How to calculate break-even ACoS: And why CLV should change your perspective
If you want to ensure a profitable Amazon business, you need to calculate your break-even ACoS. Simply put, it’s the amount that you can spend on advertising and still break-even given your product margin.
Break-even ACoS is a target — rather than an active measurement — against which you can compare your actual ACoS or RoAS. There is a pretty simple set of steps you need to take in order to identify your break-even ACoS for any given product. We are going to explain these to you — starting with how to get ACoS in the first place. However, a more sophisticated view (including CLV — customer lifetime value) can give you a competitive advantage in PPC bids, while still delivering profitable outcomes.
But first, we need to cover the basics.
What is ACoS?
For every dollar you earn through advertising, ACoS shows how much of it was spent on advertising. ACoS increases when spend grows faster than revenue and goes down when revenue grows more quickly than spend.
How to calculate ACoS
ACoS is ad spend divided by ad revenue (expressed as a percentage).
The higher the ACoS, the less profitable your ads. The lower the ACoS, the more profitable your ads.
Although ACoS is a pretty simple metric, it’s based on a range of interdependent and distinct metrics. Ad spend can be considered as cost per click (CPC) times the number of clicks, and revenue as the number of orders times the Average Order Value (AOV).
However, a more useful equation uses CVR (conversion rate) as a single metric, giving you the following:
We go into this in more depth in our ACoS strategy guide, but the basics are all you need to understand how this relates to your break-even point.
ACoS vs RoAS
It’s important to note that ACoS is the inverse of RoAS (return on ad spend). ACoS shows how much you spent on ads to gain a dollar from attributed sales. ROAS (Return on Ad Spend) tells you how much money you earn for every dollar you spend on advertising.
Why are there different terms? The answer comes down to point of view. Marketing experts use RoAS as a metric because it shows the effectiveness of ad spend. It also makes it easier to compare these results to other marketing activities. ACoS, however, provides a straightforward way to gauge the profitability of a campaign — making it great for understanding your break-even point.
If you're curious about benchmarking and RoAS on Amazon, check out our article — What’s a good RoAS on Amazon?
Working out your break-even point
ACoS is a popular metric to measure the success of Amazon PPC campaigns. But, by itself, it doesn’t provide any insight into the most important KPI: profitability. Your break-even ACoS is the tipping point between a profit-making and a profit-losing campaign.
Effectively, your break-even ACoS corresponds to your profit margin. In fact, it is your profit margin. Whatever your pre-advertising profit margin is for a given product is the maximum amount that you can spend on advertising and still turn a profit. Or, put another way, it’s your break-even ACoS.
To calculate profit margin, you need three data points:
- Revenue — the income you earn from selling your products
- Cost of goods sold (COGS) — the amount of money it takes to source/produce your products. Remember to include:
- Manufacturing costs
- Fulfillment costs
- Storage costs
- Gross Profit — this is your revenue minus COGS
By dividing “Gross profit” by “Revenue” you get your profit margin. If your ACoS exceeds your pre-advertising profit margin, you’ve passed your break-even point.
For example: If you generate $100 in sales from $25 of ad spend, that would be a return on ad spend of 4x (or 400%).
If you have $25 ad spend and revenue of $100, then your ACoS would be 25%. A RoAS of 4x is an ACoS of 25%.
And if your cost of goods sold was $60 — then your break-even ACoS would be 40% ($40) — because your profit margin is 40%.
How to plan around your break-even point
On a very basic level, you need to make sure that your ACoS is less than your pre-advertising profit margin. The greater you can make that gap, the higher your end profit margin will be, and the more money your business will make.
The problem is that PPC ads can be expensive. In a competitive market, it’s hard to win bids and always make these numbers work. No one wants to spend so much on advertising that they make a loss — unless they have a very good reason — which brings us on to how Customer Lifetime Value (CLV) changes the game.
Why CLV changes everything
Not all revenue is created equal. It’s easier (and less expensive) to retain a customer than acquire a new one. By working to increase CLV, you will increase profitability. If you can figure out a way to accurately calculate CLV (on a product-specific level), it will change the break-even point for selling that product in the long run — changing how much you can spend on advertising and still turn a profit.
For example: Let's consider a single ad that connects with a single customer who you know will buy your product three more times on average. In the example above, your break-even ACoS now becomes $160 ($400-$240). So you could spend $160 upfront on the same ad, and still be at your “CLV-adjusted break-even ACoS”.
A change of break-even point allows you to push competitive bidding while still making sure that you make a profit. A $25 spend is now generating $400 of revenue — giving you an ACoS of 6.25% rather than 25%.
How to plan around CLV-adjusted break-even ACoS
Let's look at an example: You're a supplements supplier and you can see that purchases of organic turmeric lead to high-repeat purchases and up-selling of other products. Investing close to your calculated 'break-even" ACoS on that product is far more aligned with long-term goals than bidding on another product that only seems to draw one-off purchases.
CLV provides a longer-term context for your ACoS planning and strategy. It gives you the best possible insight into different customer acquisition costs and where you can place your ad spend. However, keeping track of all this data can become very complicated, very quickly.
How to calculate CLV on Amazon
There are two calculation methods for CLV:
- Simple — which is useful for providing general ballpark figures
- Complete — which is calculated on a month-by-month, quarterly, or cohort basis
Robust CLV calculations require customer and product data. You also need data to forecast lifetime value based on past behavior.
Pro tip: This is a topic about which we are very passionate. Check out our two webinars if you want a full breakdown on how to calculate and how to use CLV more effectively on Amazon:
Models of behavior need to be created to match the data reasonably well, and it all needs speed of execution to have any benefit. Going beyond a rough estimate CLV to dive into individual and product-level analysis presents a bit of a challenge. Ultimately, it's not a task to be carried out by hand (especially if you want to keep everything up to date), and it's not information currently provided in Amazon Seller Central or Vendor Central.
The information you need to calculated CLV includes:
- The initial cost of customer acquisition
- Annual revenue contribution per customer
- Associated product costs
- Annual direct costs per customer
- Annual customer retention rate
If you want more details, check out our article — Customer Lifetime Value on Amazon. But, the long-short of it is that you will need to deploy analytics tools that are able to pull data from a number of Amazon reports — including transactional information via an API plug-in to Amazon MWS — and then use AI and machine learning to crunch the numbers on an ongoing basis.
To put our cards on the table, we (Nozzle) sell a tool that is able to do just that. Check out our eBook — How to make sense of your Amazon customer data — or just get in touch, if you want to learn more.
It's all about the data
Success on Amazon is all about data and how you use it to your advantage. The impact of CLV on break-even ACoS is a good example of where you can glean crucial insight by using some of the many levers at your disposal.
Instead of limiting your view of profitability to a single transaction, a CLV-adjusted perspective on break-even ACoS will let you outbid the competition by understanding which customers you need to focus on and, just as importantly, why you should be focused on them.
By including analysis of your customers buying trajectories and personas you can even look at how to develop your product portfolio — where to double-down and where to cut your losses. You have the data to help you decide; we can help you transform that information into action.