Two things happened recently that motivated me to write about the opportunity costs associated with running a business. First, my fifth grader received her results from the state-level exams last year and while glancing through the Social Studies concepts, I noticed that opportunity cost was tested. Who learns about opportunity cost in fourth grade? …that’s admittedly pretty awesome, although I remain skeptical about common core after its efforts to make me look dumb and old as I refer to the way we used to do “math and other stuff.”
(Side note: In case you’re looking for the definition of opportunity cost, Google tells us that opportunity cost is “the loss of potential gain from other alternatives when one alternative is chosen.” Thanks, Google.)
Second, we’ve been receiving a large amount of flyers in the mail for new dentists, pediatricians, and other services in the area. Although we tend to get a lot of bulk direct mail, this amount caught my eye.
I wondered how many of these business owners understood the return on their marketing investment and how that opportunity cost compared to saving in a workplace retirement plan (like a SIMPLE or SEP IRA).
I have to warn you: We’re going to blur the lines between financial advice and business advice here. But in my opinion that’s why we focus so heavily on helping entrepreneurs. After all, for business owners and independent contractors alike, personal net worth is hugely impacted by the financial health of the business.
Back to those flyers.
How many of those professionals are tracking the amount of new business that can be attributed to the flyers? Looking at over a dozen of them, not a single one had a web address that was different from the company’s main page to allow for tracking the inbound traffic generated from the flyers. Not a single one had a unique phone number that would track inbound calls from the flyers. Two had promotional codes that I’m assuming were used to track leads… but then again, these promotional codes could also have been blasted out on social media ads or through other channels. Maybe each new customer is asked how he or she found the business and then that data is recorded on a spreadsheet to track the efficacy of the marketing campaign… and maybe the Broncos are going to call me up as starting outside linebacker.
Why do I mention this? Because unless you have a quantifiable and systematic method for measuring the return on marketing investment, you might as well be throwing dollar bills into the wind and hoping for the best.
So first and foremost, your marketing metrics need to be captured and measured.
From there, you need to understand and optimize the “mix” of your marketing. With enough historical data, you can develop a marketing mix model that will help you understand the impacts of marketing to your revenue. With a robust model that deals with higher order effects (like the fact that some variables are strongly correlated with one another), you can create a rather impressive framework that can help you allocate your marketing budget to the campaigns that produce the best results at a given level of spending. Maybe, for instance, your model recommends you stop sending the flyers altogether and increase the spending on your email campaign. And if you don’t have any idea what I’m talking about but are curious to learn more, then let’s talk…
Your model can even give you a quick-and-dirty estimate on the marketing spend required to reach a certain revenue goal.
Which brings us back to opportunity cost.
Obviously, with a fixed marketing budget there’s an opportunity cost between all of the marketing efforts available to you. But there’s also an opportunity cost between investing in the business and saving for retirement via employer contributions to a workplace retirement plan.
For instance, let’s assume you are a data collection ninja and have attributed the revenue to your various marketing efforts. Let’s also assume you have $25,000 of profit from the business that you can either reinvest into the business or contribute to a SEP IRA. We’ll say that your investments are going to return 6.5% over the long-haul.
Based on your marketing mix model, you expect that increasing your marketing budget by $25,000 (and allocating according to the model’s recommendations) will increase your sales by $35,000 annually with a 12% variable cost ratio on this new revenue.
So what path do you take? Is there a time horizon component to consider? What about impacts to the valuation of the business or your exit strategy? Are you adding more work for yourself at the expense of other pursuits that add more value to your life?
If your financial advisor isn’t talking to you about these sorts of things, then I think you’ll find that we bring much more value to our client relationships. If you’d like to learn more about how we help merge personal and business finance, please reach out via email to either Aaron (email@example.com) or Brandon (firstname.lastname@example.org).
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