Did you know that a profitability analysis can assist your digital marketing agency to pinpoint exactly which campaigns are generating the most profit? This is done through evaluating the revenue and costs per client, or per project, to see which has the highest profitability.
Such an analysis can have a dramatic impact on your financial strategies. After all, it can help you forecast cash flow, estimate value, and make strategic investment decisions.
However, deciding which metrics to track can be tricky. In this blog, we’ll help you determine what metrics matter, so that you can make the most of your campaigns.
Understanding Profitability in Digital Marketing
To start with, it’s important to understand the concept of profitability, and how this differs from other metrics.
In a nutshell, profitability is a measure of the efficiency of your agency’s marketing campaigns. It encompasses a set of financial metrics that demonstrate your business’s ability to make money, after costs and expenses. Ultimately, it reveals how successful your agency is – your company is profitable if there’s more money coming in than going out.
It’s important to note that profitability isn’t the same as profit. This is your total revenue minus expenses, or your net income. Your profit is an absolute amount. And just because your business makes a profit doesn’t always mean it’s profitable. Keep in mind that the costs associated with running a business might be higher than the profit it generates.
The role of profitability analysis in strategic decision-making
A profitability analysis depends on a number of factors. These include your expenses, the demand for your services, the productivity of your employees, and your competition.
Because of the number of variables that can affect profitability – including some that might be out of your control, like competition – there are several ways to determine it. As such, this analysis can help your agency with decision-making.
Not only will you be able to identify potential growth strategies and risks, but you’ll also be able to revisit crucial aspects of business strategy. These include:
- Evaluating your service offering. Analyzing the profitability of different services can identify which have the highest margins and which may be underperforming. This means you’ll be able to better allocate resources to specific offerings or campaigns.
- Determining the right pricing strategies. Going over your cost structures and profit margins can help you set competitive prices, charging clients based on the perceived value they’ll be getting rather than just the cost of services.
- Managing costs. A profitability analysis can help with a cost-benefit analysis, in which you pinpoint areas with high costs and low returns. This can help you streamline operations and improve efficiency.
- Determining client profitability. Your analysis will allow you to segment clients based on revenue contribution and profitability. That way, you can create tailored strategies for high-value clients to improve satisfaction and retention.
- Make sound investments. Whether it’s investment in new tech or tools, or even talent acquisition, profitability analysis can help you determine how to drive higher returns.
Key Metrics for Profitability Analysis
As we mentioned above, there are several factors to consider during a profitability analysis, which is why your results are often displayed in ratio form. Generally, the higher the ratio, the more profitable your agency. The metrics you track should allow you to measure and analyze your company’s financial health.
However, most digital marketing agencies would use the same kinds of metrics, as they’re common to your industry.
Return on investment (ROI)
Your ROI is a measurement of your marketing campaign’s profits or losses, and helps you determine their effectiveness. That way, you can see whether a specific campaign works, and if not, what you need to do to rectify that.
It’s calculated by dividing your net profit by the total digital marketing costs, and then this amount is multiplied by 100, to get a percentage.
ROI = (net profit/total costs) x 100
Remember that net profit is your campaign revenue minus the specific costs involved, divided by your agency’s total costs.
Customer acquisition costs (CAC)
Yes, it will actually cost your agency money to attract and onboard new clients. And this is one of many costs that can eat away at your profitability.
To calculate your CAC, you need to divide how many new clients you got in a specific period, by what your agency spent to get its clients (through advertising and sales) during the same time.
CAC = Number of new clients/Total expenses during that period
Knowing your CAC can help you tailor marketing strategies, ensure you allocate the correct budget to this, and even help you review your pricing strategy.
Customer lifetime value (CLV)
Your agency’s CLV determines how much a client is worth to your business, for as long as they remain a client. The duration that a client remains with you is important here. After all, if you spend more acquiring them than they bring into your agency during their first transaction, you’re essentially making a loss. However, by retaining clients and getting them to repeatedly make use of your services, you could make a good profit. Essentially, the higher the CLV, the more valuable your client.
To calculate CLV, you multiply customer value by the amount of time that customer has value to your agency. Customer value is determined by the average purchase value multiplied by the average number of purchases.
Contribution margins
Your contribution margin can help your agency to evaluate the financial impact of each campaign. Usually, the higher its contribution margin, the more profitable it is. This means you’ll have a clear view of which of your services are the most profitable, to guide your pricing and expense management.
