The Night Henry Ford Punched Me in the Face

A couple of years ago, I built a webinar funnel to get clients. I had also been using a weekly marketing scorecard in my business. We set a weekly ad budget based on some financial projections and how much we thought we could afford (basically, what we could stomach). I think this is a reasonable thing to do, but I noticed something about a year ago.

When we would advertise way above our weekly budget, and host our sales webinar for digital agencies, we’d get lots of clients. After a few hours of digging deep into the data, I discovered the exact number of dollars it cost us to earn a customer.

More importantly, I discovered that when we didn’t advertise, we didn’t hit our goals for sales. Referral and organic leads dripped in, but sporadically. The numbers were all over the place. In the moment, when ad spend was $0, or under our advertising budget, it felt perfect. I would think, “wow, we’re not making deposits in the Mark Zuckerberg Yacht Fund, and we’re still getting some customers!”

In aggregate, we were losing money because we weren’t hitting our benchmarks. Either real money with a negative net margin, or an opportunity cost because we’d never get that week of sales back. Like hotel rooms, once that week is gone, it’s gone.

So at 2 am, saturated with advertising and funnel data, Henry Ford punched me in the face:

“A man who stops advertising to save money is like a man who stops a clock to save time.”

My mindset changed. Spending money on ads is good. Why? Because it is the FUEL that our Marketing Engine demands. It is the input for the webinar funnel we’d created.

How I Was Losing Money

Let’s say you earn a single customer worth $10,000 without advertising in a given month. The next month, you acquire two $10,000 customers, but you had to spend $5,000 in advertising budget to get there. You might look at that and say “no way!”

But of course, those numbers are missing some context.

Without considering the business’s fixed costs, the direct labor and cost of goods sold per $10,000 project add up to $4,000, giving the company a sixty percent gross margin at a per unit level.

Month 1 Month 2
Revenue $10,000 $20,000
Ad Cost $0 $5,000
COGS/Labor $4,000 $8,000
Gross Margin $6,000 $7,000

It would be easy at this point to consider dropping an advertising program. Spending $5,000 to earn another $1,000 might seem a little reckless. However, there is still a significant number missing in this model, and that is the fixed operating costs to run the business.

Most of the time when I go in and consult with digital agencies, they are underpaying themselves as owners and not considering their fixed monthly costs when pricing their work or setting goals. We’ll add fixed monthly costs to our example with an owner pulling a $60,000 salary and another $1,000 per month in fixed costs to run their virtual agency.

To illustrate this point better, I’m going to add a third month, one where we spend even MORE on advertising, but benefit from a small amount of optimization since we are now learning and testing new ideas.

Month 1 Month 2 Month 3
Revenue $10,000 $20,000 $30,000
Ad Cost $0 $5,000 $8,000
COGS/Labor $4,000 $8,000 $12,000
Gross Margin $6,000 $7,000 $10,000
Fixed Op Ex $6,000 $6,000 $6,000
Net Profit $0 $1,000 $4,000
Net Profit Margin 0% 5% 13%

As you can see, even with the outrageous cost of acquiring one additional customer per month of $5,000, the business is better off and earning a small profit. When the ad costs go up, even higher to acquire two additional customers instead of one, now we have a profitable business within a healthy range.

Facebook in particular likes to charge your credit card and email you a receipt after you spend about $750. In the month 3 example, in the moment you might get a little frenzied. Like “oh my god, I’m spending all of this money on advertising?!!! I’m stressing out!!!” Which is, of course, like watching the stock market on a daily basis. Not the healthiest habit.

(In reality, your sales cycle could be three to six weeks – or even longer – so stomaching this spend in the short run could test your steadiness.)

The numbers that matter are your monthly spend and business performance. Just ignore those emails – or do what I do – celebrate them as a leading indicator that you’ll be getting many customers soon.

Advertising Begets Scale

One of the reasons I have learned to love advertising is that you can trade time for money. If the audience and reach are big enough (i.e., Facebook with it’s 2.2+ billion active monthly users), you can search for the ceiling in your market.

Advertising gets powerful when you combine it with the power of niching. If you have a relatively small service offering that is highly productized and you can wrap delivering around an individual seat or team, then you have the potential to scale quite rapidly.

In my last example, the business can acquire a new $10k customer for $4k in advertising (this number is the Customer Acquisition Cost – or CAC), spend $3k in COGS/Labor, which leaves them with a $3k gross margin per customer. If they’re working with an offshore production agency that (in theory) has unlimited capacity to produce, and the owner has the bandwidth to manage five or six projects simultaneously, they can quickly fill that capacity with aggressive advertising.

At five customers per month, they could find themselves pushing six hundred thousand in annual sales with base pay and over a hundred thousand in profit annually. The pill they would have to swallow would be handing over $20,000 in monthly spend to Mr. Zuckerberg (or Alphabet, pick your poison I guess).

The math gets even more favorable if one considers Lifetime Customer Value (LTV). Perhaps we can agree to talk about that in a future article.

In The End

Looking at our gross margin at a per unit level distorted my vision. In the short run, I was happy with really low customer acquisition costs but in the long term, my business and I would have been much better off with drastically higher customer acquisition costs but with more customers.

The context that you need to understand is your fixed operating costs and how that number plays into sales volume and gross margins.

I quadrupled my ad spend, which doubled my customer acquisition cost but made me a lot more net profit. Then I doubled that ad spend and it continued to benefit. At one point I was paying over $50,000 a month on advertising – which started to show some diminishing returns. We found the ceiling which was what we were wanted after all.

Then we optimized and all that jazz.

So thank you, Henry Ford, for punching me in the face. I could use more wisdom like that in my life to help me see the forest for the trees.

Are you trying to save on advertising when you should be leaning into it? Perhaps Mr. Ford can help you too.

Write a Comment