When is it worth buying ads on Twitter and Facebook?

Have you ever wondered why there are so many Starbucks locations? Or why they have free wi-fi and comfy couches? It’s because the Starbucks marketers know that they’re not trying to sell a $5.90 cup of coffee — they’re trying to acquire and maintain a $15k customer. That simple math trick changes a lot about how you approach your marketing.

-Ted Ammon

The days when Twitter and Facebook were happy to have tons of users while making no money are over. Now that they’re both public companies they both have to answer to public investors who want to see big profits. To deliver on these expectations both networks, particularly Facebook, are urging small businesses to buy ads.

The kind of ad targeting that the two networks now offer is pretty incredible. For instance, did you know that both allow you to upload your own mailing lists so that you can show ads to the specific people who are already interested in or have bought from your business? (More info here about Facebook and Twitter custom targeting features.)

While smalll businesses on social media should definitely have a look at these tools, an important consideration is the cost. For example, Twitter generally recommends that you bid $1-$2 for each promoted tweet. If accepted you’ll pay that bid whenever a user clicks, retweets, replies, favorites or follows because of your ad. Reach a few hundred people and the costs could add up significantly.

In addition many small businesses see the best results when they use their ads to offer a discount or promotion on their products. Add the cost of the ad to the cost of the promotion and the total cost of acquiring that new customer could surprise you.

Yet for all this it may still be worth it to your business’s bottom line. How do you know? One method is to compare the acquisition cost to your new customer’s total lifetime value.

The total lifetime value is a calculation you can do to estimate how much your customer is worth to you over the life of their relationship with your company. Now it might sound a bit cold to try and put a dollar value on your beloved customers. But look at it another way — knowing their lifetime worth can also encourage you to take a long-term view and invest more in retaining that customer by delighting them with top-notch service and exceptional value for their money.

Calculating the LTV can be a simple exercise, with more ease but less precision, or a complex one. The basic components for a simple calculation are:

• The average revenue you make per customer
• Your gross margin per customer
• The percentage of customers that stay and become repeat customers

A more precise LTV calculation might also include:

• For businesses that are not cash-and-carry, the amount you would have to spend on servicing your retained customer, like administration, billing or customer support
• The discount rate, which acknowledges the time value of money, or that a dollar given to you today is worth more than one given in the future because of your ability to invest it now.

Curious to learn more about calculating your customers’ LTV? Check out this easy-to-understand infographic that uses Starbucks as a case study. Be sure to also read the comments on the page as they point out some things that are important to keep in mind before you start on your own calculations.