The starting point for any PPC campaign is crystal clear goals. Sit down and consider what you’re trying to achieve. In my experience many people answer this fundamental question with arbitrary goals like “generate leads” or “deliver a return”.

The issue with this is that when you start delivering leads, you have no idea how they translate into bottom line revenue.

You may be confident that leads with a $30 CPA are profitable but as you scale the CPA will rise (more on this in a minute). There’s a tipping point where revenue will plateau and decline as the CPA increases.

In this article I will explain how to calculate your cost per acquisition (CPA) and a formula you can use to ensure you remain profitable.

What is CPA?

CPA (cost per acquisition) is the percentage CLV (customer lifetime value) you’re willing to sacrifice to gain new customers.

Simple example – You calculate that on average each new client generates $2000 in total revenue.

Giving up less of the CLV ($2000) means lower growth but higher profitability. And the adverse is true. A higher percentage towards your CPA means higher growth but less profitability.

Another important term is Max CPA. This is the maximum percentage of your CLV you can sacrifice before you lose money.

It’s important to calculate your max CPA and target CPA. There is more flexibility with your target CPA which I will discuss in a second.

The CPA Curve

A traditional CPA curve looks like the graph above. The more you scale (volume of conversions) the higher the CPA cost.

As the volume of conversions moves in a straight line, the cost per acquisition represents a hockey stick (not the good kind).

After a certain point the CPA will rise exponentially whereby any increase in conversion volume becomes more expensive. There is a finite number of conversions available at each CPA amount.

To give you a simple example. Let’s say you’re a time tracking SaaS company. It makes sense to run search campaigns targeting all the obvious lower funnel keywords. These could include,

• Time tracking software
• Time tracking tools
• Software to track employees

You find that you’re able to generate around 250 free trial users per month at an average $25 CPA.

That’s great. You know this is well below your max CPA so you want more! Unfortunately there is only a limited number of people searching for a product just like yours.

Because you want growth, you look for new keyword opportunities. You’ve exhausted all the obvious choices so you move to more mid funnel options such as,  

• How do I track my time
• Workplace efficiency tools
• Time tracking spreadsheet

These users may be interested in your software but they’re in a different stage of the funnel. They know they have a problem but they’re still researching solutions.

You may find these new keywords generate an additional 100 trial users per month but the average CPA is twice as much at $50.

As you scale your PPC campaigns you’ll find the CPA increases. This fundamental marketing principle requires that you calculate the CPA tipping point. whereby additional volume has no upside to the business.

How to calculate your CPA

The most important metric you will need to reverse engineer your CPA is CLV (customer lifetime value). This is the average dollar amount each client generates over the lifespan of the relationship.

You can calculate this number in many ways depending on your business model. Let’s keep things simple for now.

Example 1 – Your customers only make 1 purchase with you.

Total revenue / total customers = CLV  

Example 2 – You’re a SaaS business and your customers pay monthly. You also must understand your churn rate (the percentage of customers who cancel each month) and the average monthly revenue per client.

(Average monthly revenue per client / Churn rate) = CLV

Let’s say $500 per month and a 10% churn rate. The calculation would look like this,

($500 / .1) = $5000 CLV

Now we have our CLV we need to calculate any fixed costs associated with each client. This could include website hosting, customer support, accounting, transaction costs. It will be difficult to work out these numbers but get as close as possible.

You work out that for each client on average you have fixed costs of $1000, leaving you with $4000.

20% of your CLV goes to fixed costs so your Max CPA is 80% ($4000).

We’ll discuss your target CPA in a second.

Funnel Steps

Another somewhat complicated but critical step in your calculation is the funnel in which users travel through to becoming a customer.

Using our SaaS example it’s common for potential customers to sign up for a free trial before they become a paying customer. If you know that 10% of free trial users convert into paying customers you factor this into your calculations.

Example – Max CPA = $4000 X 0.1 = $40

Your Max CPA for a free trial user is $40.

This same principle can apply to all funnel steps. Maybe you’re promoting a white paper download to bring value to potential clients. You know that 2% of people that download the white paper will convert into a paid customer. Use the same free trial calculation to arrive at your max white paper download CPA.

User funnels are often far more complicated than this. It’s difficult to calculate these numbers without a decent amount of data. The conversion rates also fluctuate. Although not an exact science using your best estimates will put you way ahead of most advertisers.

Growth VS Profitability

Following on from the above where we calculated our $4000 Max CPA. We know we can spend between $1 & $3999 to gain a new client and remain profitable. The Target CPA you set depends on your growth strategy,

(CLV – fixed costs – CPA) = Profit

As we discussed earlier the higher the CPA the more conversions you can reach.

A critical calculation is to find the tipping point whereby more conversions (at a higher CPA) negatively affect bottom line revenue.

The above graph highlights this point. You can see that once the CPA exceeds $95 the bottom line revenue declines.

Here is the data set used to calculate this.

• Avg Monthly $ = The average monthly revenue per client.
• Lead > Client % = The conversion rate from the initial conversion to becoming a paid client. For example the percentage of free trial users to a paying client.
• Churn % =  The average percentage of clients who drop off each month.
• Fixed Cost = This could be rent, coffee or any other fixed costs you want to include to stay profitable.
• Cost per client = The average cost over the lifetime of each client relationship.
• Agency Fee = You can remove this if you’re managing campaigns in-house. We arbitrarily set the agency fees at 15% of spend or $1000 (whichever is higher)./span>
• Net = Your profit after all costs. Including ad spend, agency fees and fixed costs.

You can download a copy of the spreadsheet here and experiment with the numbers. I included “fixed cost” which you can include or bake into your “cost per client”, the decision is yours.

Putting it into practice

If you’ve taken the time to go through all the steps above you may think how can I predict the volume of conversions at each CPA amount? That’s a very fair question.

The numbers vary per industry. Attorney and mortgage related keywords can have incredibly high CPC’s (cost per click) with subsequently high CPA’s. Ultimately the market sets the price.

Wordstream published a Google ads benchmark report which sets the current average search CPA at $48.96. The B2B sector for search is $116. I’d take these numbers with a pinch of salt but at least it provides a rough starting point.

The only true way to predict is with real world testing. If you’re just starting out in PPC realise that it can take weeks or even months to find the sweet spot. I suggest you clearly understand your max CPA and start testing different channels. The Google Ads cost per acquisition may vary greatly compared to Linkedin.

Once you collect data, you will have some real numbers to benchmark. If you’re running brand campaigns we advise you to create separate goals and KPI’s.

Summary

If you read this far and followed along, well done. The hard part is putting it into practice. It can be especially difficult if you’re an agency like us and you’re relying on your customers to provide these numbers.

Don’t give up, push hard for them, in the end they will thank you for it.