Virtually every business owner wants to grow.
But we spend so much money to grow writing checks gets stressful. Marketing, customer service, sales commissions–it really starts to add up.
Good news! There’s an easy way to assess whether a cost is adding to your business or subtracting from it.
Let’s dive right in.
How to ballpark the upside (or downside).
If a cost is ROI-positive, it’s a no-brainer. For example, nobody stops selling when they hit their sales goal to avoid paying commissions, right?
So here’s a super-easy way to evaluate a cost:
Figure out how many customers it will take to pay it back.
Let’s run an example: Customer Service Rep.
Suppose you want to hire a customer service rep. You plan to pay $40K, but they’re insisting on $45K. You think they’d be a great fit, but can you afford the extra $5 grand?
To find out, we’ll need four things. We can estimate for now and refine the numbers later.
- Average annual customer premium: $3000.
- Average commission rate: 10%.
- Average customer retention: 7 years.
- Our agency’s net profit margin: 30%
With that information, we can figure out the bottom-line value (profit) of a customer. In this case, $3000 x 11% x 6 years x 30% = $630.
That’s how much an average customer puts in our pocket. It’s called CLV, or Customer Lifetime Value. That’s a super-useful number for back-of-the-napkin calculations.
(P.S, replace my numbers with your numbers.)
So, our customer service candidate wants an extra $5K. How many customers would they need to save or add to justify the cost?
$5000 / $630 = 8 customers.
If this rep is good enough to help us increase our business by an additional 8 customers per year (either through retention, upsells, cross-sells, or referrals), it’s a green light.
If they can do better than that, we’ll be leveraging their talent to grow the business. That’s our goal with every cost.
The Downside Of Cost-Centric Thinking
I routinely talk with agents who are so overwhelmed by their ever-increasing expenditures that they’ve stopped spending money to make money. They wouldn’t spend $1000 to make $10,000 because “I can’t afford it.”
Theoretically, if there’s a cost with a positive ROI, you should be able to scale it until it stops being positive.
For example, “I can’t afford better leads” is only true if the ROI is (a) negative or (b) worse than something else you could do with the same money.
This applies to a wide range of potential expenditures. For example:
Outsourcing and delegating: Does offloading your low-value tasks free you up to gain enough $630 customers to pay it back? (This is the argument I make for using Client Focus: 1 new customer could pay for the service for a month or two.)
Leads: If an average new customer is worth $630 of profit, how much would you have to spend on a particular type of leads to get one more of them?
Talent: Can good talent produce enough extra customers to make up for not hiring cheap labor?
Knowing how to evaluate these scenarios will give you an advantage: speed.
Speed is critical because it’s what gets you to market faster and earns you profit that you can reinvest sooner. If your efforts are going to compound over time, you can’t afford to be slow.
Having easy ways to assess whether a cost makes sense or not will help you make decisions faster and make you sleep better on days when you have to write checks.
In fact, if you know that every check you’re writing is ROI-positive, you can look forward to writing them!