Before you even begin to think about the detailed techniques of performance marketing and selling your product or service directly – the market, the design of the material, the method of order fulfillment – you must look at the most important aspect first: the basic mathematics, the vital formula.

The first factor in the performance marketing equation is the value of a conversion or the margin per order or per dollar turnover. The basic question you have to ask is:

What is an extra order or an extra dollar turnover worth to you after cost of manufacture, direct overheads and cost of distribution, debt collection (if you are into bill-me-later or postpaid schemes) and cost of unusable returns (if you are into non-digital products and services)?

Call this value factor: V.

The second factor is the cost of promotion, including share of design cost, cost of front-end and back-end web development, cost of traffic or lists, incentives, and cost of customer service. All these costs should be calculated either in total over your performance marketing campaign or – specifically in the offline arena – per thousand direct mail shots, per thousand leaflets, per thousand SMS texts or free standing inserts distributed, per phone call, etc.

Call this factor: C.

The third factor relates to response or conversion rate. This is simply the number of conversions or orders obtained from a given performance marketing effort.

Call this factor: R.

The first calculation of your performance-based business viability then becomes fairly simple. You divide the cost factor (C) by the response factor (R), and it is either more or less than the value (V). If it is more, the operation is unprofitable, it is less, it is worthwhile.

The break-even formula to remember is:

Cost of Promotion (i.e. per hundred shots) / Conversions (i.e. per hundred shots) = Cost per Order

This will be either more or less than the average profit per order.

Let’s take an example and fit it to this formula. Assume that you are selling attendance at a webinar and that the cost of your SMS text promotion is $35 per hundred texts and that your response is 2.5% enrolments. In this case your break-even point is achieved if your profit per attendance is $14.

Promotion Cost per Hundred: $35 / Response: 2.5% = $14 per Conversion

But this is, of course, only the basic calculation to establish feasibility (in this case: of SMS texting your own prospects database). The value of each of these factors can be varied and the effect of these variations on each of the other factors differs from case to case.

Let’s take the value factor first. You can usually increase or reduce your selling price either for the same product or by increasing or decreasing the quantity, quality, or mix of what you offer at any time. This altered value V might not affect the cost of promotion (factor C) but will almost certainly alter the response factor R.

The secret of successful direct selling is that a given variation of in one factor will seldom cause an equal reaction in the others and only by testing (which is usually possible) can you arrive at the right value V.

Next, examine the cost factor C. This is, of course, infinitely variable upwards although there is a definite limit downwards.

In direct mail, SMS, email as well as cost-per-click traffic, for instance, you are governed by the minimum cost of one unit of mail, SMS, email shot as well as of one click. But you will need to test what extra response each additional dollar per hundred spent on better (often longer) copy, design, more complex landing pages, more targeted traffic, and lists, etc. will bring you. All of them will affect conversion rate but it is their cost effectiveness which is vital to your success formula.

In performance marketing the length of the ad (i.e. YouTube video ads, audio ads, direct response TV and radio ads, etc.), size of space (i.e. half-page vs a 2-pager in your local print newspaper, long vs short copy on your landing page), media used as well as the copy and design and position of the ad and the incentives or offers you make will influence cost and conversion, C and R.

Experience will enable you to judge whether there is a chance of success which justifies even testing, and by applying the above formula to a bracket of possibilities, you can save time and money. You will need to plot a break-even chart like the one below to fit your range of possibilities of V, C, and R.

Loss Leader-based Campaigns

So far we have assumed, for the sake of simplicity, that you wish to make a single sale from a single effort. In practice this is seldom so. You should not expect to make a profit from the first transaction. No subscription box clubs, streaming services, or membership sites will ever expect to pay for the acquisition ad out of the revenue from the original offer – which is usually a loss-leader.

Similarly, your favorite clothing ecommerce will usually make a bargain offer through a dollars-off coupon ad online at a loss but will go on selling profitably to these new customers over the following months and years.

It is additional sales, often over an extended period, which give a sound performance marketing a.k.a. direct response business. This important fact must be taken into account when calculating the value of a new order.

