When it comes to running paid ads to grow your ecommerce business, understanding key performance indicators (KPIs) is essential. These metrics help you understand the effectiveness of your paid advertising, optimize your spending, and ensure long-term profitability.
Here are 5 critical metrics every DTC brand owner and marketer should be familiar with:
1. Contribution Margin (CM)
What It Is:
Contribution Margin (CM) is the amount of money left over from sales after covering all variable costs. For better accuracy use CM3 which also includes fulfillment costs and paid advertising spend. This metric helps you understand the profitability of your products before fixed costs are accounted for.
Why It Matters:
A higher CM means more money is available to cover fixed costs and generate profit. While a CM closer to 100% is ideal, most businesses realistically aim for a range between 20% to 50%.
How to Calculate:
Contribution Margin 3 = (Net Sales – COGS-Fulfillment costs-Advertising costs) / Net sales
Example:
If your net sales are $100, and your variable costs are $60, then your CM is 40%. This means that 40% of your net sales are contributing to covering fixed costs and profit.
2. Customer Acquisition Cost (CAC)
What It Is:
CAC measures the total cost of acquiring a new customer. It includes all marketing and sales expenses.
Why It Matters:
Keeping your CAC lower than your Customer Lifetime Value (CLTV) is crucial for profitability. A lower CAC means you are acquiring customers efficiently and maximizing your return on investment (ROI).
How to Calculate:
CAC = Total marketing and sales costs / Number of new customers acquired
Example:
If you spend $10,000 on marketing and acquire 200 new customers, your CAC is $50. This tells you how much each new customer costs in terms of marketing expenditure.
3. First Purchase Profitability (FPP)
What It Is:
FPP measures whether you are making a profit or loss on the first transaction with a new customer. It’s a crucial metric for understanding the immediate financial impact of your customer acquisition efforts.
Why It Matters:
Achieving profitability on the first purchase is vital for healthy growth. It reduces the financial risk and reliance on future purchases to recoup acquisition costs.
How to Calculate:
FPP = Revenue from first purchase – Cost of goods sold (COGS) – Customer acquisition cost (CAC)
Example:
If the revenue from the first purchase is $100, the COGS is $40, and the CAC is $30, your FPP is $30. This indicates a profit on the first transaction, making your initial investment in acquiring that customer worthwhile.
4. Customer Lifetime Value (CLTV)
What It Is:
CLTV is the total revenue you can expect from a single customer throughout their relationship with your business. It helps you understand the long-term value of your customers.
Why It Matters:
Increasing your CLTV gives you more flexibility with your ad spend, allowing you to invest more in customer acquisition while maintaining profitability. A higher CLTV means that each customer brings more value to your business over time.
How to Calculate:
CLTV = Average value of a sale × Number of repeat transactions × Average retention time
Example:
If the average sale value is $50, customers make an average of 4 purchases, and they stay with your brand for 2 years, your CLTV is $400. This metric indicates the long-term revenue potential of each customer.
5. Product Margin
What It Is:
Product Margin measures the profitability of a product. It’s crucial to understand how much you can afford to spend on advertising for each product and how much discount you can offer.
Why It Matters:
A healthy product margin (typically above 30%) ensures that your business can run profitable paid ads and absorb marketing costs without eroding profits. It also helps in pricing strategies and promotional decisions.
How to Calculate:
Product Margin = (Selling price per unit – COGS per unit) / Selling price per unit
Example:
If the selling price of your product is $100 and the COGS is $70, your product margin is 30%. This means you have a 30% margin to cover fixed costs, advertising, and generate profit.
Conclusion
Understanding these five business metrics — Contribution Margin, Customer Acquisition Cost, First Purchase Profitability, Customer Lifetime Value, and Product Margin — is fundamental for any DTC brand looking to invest in paid advertising. These paid advertising KPIs provide a clear picture of your financial health and guide strategic decisions to ensure your advertising efforts are profitable and sustainable. By mastering these metrics, you can optimize your ad spend, improve your ROI, and drive long-term growth for your brand.
Optimize your paid advertising strategy by focusing on these essential metrics, and watch your business grow sustainably and profitably.
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