Stop Leaving Profit Dollars on the Table
So, it’s time to set monthly ad spend and marketing efficiency targets.
You’ve put in the work to meticulously calculate the perfect MER target that ladders up to your annual 15% EBITDA margin goal.
And you can’t wait to sit down and tell your ad buyer, “Your goal is to stay at or above a 4.0 MER all month. If you drop below that, you need to pull back spend and restore a 4.0+.”
Why are you telling your ad buyer this?
Because a 4.0 MER = 25% of revenue which perfectly pencils out to the 15% EBITDA margin you are shooting for.
This is great, right?
Well, not really.
This in fact may be a huge mistake.
As a Fractional CFO for growing profit-focused DTC brands, I keep encountering brands who mistakenly reverse engineer their marketing efficiency targets to align with a specific EBITDA margin.
This one-dimensional approach to setting ad spend and MER targets can constrain ad spend volume and actually result in a lower net profit.
Is this confusing?
No worries – I’ve got you.
In today’s blog, I’m going to walk you through a counterintuitive mindset shift that will unlock additional profit dollars for your business.
What is it?
To start making decisions that maximize contribution margin dollars, not EBITDA margin ratios.
Why Maximize Dollars Instead of Margin Ratios?
Why should you care about dollars instead of margin ratios?
A margin ratio is just an expression of efficiency – a percentage of net revenue.
Although margin ratios are important metrics to track, they don’t tell you anything about how many dollars the business is generating in profit.
And at the end of the day, profit dollars are most important because…
Dollars pay vendors.
Dollars pay employees.
Dollars pay owner distributions.
EBITDA dollars drive M&A valuations.
Dollars are hands down more important than margin ratios.
Need I say more?
Time to Empower Your Ad Buyer
Ok, so now that we’re on the same page about maximizing contribution margin dollars, how should this inform your monthly advertising targets?
First, you should set ad spend and MER targets by reverse engineering them from a monthly contribution margin dollars goal.
So, the starting point in the process is deciding how many contribution margin dollars you want to generate, not deciding what EBITDA margin ratio you want to hit.
Why is this mindset shift important?
Because there are an infinite number of MER x ad spend pairs that will result in the same contribution margin dollars outcome.
What’s the unlock inherent in this mathematical fact?
Empowerment!
Empowerment? Let Me Explain…
Constraining your ad buyer with a single MER target forces them to pull back ad spend when MER drops below the given target.
The problem is – what if your ad buyer could have spent more ad dollars at a lower MER and generated more contribution margin dollars, which means more net profit dollars to pay distributions or invest in growth?
Wouldn’t it have been better to let her hit a lower MER but generate more profit for the business?
This is why instead of providing a single MER x ad spend target for your buyer, you should instead provide a scenario calculator that allows your ad buyer to see how different combinations of MER and ad spend produce different levels of contribution margin dollars.
What we’re doing here is empowering your ad buyer to understand there are multiple ways to use the levers of ad spend volume and MER to produce the desired contribution margin dollars outcome.
This empowerment allows your ad buyer to adjust ad spend in real time alongside a sense of confidence in exactly how many profit dollars they are going to generate.
Whew! That Was Confusing – Feels Like We Need An Example
To make things easier to understand I put together the simple example above.
In Scenario 1 you gave your ad buyer a 2.75 MER target for the month and told her, “Don’t ever drop below a 2.75 MER.” In order to maintain a 2.75 MER, your buyer stopped scaling ad spend mid-month and was able to spend $290,909 ad dollars. This produced $183,491 contribution margin dollars and $87,491 in net profit dollars.
In Scenario 2 you empowered your ad buyer with an Excel template that can take different MER and ad spend scenarios and calculate the resulting contribution margin and net profit dollars.
Throughout the month, using the Excel template as a guide, your ad buyer was able to scale ad dollars to $400,000 – producing $193,000 contribution margin dollars and $97,000 net profit dollars at a 2.5 MER.
By empowering her with the Excel scenario tool, she was able to generate more net profit dollars at a lower marketing efficiency.
Conclusion
Look there’s lots of nuance to all this, and I’m not saying to relax your MER and go ad spend crazy.
But what I am saying is this - take the time to understand that profit maximization is driven by contribution margin dollars maximization. And contribution margin dollars maximization is not always driven by contribution margin ratio maximization. You must also account for ad spend volume.
If you can take the time to tool up your marketing team with the ability to understand and leverage these concepts in their day-to-day execution, you will be amazed at how quickly they start generating more net profit dollars…
And more net profit dollars means:
More money for growth investment
More money for distributions
More money if someone wants to buy your brand from you.
Find these concepts confusing?
It’s okay – you don’t need to become a contribution margin guru. That’s what a CFO is for.
At Free to Grow CFO, our team of DTC finance experts can help build and explain the tools needed to empower your ad buying team to maximize profitability.
I hope you found this helpful.
Until next time, scale on!
Whenever you’re ready, here are two ways Free to Grow CFO can help you.
Ecommerce bookkeeping/accounting in QuickBooks Online or Finaloop
Get timely financial reporting, completed by our team of Ecommerce accounting experts, that is insightful and helpful for making decisions.
Fractional CFO services for Ecommerce Brands
Get the executive-level CFO expertise you need to scale your DTC brand alongside healthy profit, cash flow, and confidence – BUT, without the full-time salary.