To calculate your overall contribution margin, you subtract all variable costs from your agency’s total revenue.
You can also narrow this down to calculate the margin for each campaign, by subtracting associated variable costs from a campaign’s revenue.
Analyzing Campaign Performance
One of the key features of profitability analysis is to track the performance of your digital marketing campaigns. And there are a few methods to do this.
To begin, you’ll need to define your objectives and the Key Performance Indicators (KPIs) you’ll be using. This might include:
- Conversion Rate. This is the percentage of visitors who complete a desired action (whether that’s enlisting your services for a campaign, requesting a quote, or signing up for a newsletter).
- Click-Through Rate (CTR). This tracks how many users actually click on an ad instead of simply viewing it.
- Return on Ad Spend (ROAS): Here, you can work out the revenue generated for every dollar spent on your campaign.
Then, you can decide on the tools to help you track these metrics. This could be Google Analytics, the data stored on social media channels, or the information available through dashboards in marketing automation platforms like HubSpot.
Finally, you’ll need to decide on an attribution model:
- Last-Click Attribution: This gives full credit to the last touchpoint before a conversion.
- First-Click Attribution: Here, all credit is attributed to the first touchpoint.
- Linear Attribution: This distributes credit evenly across all touchpoints in the customer journey.
- Time Decay Attribution: In this instance, more credit is given to touchpoints closer to the conversion.
With this done, you’ll be able to attribute revenue to specific digital marketing activities. When doing this, it’s important to compare performance across channels and campaigns. This will help with benchmarking, both internally across campaigns and externally with your competitors. It also assists in analyzing which channels perform best, for detailed campaign comparisons.
The Role of Data in Profitability Analysis
A profitability analysis relies on accurate and comprehensive data. After all, good data will let you make informed decisions, which will help with better targeting, budgeting, and strategy development.
The data you collect during your profitability analysis can help you gain detailed insights into customer behavior, preferences and trends. With this knowledge, you can personalize your marketing efforts. But there are two types of data you can analyze: quantitative and qualitative data.
Quantitative data includes metrics like your CTR, conversion rates, and sales figures. These give you measurable and objective insights. This data is objective and not open to interpretation, making it the easiest type of information to use in an analysis.
Qualitative data relies on subjective metrics like customer feedback, reviews, and the comments you receive on social media. It reflects client sentiments and motivations, but can be difficult to quantify.
The best approach is to use both kinds of data, to give you the ‘what’ and the ‘why’ of your analysis. That way, you can use the information you gather for strategic purposes.
Translating Insights into Financial Strategies
As mentioned earlier, a profitability analysis can help with a number of financial strategies. This includes how you allocate budgets. By knowing which channels deliver your highest ROI, you’ll get a cost-benefit analysis of all your campaigns. This means that you’ll know where to best allocate resources to increase profitability.
It will also allow you to adjust your budgets depending on campaign performance. Remember that no budget is static, and being flexible in where you allocate your cash can help ensure your campaigns always have the highest possible ROI.
Optimizing campaign performance based on profitability insights
With the data you collect in your analysis, your agency will be able to refine its audience targeting and segmentation. To maximize performance, you should focus your efforts on higher-value segments.
One way to do this is through A/B testing for different campaign elements such as copy or visuals to determine the most effective variations. You can then use these insights to optimize the conversion paths and create retargeting campaigns, where necessary.
Of course, whatever strategy you choose should be flexible – you need to be able to make adjustments based on new data. This could include changing the scale or even the marketing approach you use.
Challenges in Profitability Analysis
Despite the many benefits of profitability analyses, they still come with a few challenges. For example, inaccurate cost allocations for your services can skew your profitability calculations. This includes ignoring unusual or indirect costs, like overhead or admin expenses. That’s why we recommend using activity-based costing (ABC) techniques, which allocate costs based on the activities driving them.
Another potential issue is data quality. Without accurate and reliable data, you won’t have accurate and reliable results. And this can have a knock-on effect on all the financial strategies and decisions you base on your analysis.
Similarly, unless you have outlined clear performance metrics, you run the risk of spending time and money analyzing metrics that will not actually have any practical effect.
As such, it’s usually a good idea to consult a professional when it comes to profitability analysis, to make sure you make the most of the process from start to finish.
For guidance on how to maximize your finances, or help navigating profitability issues, schedule a Discovery Call with one of our CPAs. We’re here to help you!
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