Question

Background Information:

Zappos is reviewing whether it should buy exclusive rights to get premium placement advertising on Facebook. Zappos has recently conducted an advertising test with Facebook in order to determine the effectiveness of Facebook advertising. Zappos has analyzed the Facebook advertising results and determined the profile of people who buy Zappos shoes after seeing the ads on Facebook.

At the launch of the agreement, Zappos is expected to make an upfront payment of $25 million to Facebook. In addition, Zappos would spend an average of $90,000 per day on Facebook advertising for a full year.

In return, Zappos’s brand would be featured exclusively and prominently on many of Facebook’s pages for its target audience for one year. More specifically, Zappos expects to be present on 60% of its Facebook’s targets’ 60 million page views per day. Based on its testing history, Zappos expects 0.25% of every page view at Facebook would result in a visit to its own website for the entire year of this deal. Zappos also finds about .75% of the visitors to its site actually buy shoes and other merchandise.

While the typical retention rate for Zappos customers is over 80%, management believes customers coming from the Facebook site will have a retention rate of only 65%.

The dollar amount of a typical order is $80. Assume average purchase cycle is once per year.

Zappos’ CFO is concerned that, with a 35% gross margin per order and 10% cost of capital, this deal may not be worthwhile.   

Assume customers acquired at the end of the year are worth the same as those acquired at the beginning of the year. Assume a discount rate of 10%.

Question:

What is Zappos' cost to acquire (CTA) a new customer under this deal?

a) $235

b) $133

c) $101

d) $1.70

Answer 1

Answer:

Correct answer is:

a) $235

Explanation:

Total spend by Zappos in a year:

= Upfront payment + Payment per day * 365

= $25,000,000 + 90,000 * 365

= $57,850,000

Customers acquired:

Zappos expects to be present on 60% of its Facebook’s targets’ 60 million page views per day. Based on its testing history, Zappos expects 0.25% of every page view at Facebook would result in a visit to its own website for the entire year of this deal. Zappos also finds about .75% of the visitors to its site actually buy shoes and other merchandise.

Customers acquired (who actually buys) in a year = (60,000,000 * 60% * 0.25% * 0.75%) * 365

= 246375

Cost to acquire (CTA) a new customer = Total spend / Number of customers acquired = 57850000 / 246375 = $235

As such option a is correct and other options b, c and d are incorrect.