Why Cost Per Lead Is The Wrong Metric to Optimize

In my last two years, my team and I have had the opportunity to serve many clients who are generating incremental revenue by sourcing leads for their businesses via digital marketing.

It’s extremely effective and various industries can and do use it:

• Finance companies can generate leads to sell more credit cards, car loans, checking accounts, insurance policies, and so on
• Auto industry generates leads to drive people to do a test drive and buy a car
• Real Estate developers generate leads to sell homes, condos, and vacation homes
• Universities generate leads to attract new students
• Professionals such as doctors and lawyers generate leads to find new patients and clients

We’ve had successful case studies in all these industries, but I’ve also seen many cases where this process is a disaster.

They major mistake that I see is that the agency focuses only in one metric: cost per lead.   This is usually because their client has told them that this is the metric to optimize, and by optimizing, they mean reducing the cost (this is a wrong assumption as you will later see).   The other reason is that the client is not providing the agency with feedback on conversion rates, in other words, with what happens with those leads.    This may happen because the client does not have a good CRM system and cannot track the leads correctly or because they deem that information “confidential”.

Why does the industry function like this in most cases?   Well, I conduct tens of hiring interviews every month, and have noticed that many media buyers do not really understand the relationship between cost per lead, cost per acquisition and conversion rates.   The analytical abilities of most media professionals is poor (but that is a subject for another blog).

So while this blog may sound very basic and it is, I am writing it because I have encountered this situation many times and frankly because I am even ashamed that this is happening in the advertising industry in Latin America of which I am part of.

 First, a definition of the tems:

• Cost Per Lead (CPL): is the cost of finding a person who is interested in buying your product or service.    So for example, if you spend $5,000 in a digital campaign that drives traffic to a landing page where potential customers can complete a form, and 100 people complete the form, you have generated 100 leads at a cost of $50 per lead ($5,000 / 100).
• Conversion Rate: is the percentage of people who ended up converting (or buying).    Using my example above, of the 100 people who have registered, you call center calls all of them.  Some of them answer, some do not, and of those who answer, some come and visit your office, some buy and some do not.   In the end, let’s say 3 people buy your product.   In this case, your conversion rate is 3% (3 divided by 100).
• Acquisition Cost (CPA): is the cost of generating a buyer.  In our example, the media acquisition cost is $1,667 per buyer ($5,000 divided by 3).   In this case, and we are being very simplistic because we are only calculating the media cost and not the cost of the whole lead gen process, such as the cost of the call center and the cost of servicing the customer during the whole buying process (e.g. test drive cost, cost of the dealership, etc).   You can and should contemplate these other costs as well.

So now that we understand these terms, there is a simple formula that shows the correlation between these metrics:

CPA = CPL / Conversion Rate

In our example:

• CPA = CPL which was $50 divided by the conversion rate which was 3%
• CPA = 50 / 0.03
• CPA = $1,667 (rounded to the nearest dollar)

Now that we see the formula, we can see that CPA can decrease if the conversion rate increases, or if the cost per lead decreases.    If you are mathematically inclined, you can get a lower CPA if either the numerator (CPL) decreases or the denominator increases (Conversion Rate).  So why do clients ask the agencies to lower the CPL?   Shouldn’t they be as concerned to improve the conversion rate?

So why is optimizing for CPL very wrong?

Because what we really want to optimize is the Cost Per Acquitision.  CPL is just one variable that makes up the CPA.    What happens with conversion rates really matter.

It is quite “easy” to lower CPL’s in a digital campaign.  You can amplify the audience, or target a segment of the audience which is less expensive to reach.  Say you are running a lead gen campaign on LinkedIn and you are selling a software targeting Human Resources professionals.  You can target your campaign to HR professionals or to professionals in general.   Reaching HR professionals will be usually more expensive than reaching all professionals because of a simple “demand-supply” situation.  There a lot fewer HR professionals and probably many companies want to target them.   So, if I target HR professionals, my CPL will tend to be higher than if I target generic professionals, but which of these audiences will generate a higher conversion rate?   Most likely it will be HR professionals since the product is tailored for them.

In a drastic example, I can lower CPL by 50% but if my leads are “garbage” and the conversion rate goes from 3% to 1%, I actually increased my CPA by 50%.

Another very important reason why NOT to focus on CPL is that there is no feedback that allows me to improve the targeting.   Let’s say I  work at an agency and I send my client 1,000 leads interested in buying a car.   Knowing the profile of those who convert is very useful.  Let’s say that out of the 1,000 leads, 100 people bought a car, but all these people are women between the ages of 25-34 years old.  Well this information is very important.   My next campaign will probably focus just on this demographic.  If I do this, my CPL will probably increase (more segmentation costs more), but my conversion rate is likely to improve.

I see a lot of value destruction going on today as the practice of focusing on CPL is widespread and only a few agencies have the full conversion funnel data they need to really optimize for CPA.

In my interviews I usually ask potential employees the following question:

What is better?  Having a CPL of $5 with a conversion rate of 10%, or having a CPL of $10 with a conversion rate of 20%?  

The question has a trick and I am evaluating basically two things:

50. See if the candidate realizes that the CPA is the same in both scenarios. The CPA is $50.
51. Understand the candidates’s thinking process, her creativity and her comfortability making hypothesis with little data. While the CPA is the same, one could argue that a higher CPL and a higher conversion rate is better because in the second scenario you only need 5 leads vs. 10 leads to convert.  Therefore, you have lower costs during the rest of the lead-gen process (e.g. call center costs).   Or someone argued that having a lower CPL is better because you are generating more leads which you can target at a later date (not the best answer, but acceptable).

To conclude, understanding that CPL and Conversion Rates are all part of the same metric is key and the metric to optimize is Cost per Acquistion.  If an advertiser does not want to share conversion data with its agency because it deems this information confidential, it should bring the whole process in-house.  If it does not share this info because they don’t have it (yes, most clients do not really understand their conversion rates and therefore CPAs!), they should stop all campaigns and implement the processes, the people and the systems to measure this.   The lead-gen process is never static – you need to continually be running different campaigns to see what factors give you the lowest CPA.  If you cannot measure this, you cannot improve and the old marketing cliché is true:   Only 50% of your advertising spend works but you don’t know which half is working!

Also, and another one of my pet peeves.  You should invest as long as your CPA > CLV (Customer Lifetime Value).   CLV is another concept that a lot of media buyers do not know or understand, but that is also a topic for another blog.