After getting a bachelors degree in economics almost 30 years ago, I decided to take a look at some of those theories and see how they can benefit you in your business today.
Today we’ll cover…
Cost-Benefit Analysis
Imagine you’re a plumber looking to buy some advertising. You have $1,000 to spend. And you have three options to choose from. You could buy one display ad in the yellow pages. Or buy pay per click ads on Google or FaceBook or send letters out to all your existing customers.
So how should you decide what to do? Well if you have more money or the costs of the yellow pages ad was less, you could test all three and see what produces best. Ultimately you’re looking for the best result for your advertising dollars. And that result is typically measured in sales and/or profits.
Yellow Pages Ad
So lets look at the yellow pages ad first.
You’ll have to look at the key metrics.
- What’s the circulation? Let’s say it is 20,000 people.
- How many people will see your ad? Well if you’re a plumber and they have a leak or a sewage line that needs snaking, they’re likely to be searching in the yellow pages. So lets say potentially 100 people see it.
- Now how many people who see your add choose you. Let’s say it is 5.
- And so you get 5 people to call you. How many convert to a sales call. Let’s say 3.
- So if you spent $1,000 for that ad, you need to make at least $1,000/3 = $333 per sales call. Now for a plumbing problem you could have minor ones that only bring in $150 and others that might generate $2,000. So that is possible.
FaceBook Ad
Now what if you were doing pay per click ads on FaceBook? So you have an ad show up in their FaceBook news feed. And since more people are searching on FaceBook now, and with the local targeting (such as by zip code or city name), you’re able to reach the same 20,000 people in the community.
So then the key questions here are, “Are people seeing your ad on FaceBook more likely to call than someone who saw your ad in the yellow pages?” I still would think that a yellow pages ad is likely to generate more calls since FaceBook ads are still not as trusted a source by the general public as the yellow pages are.
So lets say you get 10 responses but because they are less trusting of the medium, you still get only 3 responses. So you end up with the same results as with the yellow pages ad.
The difference here is your risk is reduced. You don’t have to commit to the full $1,000 all at once. You can also test different pictures, different headlines and body copy. You just have a lot more flexibility to do more realtime adjustments rather than paying and hoping (as you do with the yellow pages).
It reminds me of the difference between film cameras and digital cameras we have today. With film cameras you had to take a leap of faith and hope that you got the focus and exposure right and without the person blinking.
With the digital camera you just shoot, adjust, shoot again. And you can overdo it because you can always delete the bad pictures later.
With FaceBook or Google Adwords advertising, you have the ability to adjust on the fly and optimize your ads.
Also you’re not tied to one idea for the next year as you are with the yellow pages.
Direct Mail
So now lets look at the third option: doing a mailing to your existing clients.
This may take a little more up front work because you need to design a mailing (post card, letter, coupon). Then you need to decide if you are going to mail it on your own or with a coupon mailer (who will mail your coupon with other coupons from other businesses). You already have a list (your existing client list) so that isn’t a problem.
Your cost may be a couple hundred dollars for the mailing design. Then mailing costs (maybe 50 cents to a dollar apiece). So lets say you have 1,000 clients. And it costs you a dollar apiece to do the mailing.
Well this is better than your yellow pages ad in terms of initial response. Because you’ll see results after you mail. But you won’t likely see ongoing results since the mailing will hit the circular bin within a day to a month at the most. So this is a one-shot offer. So you’ll need a really good offer.
Let’s say in the plumber example you offer an annual snaking of the sinks and toilets in a house. The reason for the offer is to potentially see other plumbing problems that could convert to a higher dollar opportunity.
So out of the 1,000, since some are good clients, you may get 25 calls and 15 who purchase your service at $75. So that would be $1,100. With the potential to go to several thousand dollars.
The difference here was a warm list and clients who had prior experience with you.
Assumptions Matter in the Cost-Benefit Calculations
As you can see a lot of factors go into this.
The keys are understanding the cost and the benefit of each option.
And to get there you need to dig in deep to the assumptions. And then, where possible, test, test, and test more. Because even small changes in the metrics can have a huge impact on your results.
So look to your situation. Are you weighing the costs and benefits to compare options? Or are you just choosing the first thing the salesman sell you? You might want to comparison show and then determine you selection.
In the next installment we’ll look at the next Economic principle, Specialization.
Until then…