In email promotions, a cold approach costing $30 CPM to a non-customer list (i.e., users outside your CRM) may convert at as little as 0.05%, resulting in a cost per order of $60, but subsequent promotions to the list of new customers gained from the original campaign might give a conversion rate of 10% or more: at virtually no cost (if you employ email shots) or at cost of only few dollars if you used paid media as well (SMS texts, retargeting via Facebook and Google, telemarketing, robocalls, etc.)

Similarly, a dollars-off campaign for new customers may lose you money but provided that there is every chance of continued sales you can calculate this acquisition cost per new customer and set an acceptable norm.

Far from expecting the first sale to pay for the cost of acquiring a customer, it will in fact generally pay you to invite a considerable loss at the acquisition stage in order to have a larger CRM database to exploit at later stages of your performance marketing program.

‘Classic Continuity Series’ Subscription Business Model

Note: the quite complex model described below, often called ‘classic continuity series’ business model, is probably the most complicated subscription-based business to cost and manage because of the vast number of factors which affect success and failure. 

Therefore, you may choose to go first for a much simpler credit card-based, ‘til forbid subscriptions with simple assumptions regarding the average length of subscription (i.e., 2.5 or 3 months for general consumer subscriptions, 6 months for business-related subscriptions, 12 months for software-as-a-service subscriptions).

Let’s take a simple example to explain the continuity series model.

A subscription box business decides to produce a series of 12 boxes to sell at $18 per box with a production price of $4.50 a box. The following two tests are conducted:

Offer A assumptions

1. Email campaign cost: $30 CPM
2. Offer: first box $18 plus $2.25 shipping and handling. If retained committed to at least one more box.
3. Cost of the box including shipping and handling: $6.60
4. 10% of buyers return first box. 50% are reusable.
5. 5% bad debt as we will employ bill me later scheme instead of credit card charges.
6. Customer service, including collection costs, $1,800 per 1,000 orders or $1.80 per order.
7. Fulfillment (order handling) costs $1.50 per conversion.

Conversion rate	0.1%	0.125%	0.15%	0.175%	0.2%	0.225%	0.25%
Cost per 100 conversions	$9,000	$7,200	$6,000	$5,142	$4,500	$3,999	$3,600

Cost of 100 products including shipping and handling	$660.00
Debt collection due to bill me later scheme	$180.00
Lead capture and order fulfillment	$150.00
Total	$990.00
Income per 85 products retained and paid for	$1,721.25
Plus value of 5% reusable returns	$22.50
Total income	$1,743.75
Net contribution per 100 conversions (85 paid first product customers)	$753.75

Original Conversion rate	0.1%	0.125%	0.15%	0.175%	0.2%	0.225%	0.25%
Total Cost (Cost per 100 conversions – Net contribution per 100 conversions)	$8,246.25	$6,446.25	$5,246.25	$4,388.25	$3,746.25	$3,245.25	$2,846.25
Acquisition Cost per New Customer (Total cost / 85 new customers)	$97.01	$75.84	$61.72	$51.63	$44.07	$38.18	$33.49

Offer B assumptions

1. Email campaign cost: $30 CPM
2. Offer: first box free, i.e. box one and two on free approval for 7 days – if you are dissatisfied return both, if you retain them, pay only $18 plus $4.50 shipping and handling for two boxes. If retained committed to at least one more box.
3. Cost of the box including shipping and handling: $12.90
4. 6% of buyers return two boxes. 50% are reusable. (The reason for assuming a reduction of returns from 10% in the case of Offer A to 6% on Offer B is that two for the price of one is clearly much better value.)
5. 5% bad debt as we will employ bill me later scheme.
6. Customer service, including collection costs, $1,800 per 1,000 orders or $1.80 per order.
7. Fulfillment (order handling) costs $1.50 per conversion.

