Choosing the correct return on ad spend target is critical to maximizing your brand’s profitability.

Most of the brands I talk to are doing it wrong.

When chatting about marketing, I often meet with founders who don’t really have a reason for why their return on ad spend or cost per acquisition target is what it is. Sometimes they arrived at their target by gut feeling or by using rough heuristics. But in my view, there’s actually a right way to do this for each brand.

Assuming you’re optimizing for profitability, you should spend to the point at which your incremental marketing dollar generates more than $1 of contribution margin.

What do I mean? Let’s say you’re selling a product online–we can use a stroller as an example. The stroller sells for $400 and average gross margin with all variable costs included is, say, 50%. So you’re making $200 on every stroller sold. How much should you spend in marketing dollars to acquire $200 in profit?

Well, obviously less than $200. You need enough profit dollars after marketing both to cover your fixed costs and to leave room for actual profit. I often hear the 3x ROAS or lifetime value to cost per acquisition (CPA) target as a rule-of-thumb, meaning the CPA target in our example would be $65-70.

This is OK but not good enough. Instead you need to figure out the incrementality of your marketing spend. What does this mean? Well, generally in performance marketing there’s diseconomies of scale on spend. That means it usually costs more to acquire each customer as you spend more on a marketing channel. For that reason, you should stop spending on a channel when you calculate that the next dollar you spend on that channel will be unprofitable.

Here’s an example: in the stroller case, maybe the first $1,000 on Facebook each month would get you 20 customers–so a $50 CPA. The next $1,000 gets you 10 customers–a $100 CPA. The next $1,000 gets you 5 customers–a $200 CPA. You clearly should stop spending here because more spend will get you customers at higher than a $200 CPA, which is more than each customer is worth. You overall CPA for the month, then, would be ~$86 ($3,000 in spend gets you 35 customers).

A lot of caveats to the above. For one, how can you tell what your incremental CPA is on a channel? I’ll get to this in another post. There are other qualifications like the above analysis depends on you having enough inventory and cash for marketing to be the limiting factor. Finally, your business could be trying to do something different than maximizing short-term profitability.

In general, though, I think setting your CPA target to where your incremental dollar of spend is just profitable is the correct approach for most brands. Let me know what you think in the comments!