Today’s post is by Glenn Walker, a partner at Tiko Digital, an internet marketing firm situated among the oil derricks of Edmonton, Alberta, Canada. When not online Glenn enjoys playing hockey, like any good Canadian, and has a resulting collection of beauty scars he would gladly show you. You can follow him on Twitter at @walkergv.
Making marketing decisions can be difficult, particularly when deciding to implement a new marketing plan. It’s easy to become attached to an idea and push it forward when a plan just feels right. Trusting your gut can serve you well in some scenarios, but it’s not always the best way to make business decisions. It would be nice to have a reliable tool to objectively test the viability of your plan. Fortunately, you do!
It’s a fact of life that you have to invest resources and money in a plan in order to get a return. Fortunately, there is a simple formula called a break-even analysis you can use to determine your plan’s chance of return. The formula tests of the inputs and pricing in a marketing plan determining how many units of your good or service you need to sell in a time period to make back the money required to put your marketing plan into action.
It’s always easiest to grasp something like a model or math equation by using a real-world example. Let’s build a scenario, introduce the tool, evaluate the variables, and use a break-even analysis to evaluate our marketing campaign.
Should I Start a Dog Grooming Business?
Say you owned a small pet store, and you wanted to expand into pet grooming. You found out from a reliable friend in the pet-grooming business the next town over that she advertises using local pay-per-click ads. It just so happens that a groomer friend is looking for a weekend job to pay some bills, and you wouldn’t mind making a few extra bucks, especially since your store is already open from 8am-4pm on weekends.
This is exactly the type of situation where a break-even analysis can be helpful. We can calculate a break-even point to determine the number of grooming sessions we need to sell in order to determine if a foray into the dog grooming business is worth your investment.
Introducing Total Break Even Value (TBEV)
To evaluate the prospects of our dog-grooming business, we are going to calculate the Total Break Even Volume (TBEV), giving us the volume of units we need to sell in a particular time period at which the total profit from our marketing campaign is exactly zero.
The calculation for TBEV looks something like this:
Total Break Even Point = Fixed Costs/(Unit Selling Price – Unit Variable costs)
Note: It’s important to note when calculating TBEV that fixed costs are for a specific period. It is common practice to use months, but it could be yearly or daily. The variable costs are tied to each unit sold (goods or services) rather than a date range.
Your friend is helpful and refers you to her web ad guy who will set up a campaign for you and manage it for you for $750 dollars a month. Your friend tells you that he gets 100 new clients a month and each new customer costs $30 in advertising using PPC. Also, you have to pay the groomer $25 per dog to come into your shop and use her tools. You know in the local market you can charge $65 dollars for a 1-hour grooming session.
Let’s summarize the numbers needed for our calculation.
Fixed Costs: $750 dollars a month ongoing management fee to web ad guy
Unit Selling Price: A competitive price in your market is $65 per 1-hour grooming session.
Unit Variable Costs: $30 on advertising per new customer and groomer costs $25 for each session.
Total Break Even Point = Fixed Costs / (Unit Selling Price – All Unit Variable Costs)
Total Break Even Point = $750 / ($65 – $30 – $25)
Total Break Even Point = 75 Units (1-Hour Dog Grooming Sessions)
The Total Break Even Value calculation has determined that you need to service 75 customers before you make a profit. Your friend has been able to get 100 new customers, and you think what worked in his market could work in your market. A simple calculation determines you stand to make $250 extra dollars a month if you sell 100 sessions.
But… Always Watch for Gotchas!
Tools like a break-even analysis can be used to evaluate the viability of any marketing plan. Analytical tools can help you paint a picture of potential profit and loss and can help you make informed decisions. They are helpful guides but they are not to be used in isolation. The calculations above revealed your plan can be profitable, but did you find the gotcha in your dog-grooming plan?
Be aware of the variables you did not include in your calculation and take the time to evaluate external factors that break your model of profit and loss. For example, in the presented scenario, your groomer wanted a weekend job – that’s only 8 days a month, and your store is only open 8 hours a day on the weekends. That only gets you 64 1-hour grooming sessions a month, putting you below our 75-session break-even point. The model states you need another 11 sessions in a month just to break even. Maybe the groomer would work Fridays as well? If you could convince her to work Fridays, that extra 36 hours a month (say you’re open 9 hours every Friday) provides you the capacity (over 100 hours) you need to make the $250 dollars. The wise marketer looks at the model presented, pokes and prods it to find the flaws, and uses the tool to help make adjustments.
A Final View of a Profitable Plan
Break-even analysis is one of the most basic tools in quantitative analysis, a broad field using mathematical and statistical models to mimic reality and assist decision-making. You can learn more and find additional tools online by searching for quantitative analysis resources. For example, Customer Lifetime Value (CLV) is an equation for calculating the value of customers over time. In the dog grooming-business, how many of your new PPC customers keep coming back? How much are each those customers worth to you over time? Factor that into your plan as well.
Note: Ever wonder why insurance clicks generally top the cost-per-click surveys? Look up the customer lifetime value formula and calculate CLV of your one of your yearly insurance premiums, and you will know exactly why!
Today we have introduced a simple but powerful tool for you to use. I encourage you to look into marketing math and discover the robust suite of tools building models any marketer can use to evaluate and inform pricing and planning. If you have a thought, something to add, or have a tool you feel deserves mention, please comment or write.