Scaling is one of the most important skill for any brand to master. Let's breakdown the most effective way to scale a business by focusing on the 3 most important metrics for business growth. Often marketers use terms like MER or ROAS, but those are very low integrity vanity metrics. Most importantly, PSM helps a brand focus on how to invest in their growth, rather than chase what their marketing team mistakenly places value in... ROAS or MER.
ROAS & How Making a Sale isn't Acquiring a Customer
Let's focus on the elephant in the room here, ROAS... or MER. These are the measure de jour for ad agencies, media buyers and CMOs around the world. However, ROAS is highly flawed and to start making progress, we need to debunk it quickly and then move to value.
ROAS = AOV/CPA
The problem here is that AOV is not controllable by any ad. No ad has the ability to control how much money any customer spends. Someone could potentially spend between $20 to $2000 during any transaction. Because of our lack to control half of the equation, the output, ROAS has very little ability to drive decision making. Also ROAS does NOT account for cash flow, operating costs, reoccurring revenue, refunds or lifetime value.
MER is just ROAS across a whole business, but it is still just a report card of 1 space in time, with no context.
The other thing we need to appreciate, is that making a sale is by no means the same as acquiring a customer. This is vital because we cannot extrapolate ROAS in relation to LTV, because the total revenue of any time period is based on a volatile mix of repeat purchases, new customers and 1 time sales.
Cash flow, Profit and Business Development: PSM
PSM (Profitable Scaling Margin) = LTV / (CPA + COGs)
In short, what we are measuring here is the projected Lifetime value of the sale of a single item, and the cost to make that sale happen as well as the cost to produce and fulfill that order to the consumer.
Example:
A $200 Lifetime Value / ($50 CPA + $30 COGs)
If our product AOV is $40, we would have a ROAS of 0.8x... which would sound Terrible However, because someone who buys that offer typically matures to spend $200 in total after that purchase, our PSM would be 2.5x
A PSM of 2.5x means that we effectively could spend 250% more to make that sale before we breakeven... that means we could likely spend 5-10x more before the resulting rising CPA on Facebook would be of any concern.
With this information, we can choose to protect the profit margin per sale, or we could choose to invest that future revenue into the growth of volume for our customer base.
Analyzing PSM and choosing the offer(s) that best fit our business needs, lets us use business economics to best pair or business objectives with our marketing efforts. Rather than just chasing ROAS for a single transaction opportunity, now we can focus on what is the most powerful marketing effort we can focus on.
This really proves its value once we begin to use to prioritize our Growth and Acquisition efforts. Facebook is a machine learning platform, what are you teaching it?
Are you trying to sell 5 products, or 20... how many competing PSM offers are you investing in, that also detract from the machine learning platform's ability to use data to get better and better over time.
Maybe the right choice is to sell a low cost & low PSM offer to generate cash flow at scale, which would massively ramp up the volume of opportunity to improve LTV on that offer. IF every customer buys the same limited scope of offers, it becomes far easier to test and improve what happens after that click, and even the smallest improvements can have MASSIVE impacts on the business.
ROAS and/or MER, has no ability to ever focus on this, and that's yet another reason why, at best, its a vanity metric, and at worst, a Northstar that can cripple your potential.
How to Scale a DTC Brand
It really comes down to 4 simple things
Improve the LTV of your offer Lower the CPA of your offer
Lower the COGs of your offer
or
Find a balance that lets you drive a higher volume of customer journeys
More customers is more data
More data is faster testing
More testing is fast improvement
Focus, improve and Scale
It really just comes down to mastering this equation!
I challenge you to do this math, and make more money ASAP!
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