer. Buyers feel entitled to ask for rebates because they know factories can afford to keep their margin rates steady if it means selling more products for them, and hence securing a higher profit margin in absolute value.

Optimizing lead generation is like working on a puzzle. One piece at a time.

The problem with lead generation is that one, there is no such thing as a transparent exchange available for you to be sure of the price you pay to generate one sale; and two, you are the factory. Optimizing your funnel in a very competitive and volatile market feels like climbing stairs up and down without taking a break. It is exhausting and frustrating. Productivity gain are not linear in this industry, they suddenly surge when you crack a piece of the puzzle. Lucky you!

Because Sales volume and CAC are not linearly correlated, you will shortly experience that setting too aggressive CAC targets to your team will end up lowering your sales volume. So, shooting for high sales volume objectives will mechanically increase your CAC.

This is why you have to choose which target you want to fight for first, higher Sales Volume or Lower CAC.

Focus your efforts and deploy iterative tactics to get the best out of your lead generation process in the long run. Start with Volume first, before considering any CAC optimization moves. Here is why:

2. Introducing the CAC Matrix

Remember the formula I shared in my previous article? CAC = PPL / Sales Rate. This one is so important I have it written down on the whiteboard behind my desk, so that I can take a look at it every morning coming to work!

Now that we have a very simple formula to compute and monitor CAC, optimizing it should be very easy, you may think. All we need is either to decrease our average PPL (Price Per Lead aka Cost Per Lead) or to increase Sales Rate to get better return. Nothing more. You would be right: playing with these two levers would trigger instant impact on your target. To put it in a very simple and visual way, we built the CAC Matrix shown below. We leverage this matrix during our business reviews with our partners to set the targets of our shared business plan.

In this example, let’s assume you have a business target for your average Customer Acquisition Cost of $600 (Target CAC). This is your sweet spot, everybody within your company is very happy with any number below or slightly superior to this target. You clearly in the “Ok let’s do more of this” momentum, the Scale Phase. Between $600 and $800 is where things start to get complicated. Results are still ok though because your brand is not losing money. But clearly, the campaign / the funnel you are responsible for is below business profit expectations (ROI, Margin Rate, ROAS etc.). It is time to optimize, and fast. You are in the Optimization Phase. Above $800 (Kill CAC) things just get really ugly. Your brand loses money on every single sale, everybody is unhappy, you start fearing for your job and you hate lead generation. This phase is not sustainable and will come to an end at some point if things never start trending in the right direction: this is the Kill Phase.

This is the second piece of advise to be found in this article, but probably the most important:

Take the time to define your Target CAC (which could evolve over time, as could your business strategy) but do not forget to closely look into your Kill CAC, the average cost per sales where you start losing money.

Kill CAC is directly linked to your average Gross Margin per sales (i.e. Revenue - COGS), as I explained in my previous article.

As you can see on the slide seen above, with the three different ranges of color coding, using the CAC Matrix is very helpful to discuss Sales Rates targets and PPL value based on the passed data you already gathered and the results you expect projecting the latest trends.

That said, there is something big that the CAC Matrix misses. To perfectly reflect reality the matrix should bear a 3rd dimension not visible here: the Volume dimension.

3. CAC vs Volume - The two Faces of the Same Coin.

CAC is a result, a metric you can compute at the very end of the process, made of two simple components.

If CAC is a result, then Sales Rate and PPL must have an impact on both Sales Volume and Cost. And no, it is not as simple as PPL => Price and Sales Rate => Volume. I wish it were. Let’s deep dive a little bit more to see what drives what, and more importantly how we can take advantage of our learnings.

A) The Sales Rate

What I find fascinating about Sales Rate, is that it shares a linear distribution with Sales Volume. The better your sales rate, the higher your sales volume. Simple, beautifully simple.

On the chart seen above, we consider a fixed amount of business opportunities (1,000 to be precise) against various sales rates. As you can see, the result is a straight line. Working on your Sales Rate is thus a very good way to improve your Sales Volume… AND decrease your CAC! Yes that’s right, for a fixed amount of business opportunities initiated by a fixed amount of marketing investment, your sales efficiency will drive better results for both sales volume and CAC. This is good news!

That said (and again, this is because of the CAC = PPL / Sales Rate formula), improving your sales rate will not decrease your CAC in a linear way… Mathematicians (and economists) name this the law of diminishing returns.

Conclusion: Sales Rate incremental improvements have a positive linear impact on Sales Volume, and a good yet decaying trend on CAC. Improving your Sales Rate is primarily a Volume lever with a positive impact on CAC.

B) The PPL (Price Per Lead)

On the other hand, PPL shares a linear distribution with CAC, but not with Sales Volume. This makes PPL a very powerful lever to instantly lower your CAC, with the risk of killing your sales volume! In two words PPL is: powerful & dangerous.

On the chart seen above, you can clearly see that (assuming a 5% steady Sales Rate over time) CAC is linearly distributed when playing with various PPL.