Cost of 100 products including shipping and handling	$1,290.00
Debt collection due to bill me later scheme	$180.00
Lead capture and order fulfillment	$150.00
Total	$1,620.00
Income per 89 products retained and paid for at $22.50	$2,002.50
Plus value of 3% reusable returns	$27.00
Total income	$2,029.50
Net contribution per 100 conversions (89 paid first and second product customers)	$409.5

Original Conversion rate	0.1%	0.125%	0.15%	0.175%	0.2%	0.225%	0.25%
Total Cost (Cost per 100 conversions – Net contribution per 100 conversions)	$8,590.50	$6,790.50	$5,590.50	$4,732.50	$4,090.50	$3,589.50	$3,190.50
Acquisition Cost per New Customer (Total cost / 89 new customers)	$96.52	$76.30	$62.81	$53.17	$45.96	$40.33	$35.85

As can you see from these figures, the higher retention rate (89 vs 85) which can be assumed for the more advantageous offer means that this offer acquires new customers at roughly the same cost, or little more than Offer A even at the same conversion rates.

But it is likely that offering box one free will increase response by 50% or more. That is to say if Offer A converts at 0.1%, Offer B is likely to convert at 0.15%. In that case Offer B will of course be far more cost effective.

So much for the original offer. If the income per paid subscription box is only $15, then neither Offer A or Offer B will break even at this stage, even with a 0.25% conversion rate. But by the terms of the original offer those who retain the first box are committed to accepting one or more subsequent ones.

Naturally, in this business model a certain number of customers will fall out with each box delivered. The drop-off of customers will vary with the quality both of the user and of the product and might look something like this:

Box 1 retentions	100
Drop-off 20%
Box 2 retentions	80
Drop-off 15%
Box 3 retentions	68
Drop-off 12%
Box 4 retentions	60
Drop-off 10%
Box 5 retentions	54
Drop-off 8%
Box 6 retentions	50
Drop-off 7.5%
Box 7 retentions	46
Drop-off 7%
Box 8 retentions	43
Drop-off 6.5%
Box 9 retentions	40
Drop-off 6%
Box 10 retentions	38
Drop-off 5.5%
Box 11 retentions	36
Drop-off 5%
Box 12 retentions	34

So, to 100 paid box one starters we have sold 649 boxes, or an average of 6.49 boxes per starter.

These numbers seem to be an average for collectibles, book series, some business-to-business info product services, consumer membership sites, etc. Other businesses, for instance, Netflix-type of subscriptions will likely have much higher retention whereas adult entertainment-type of streaming services will retain much lower numbers of their customers, especially if heavily discounted or employing free trial offers.

Back to the example: now we are able to assess the value (V) of an order. If the gross profit per box is $12 then we can obviously afford to spend up to 6.49 x $12 = $77 to acquire a new customer for this subscription business.

As tables above show a conversion rate of 0.125% costs either $75.83 or $76.29 therefore on either offer a conversion rate of 0.15% would be profitable.

This example has, of course, been grossly oversimplified to demonstrate the method of reasoning and calculation in determining performance marketing methods profitability on a continuing sale.

There are many other costs to be taken into consideration but there are also other benefits. The greatest item on the credit side is the value of the customers in your CRM for other promotions. Even those who drop off are good prospects, but especially those who stay on until the end of the subscription series (if it indeed has an end). These are the most valuable prospects in any business and would give excellent results on subsequent promotions, provided the products are tailored to the market.

The variables of Offer A and Offer B above contain, of course, only one very simple alternative. There are countless other differences in the product, the offer, the creative, and the targeting methods and media which could be devised and tested, and which might affect the cost of the campaign, the length of the subscription, the cost or price of the product, payment method and therefore the mathematics.

Summary

1. It is essential to establish the value of an order, or a positive conversion where the initial objective is not to get orders, before you can decide how to promote – by what method, with what kind of media and targeting and with what incentives or offers.
2. Often the cost of traffic is critical. At other times it is almost irrelevant. In certain cases, expensive creative cannot be justified while at other times it is essential.
3. It is highly unlikely that your performance marketing campaigns will be profitable from the get-go, but this does not mean you are not to be held accountable for your marketing activities.
4. There is no guessing when it comes to campaigns based on loss leaders. They require careful calculations and assumptions before doing anything else.