Ultimately, here’s what you should think about when deciding how much you should spend on digital advertising:
- How much investment is needed in order to hit my revenue goals?
- What percentage of my marketing budget can I realistically afford to spend?
- What is the lifetime value (LTV) of my average customer?
- How well am I converting website visitors into leads, and leads into customers?
- How much money am I spending on each bid?
At the end of this post, you’ll know how to use historical data to determine how much money you need to spend to hit your business goals and how to optimize your efforts to get the most out of each advertising dollar. Sound good? Let’s jump in.
1. How much investment is needed to hit revenue goals?
So — where do you start?
Well, the primary goal for most businesses is to generate sustainable long-term revenue growth. That’s why, when determining how much to invest in digital advertising, you should work backward from your company’s revenue goals.
Working backward can help you determine how much revenue your digital ads are responsible for bringing in, which can inform how much investment you need to make that goal reality.
Here’s what this might look like:
It all starts at the top with your business goal, which is most likely to increase revenue. You’ll have many departments working together to achieve this overarching goal, including marketing, sales, and customer service. By taking a look at historical performance across your business, you can identify what percentage of revenue each department is able to deliver.
Within marketing, you’ll have multiple objectives that feed into marketing’s responsibility, including paid, owned, and earned objectives. You’ll launch a number of initiatives to support this business goal, including paid media campaigns.
To understand this concept, let’s walk through an example. Let’s say your business has the goal of increasing revenue by $100,000 this year. From historical performance, the business makes the marketing department responsible for 50% of this goal. Great — now, what initiatives are you going to launch to bring in that $50,000 revenue?
Well, digital ads are going to be only one of the many tactics you launch, all of which will need investment. Based on the historical performance of your ad campaigns, you know that you have an average $2.50 return on ad spend (ROAS). This means, for every $1 advertising dollar you invest, you make $2.50.
If you think that your other marketing campaigns on owned and earned channels can impact 75% of marketing’s overall goal, that leaves 25% for you to hit with ads, or $12,500. Divide this by your ROAS of $2.50 and you’ll find that you need to invest $5,000 throughout the year to hit your revenue goals.
2. What percentage of your marketing budget can you realistically afford to spend?
Now, do you actually have $5,000 to spend on your digital ads? If you do, then great — you can continue to sustain long-term revenue growth with your existing advertising strategy. But I wouldn’t be surprised if many of you simply don’t have the advertising dollars you need to make the impact you want.
Or, maybe you’re experimenting with digital advertising for the first time and don’t have historical data on ad spend and ROAS to inform your decision. What do you do then?
It’s a difficult question to answer honestly, but you need to ask yourself: “How much money do I actually have?” Take a look at your cash flow and profit to get a grasp on how much money is realistically available for digital advertising investment.
If you set a budget that you can’t afford, the long-term success of your campaigns, and sustainable growth, is doomed from the start. That’s why it’s important to start off with a budget that you’re comfortable with and can commit to in the long-run.
But don’t worry — even if you have a limited budget, that doesn’t mean you can’t use paid media as part of your greater marketing mix. Ultimately, before jumping right into ads, you want to further optimize other business metrics to get the most out of each and every advertising dollar.
3. What is the lifetime value (LTV) of your average customer?
Lifetime value is a prediction of the profit attributed to the entire future relationship with a customer. Simply put, LTV answers how much money you will make from a single customer over time.
To calculate LTV, take the average yearly revenue your average customer brings you and multiply it by the average lifespan of a customer.
For example, if your average customer pays you $500 a year, and stays with your company for six years, we can say the average lifetime value of a customer is $3,000. But let’s not forget how much it costs to service a customer. If you factor in that it costs you $50 to service that customer each year, or $300 over their entire lifetime as a customer, you can say the average lifetime value of your customers is $3,000 minus $300, or $2,700.
Now, the higher your lifetime value, the more money you can realistically spend to acquire a new customer. If you’re feeling strapped for advertising dollars, consider taking steps to increase your customer’s LTV.
There are a ton of best practices for increasing customer lifetime value which I won’t go into detail in this article. But to get you started, think about things like your business’s subscription and pricing models. Launching marketing initiatives to move the needle on LTV will, in turn, make your digital ads more successful and less costly.
4. How well are you converting website visitors into leads and leads into customers?
Now that you have an average lifetime value for your customers, you can work your way backward to see what your monthly advertising budget should be. We’re going to walk through this example focused on the value of a form conversion, but you can apply the same approach to whatever conversion points you’re optimizing your ads for.
You’ll want to consider two things to figure out your advertising budget:
- Your average conversion rate: The rate at which website visitors to your site convert on a form and become a lead.
- Your average lead-to-customer rate: The rate at which leads become paying customers.
Let’s say you run an IT Solutions company, and you want to advertise for your upcoming webinar on network security. You dig into the performance of your landing pages for past webinars and learn that you have a 7% webinar conversion rate and that your lead-to-customer rate is 10%. So if ten people sign up for your webinar, you can expect that one person will become a paying customer.
What are these numbers for your business? Are they lower than you’d like? If so, that means that your advertising dollars are not being spent as efficiently as they could. To increase your landing page conversion rate, consider testing your calls-to-action and adding social proofing.
And to convert more leads into customers, you could use email automation to nurture your potential customers towards making a purchase. There’s a lot you can do here, but for the purpose of this exercise, just know that if you have low conversion rates, pouring more money into your underperforming ads isn’t the best use of your resources.
5. How much money are you spending on each bid?
To make the most of your ad spend, you want to bid less than your expected return. LTV, conversion rate, and lead-to-customer rate can be used to determine what your maximum bid should be using this equation.
Maximum Ad Spend = LTV x Conversion Rate x Lead-to-Customer Rate
Let’s jump back to our webinar example to see this in action. If you divide one new customer by your lead-to-customer rate, you’ll see that we need 10 webinar signups to yield one new customer.
Next, divide the number of webinar signups we need by the average conversion rate. Using our 7% webinar conversion rate, we find that you need roughly 143 clicks on your ad to generate one new customer. If that customer is worth $2,700 to you, we can start to calculate how much you should spend per click on your ads.
If we ignored all the other costs of acquiring a new customer, then your break-even bid would be your customer lifetime value, divided by 143, the number of clicks you need to generate one new customer. This means you could bid $19 per click on your ad and break even.
Follow this process for your previous ad campaigns. Were you bidding too much? If you were, then that means that your advertising budget wasn’t being used effectively to reach your revenue goals.
Improving your ad copy, keyword strategy, targeting, and more all play a role in how much you’re spending. Here’s another helpful blog post to learn how to optimize your digital advertising costs.
Reevaluate Spend to Maximize Impact
Your advertising budget should bend and flex to meet the evolving demands of your business over time. Taking an experimental mindset when reevaluating your spend will help you identify the most profitable initiatives in your strategy and adjust the way that you budget.
Additionally, it’s important to keep in mind that there are plenty of free, organic-driven opportunities to increase brand awareness and sales on social media. If you’re strapped for cash but want to use social media for business growth, take a look at our Social Media Marketing: The Ultimate Guide for free alternatives.
Lastly, a word of advice: I’d recommend reevaluating your spend no more than on a quarterly basis. That way, your campaigns will have enough time to bring in reliable results, but you’ll still have enough time to adjust your investment accordingly to meet your end-of-year goals.
If you or your team want to level up their digital advertising know-how, check out this free Ads Training Course to learn today’s best practices for succeeding with digital ads on search engines and social media.
Editor’s note: This post was originally published in April 2020 and has been updated for comprehensiveness.
Originally published May 11, 2020 7:00:00 AM, updated May 11 2020