But what is the problem with Sales Volume then? Why isn’t it also linearly distributed? Let’s look into the three main channels you can get traffic from, and see how they interact with leads volume and thus sales volume:

Offline Marketing Channels such as events, which is a big driver of leads in B2B for instance. Your marketing team can choose to invest less in an event, by securing a smaller booth, sending sales reps as attendees and not as exhibitors, only paying for running a presentation etc. Impact on leads volume is always hard to predict, but one could argue that having a smaller/cheaper booth does not eventually lead to fewer conversations with attendees, i.e. fewer prospects logged into your CRM at the end of the show. Offline channels return on investment is hard to predict and rely on many different factors such as the quality of the audience, your sales team energy and motivation etc.

Online Organic (i.e. free) Marketing Channels: We are talking about SEO, SMO, Emailing, Webinars here. These channels are more predictable, but still volatile, hard to turn into a steady predictive lead flow. Your business relies on Google’s / Facebook’s / Linkedin’s and other’s organic algorithms which are hard to control in the long run. Who has never been part of a webinar with too few attendees, a drop in email open rate or experienced a sudden change in Google’s SEO algorithm?

Online Paid Marketing Channels: This is what I know best, for I have been creating, running and optimizing for more than 10 years now. The good thing here is that they are on/off channels. However to master it you have to understand the way paid media channels work: most of them have auction-based business models. Trying to decrease PPL usually means to decrease the Bids you place in your campaigns. Here is what happens when you do this:

This is the typical curve Google Bid Estimator will provide to help you estimate the volume of clicks you could get for any given bid (Cost Per Click). In this example, you see that lowering your Bid Price by -40% (from $2.5 to $1.75) should make you lose 90% of your expected Clicks Volume. Again, not a linear correlation. Because major paid marketing channels are so competitive now, all advertisers you are competing with pay their traffic with very similar bids. Lowering your bids will eventually turn off your visibility, generating close to zero clicks volume.

We will deep dive into the Lead Generation Funnel Key Metrics (and how to compute them) in my next article. For now, let’s use the PPL formula to highlight the correlation between Leads Volume and PPL:

Leads Volume = (Clicks x CPC) / PPL

Leveraging this formula, and again because of the CPC - clicks volume non linear correlation, you get a similar curve for leads volume vs PPL:

Assuming a steady over time sales rate, you can easily turn the leads volume numbers of the chart seen above into sales volume. The shape of the curve will be exactly the same.

Conclusion: PPL is a very powerful lever to decrease your CAC, but doing so usually has a huge negative impact on leads volume, i.e. at the end of the day on sales volume. To avoid this you will have to combine a PPL decrease strategy with other tactics that might counterbalance the loss of volume.

4. In Search of your Business Optimum

Another very important question I’ve been long thinking about is how to identify a business optimum? Meaning, if achieving your Target CAC were really easy, what value would you then choose, and why?

When it comes to building forecasts and business targets, most decision makers use an old-fashion, yet very popular, habit: Customer Acquisition Costs (or to simplify marketing) has to fit in some market practice ratio. Who never heard that 30% is a good ratio for your marketing cost when compared to your Revenue? But is this really true?

It’s true that I love to challenge habits and opinions, comparing them with research, facts and data. I love this so much that one of our 5 Corporate Values at Dolead is “Data wins Arguments” .

First things first: how should we define a “business optimum”?

A Business Optimum is the maximum amount of Sales you can generate at a CAC that maximizes your Gross Margin in absolute value.

Let’s take a simple example. What is best: generating 20 sales of $100 each with an 80% margin rate (i.e. you earn a total gross margin of $1,600) OR 80 sales of $100 each with a 20% margin rate (i.e. you earn a total gross margin of… $1,600). With both options you end up making the same Gross Margin. With the second one you are bigger, less at risk with volatility, but you have a more complex funnel to handle (more people, more technology etc.)

The real answer is that none of these two options are optimum. What if you could generate 50 sales of $100 each with a 50% gross margin? In this scenario you earn $2,500 in gross margin! Looks better right? (56% better to be precise). Maybe your business optimum is somewhere close to 50 sales per months.

What is true with this very simple example is also true when dealing with a very complex lead generation fueled business. Your gross margin optimum (some would name it ROAS, ROI, Profit Margin, whatever) is hard to spot, but did you ever try to find it?

Your Business Optimum is not a fixed percentage of your Revenue. The Optimum Target CAC you should use depends on your lead generation funnel optimization resulting in the shape of the curve of your sales volume per CAC. Because for online marketing campaigns your sales volume is indexed on marketplaces with highly competitive auctions, your Target CAC will vary over time.

Conclusion

Now that you have read this article, I hope you have a better understanding of how the 3 key metrics underlying the whole lead generation funnel interact with one another. PPL, CAC, and Sales Volumes are the corner stones of your lead generation strategy.

But there are many more sophisticated metrics to log and monitor that you will need to optimize your funnels. Lead Generation Key Metrics is the next stage you need to master. I will cover this in my next article. I hope you have enjoyed this, keep reading!

[This article is part of a group of 5 dedicated to provide an insightful guide to online lead generation: “How to Set-Up the Ultimate Lead Generation Machine?”. Part 1: What exactly is lead Generation?; Part 2: CAC, Sales Volume & Business Optimum; Part 3: Metrics, Metrics, TEAMS!; Part 4: Log, Build, Automate; Part 5: Arbitrage Tips & Tools]